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Revised 02/2013

Chapter III — Methods of Tax Determination


Retailers now use various record-keeping systems. Several methods of determining the taxes due are also used, including:

  • Separate keys on cash registers used to indicate taxable or nontaxable sales
  • Computer-generated sales registers
  • Retail inventory method
  • Gross profit method
  • Estimated taxable percentage
  • Special reporting methods allowed by statute

Cash Register Keys

Retailers, particularly the smaller ones, have a relatively simple method of indicating taxable or nontaxable sales through the use of separate keys on the cash registers. The retailer will usually have a separate key identifying tax collected. Reported taxable sales will consist of the monthly or quarterly tax collected amount divided by the applicable tax rate. When this procedure is used:

  • Determine the taxpayer's knowledge as to which items are taxable and which are exempt from tax
  • Determine what guidelines or information have been given to the cashiers to determine taxability
  • Determine the taxpayer's exact sales tax reporting procedures
  • Trace the postings of taxable sales and tax collected from cash register tapes to summary records and to the tax returns
  • Verify the reliability of this procedure by comparing it to the results of the application of the purchase ratio method, at least on a preliminary sample basis

Computer-Generated Sales Registers

A rapidly expanding method of recording sales transactions for grocery stores is through the use of "product code" recognition for checkout stations. This system uses the standardized manufacturer's product identification code on the wrapper of the merchandise. Various scanners read the coding, and a central computer system matches the product code with the selling price of the item and records this amount on the checkout stand register tape. The taxability of the product is also determined by the central computer system that obtains the total tax due on each transaction.

An audit of a taxpayer using the "product code" system may be limited to:

  • Verification of the correct internal coding for taxable and nontaxable items
  • Verification of summary records generated by the system
  • The inclusion of all receipts for report periods

NOTE:   Internal codings should be obtained for the entire audit period. A taxpayer's determination of the taxability of an item may have changed during the audit period. In addition, the taxability of products may have changed during the audit period.

Retail Inventory Method

Some large convenience store chains use the retail inventory method as a method of sales and inventory control, i.e., for loss and theft, etc. Generally, records do not reflect a "tax collected" amount.

Convenience stores have a high rate of employee turnover. Sometimes, the employees are instructed to collect tax whenever in doubt. This usually leads to an over-collection of tax. These amounts are due to the State unless the overages can be refunded back to the original customer.

Under the retail inventory method, all purchases are priced at retail at the time of receipt. Inventories are generally taken on a weekly or bi-monthly basis. The taxpayer determines book sales using the following procedure:

          Beginning inventory at retail (actual)
          + Purchases marked-up to retail
          -------------------------------
          Merchandise available for sale at retail
          - Ending inventory at retail (actual)
          -------------------------------------
          Book sales at retail

The taxpayer then compares the book sales amount to the actual sales to determine an overage <loss> adjustment to inventory:

          Actual sales at retail
          - Book sales at retail
          ----------------------
          Overage <loss> adjustment

The taxpayer should report sales tax based on the taxable portion of book sales.

In order for a sales tax audit to be conducted on a taxpayer using the retail inventory method, inventory and purchases must be identifiable by product, and the actual physical inventories must have been made. Verify the taxpayer's calculations of sales tax using the purchase ratio method (except that purchases are recorded at retail prices). The general concepts of the Purchase Ratio Method are covered later in Chapter IV, Section I.

NOTES:

  • The overage/<loss> adjustment may not be applied to purchases unless taxable and/or nontaxable substantiated losses can be established
  • See substantiated losses section

Gross Profit Method

Basically, the mark-up method involves applying a gross profit mark-up percentage to the adjusted cost of goods sold in order to estimate sales. This procedure may be used when the expense and cost of goods sold records are adequate, but the sales records are inadequate. Or, this method may be used to substantiate the reliability of sales records. The gross profit method is most effectively used on businesses in which the unit sales price is small, the volume of transactions is large, and gross profit mark-up does not fluctuate greatly.

Using the gross profit method, sales may be estimated with a fair degree of accuracy. This is done by calculating a weighted mark-up through a shelf test of the merchandise purchased.

A standard shelf test includes:

  • An actual physical examination of products, quantities, price tags, price stickers, signs, or any other devices used to inform the customer of the sales price. Standard catalogs and price lists may also be used when other sources are unavailable
  • The computation of a markup percentage after testing items purchased

The last step is to determine audited gross sales:

          Calculated Markup Percentage + 100%
          X Cost of Goods Sold
          --------------------
          Audited Gross Sales

Since the markup is based on the cost of purchases, the percentage used in calculating sales will be the markup percentage plus 100%, with 100% representing the original cost of the purchase.

EXAMPLE

Adjusted Cost of Goods Sold for a Period = $7,200
Markup Percentage = 30%
$7,200 X 1.30 = $9,360 (Gross Sales)


Example - Schedule of Shelf Test

Estimated Taxable Percentage

Some taxpayers may establish an arbitrary estimate of the percentage of taxable sales. This percentage may or may not have been based on a review of purchases. During an audit, use the purchase ratio method to verify the accuracy or validity of the taxpayer's percentage.


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