Auditproofing – Average Costs

So far, I’ve discussed the POS system and how to maintain it for accurate reporting, how to document your sales mix for all audit periods, and the importance of maintaining an accurate history of your menu prices.  Taken together, these bookkeeping tasks are crucial in helping the restaurateur determine, and properly support, accurate weighted average prices.  This is a crucial component of the mark-up calculation performed during a typical audit.

Now we’ll take a look at the actual cost of the alcoholic beverages purchased for sale.

Gross Quantities & Costs

In Ontario, licensed establishments are required to purchase all alcoholic beverages from licensed agencies, the LCBO or Brewer’s Retail.  Each vendor keeps track of licencee purchases with the use of licence numbers.  This allows auditors to obtain a listing of every bottle of alcohol purchased by a licencee for any period of time.  Details include the bottle size, quantity purchased, description, invoice cost and date of purchase.  In Ontario, the details include the price net of GST, the licencee discount, and the gallonage tax.  These figures allow the auditor to calculate a net cost for each bottle of alcohol purchased (wine, liquor, beer).

All of this information is provided to the auditor in electronic form.  Typically, the auditor imports the data into an Excel spreadsheet, where it can be sorted to match the sales categories and sub-categories.  From there, the auditor will summarize the total ounces and cost of alcohol purchased in each category.

Allowances

Depending on the type of restaurant operation, the auditor will make one or more allowances to consider the effects of spoiled (tainted), spilled and over-poured alcohol.  Usually, this allowance is expected to cover staff theft as well.  Additional consideration may be given to alcohol used in cooking and customer comps.  The amount of the allowance (usually expressed as a percentage) is based on the restaurateur’s responses to questions during the initial interview, the nature of the restaurant’s operations, and the auditor’s judgement (based on “similar” operations) as to the percentage that might be considered “reasonable”.

Depending on the type of alcohol and the peculiarities of the operation, allowances can be as low as 1% and up to about 50%.  In many cases, the allowance is about 10% for all possible reasons (spilled, spoiled, over-poured and stolen).  Any allowance greater than this will need to be properly supported.

All other adjustments will need to be properly supported with logs or ledgers detailing the reasons adjustments are required for alcohol used in cooking, customer comps and other reasons.  This will be a topic of a subsequent post, but for now, you should know that logs will be required to support any other adjustments to costs.

Proper Matching

It is extremely important to make sure that the auditor is properly matching the correct alcohol with the drinks sold in each category.  It is equally important for the auditor to exclude beverages that are not actually sold to customers.  For example, several liqueurs may be used solely for flavouring martinis or cocktails.  Similarly, Vermouth is rarely, if ever, sold on its own.  These are commonly regarded as mixes.  Some restaurants consider port wine sales in the same category as after-dinner drinks, brandies and cognacs.  Most likely, these will be reported as liquor sales rather than wine sales.  Care should be taken to making sure that the auditor is aware of the restaurant’s categorization of menu items.

Cost Per Serving

During the initial interview, the auditor will ask questions of the restaurateur in order to pin down the serving sizes for all drinks sold.    The auditor will also examine menus to help determine the serving size for all alcoholic drinks.  The auditor will also be asking questions to gain an understanding of the potential over-pouring of each category of drink (wines, draft beer, liquor).   It is extremely important to have expert advice prior to providing this information to the auditor during the initial interview.  If inaccurate or vague information is given, it will be very difficult to get the auditor to change his or her assumptions later on.

Taking all of these factors into consideration, the auditor will develop an average cost per serving for each category of alcohol sold by the restaurant.  This figure incorporates the allowances described above.  The average cost per serving for a category is matched with its corresponding average category selling price to determine the average category mark-up percentage.

Putting It All Together

Finally, the auditor takes the total cost of alcohol purchased for each category and multiplies this by the applicable mark-up percentage, to provide an audit estimate of the sales that “should have been” generated from the purchased alcohol.  This is done for all liquor categories.  These total projected sales, calculated by the auditor, are compared with the total alcohol sales reported by the restaurant, for each category.  If the reported sales were lower, the difference is considered unreported sales.  The restaurant will be assessed for the sales taxes on the unreported sales, and will likely be assessed income taxes on the difference, as well.

Auditproofing

Now that we know how the auditor performs the sales projection, we need to perform a similar analysis before the auditor arrives at your door.  Regarding average costs, you should be prepared to invest the time to keep track of the quantity and cost of every bottle of alcohol purchased by the restaurant.  Unfortunately, you will have to manually maintain this list.  I suggest an Excel spreadsheet.  Every item should be listed along with all of the details noted above (date, quantity, bottle size, etc…).

Once this and the other procedures (average selling prices, sales mix) have been performed, we can prepare analyses similar to those that the auditor will carry out during an audit.  Then, when the audit takes place, you will know the assumptions necessary to support the tax returns that were filed.  These proactive analyses will also be used to document and explain variances from the standard mark-ups on an ongoing basis.  These explanations will be very useful in supporting the reasonableness of the various assumptions made during the audit.

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