This post concerns the use of zappers in restaurant operations.  It is not a “how to” guide in their “proper” use, nor is it, in any way, an endorsement of their use.  In fact, if you are even thinking of employing a zapper to fill your pockets with cash stop and read this post.  It is not worth the risk.  You will get caught, eventually, and here’s why.

Use a Local POS Vendor

If you purchase your software and zapper from a local vendor, distributor, developer or consultant, you will get caught.  If you use a zapper, you will need some technical support to ensure that your computer system does not keep any stray bits of zapped data on the hard drive.  As a result, you are locked-in with your consultant or other advisor.  There will come a day when that person will be caught assisting another taxpayer in the use of a zapper.  One way or another, the tax authorities will gain access to the consultant’s customer list, and you will become the latest target for an aggressive tax audit.

The Ministry of Revenu Quebec has used this method of identifying restaurant tax evaders quite successfully.  They have also worked with the Canada Revenue Agency to execute search warrants in other provinces.  The next step (much harder) is to collaborate with tax authorities in other countries, such as the U.S. 

Zappers Aren’t Perfect

Even though zappers can delete or modify specific transactions and make it appear as though they were never there, many POS systems have frequent backup sub-systems to prevent the loss of data in the event of an unexpected shut down or power loss.  These backup versions of files may remain on the computer disk and may contain remnants of the original “zapped” transactions.  Where the use of a zapper is suspected, a tax auditor may call in a computer audit specialist to obtain the evidence of zapper usage.  Using a zapper consultant to help cleanse your computer system means you have an accomplice (see first point).

Comparative Analyses

Auditors of all types (not just tax auditors) use analysis to help determine whether financial figures “make sense”.  In a typical business, we compare key metrics with those of similar businesses.  Where there are significant differences that have no reasonable explanation, we suspect errors or omissions in the accounting system.

Typical metrics might include the percentage of cash sales and whether this has changed significantly over the course of the audit period.  An obvious one is the margin percentage for major product groups (wine, beer, liquor, food).  Another might be the cost per ounce of alcohol for a variety of categories.

While most restaurants and bars do not have ready access to key metrics for similar establishments, rough guidelines are available from restaurant associations and other restaurateurs.  Care should be taken to making sure you compare metrics from similar establishments.  Metrics for a sports bar will be very different from those of a fine dining restaurant.  Where proper comparatives are not available, you need to make sure that your margins (and other metrics) are reasonable, by comparing your actual metrics with what you should have expected given your prices, costs and other known information.

Vertical Analyses

Auditors also look at the relationship between various financial figures, as a test of their reasonableness.  Many financial figures are related to sales volume or dollars.  To some extent, labour costs, supplies,  and a variety of other expenses vary with the volume of business.  An auditor will analyse these relationships over time to determine whether there may have been unreported sales.  Few restaurateurs would be capable of the meticulous recordkeeping and adjustments that would be required to make sure these analyses stayed consistent at all times.

Accounting for Cash

Most businesses generate some cash sales.  There is nothing wrong with this.  Once the cash has been received, it becomes an asset of the business.  Well run businesses ensure that all receipts (including cash) are promptly deposited, intact, into the bank accounts.  Many small (and some large) businesses do not follow this sound practice.  Where such funds are not deposited into the bank, it is imperative that the owner meticulously account for all cash received with proper cash disbursement records and receipts (invoices).

Some restaurateurs are known to pay some of their staff in cash, without going through the regular payroll system.  This is done to try to keep the labour costs in line with the reported sales (after zapping or skimming).  Another practice is to purchase some supplies or inventory with cash, perhaps using separate cash accounts with existing vendors.  In each case, the restaurateur has brought in accomplices to the fraud, increasing the chance of being caught.

Owners Living Above Their Means

While typically not used in restaurant audits, it is possible to examine the owner’s lifestyle to determine whether it makes sense, given the level of income reported from the business.  If the owner’s lifestyle cannot be supported by the income from the business and other legitimate sources of funds, this becomes evidence that funds have been fraudulently removed from the business.  Note that this method of assessing taxes is much more prevalent in the U.S.  It is also used in Canada, and elsewhere, where it is difficult or impossible to verify income by any other means.

Changes in Cash Receipts

When a zapper is first used, or a skimming operation is commenced, there will be a decrease in cash receipts reported by the restaurant.  This may provide evidence that a tax fraud has taken place and prompt the auditor to examine the books and records more closely.

That said, not all sudden decreases in cash receipts are fraudulent.  A significant change in the restaurant operation may be completely legitimate and reasonable, depending on the circumstances.  At the end of a patio season, cash sales may drop off considerably as fewer customers pay with cash in an indoor dining room.  Similarly, if business at a bar drops off relative to its dining room volume, there will likely be a significant drop in cash receipts.

Paper Guest Checks

Most guests are provided with guest checks during their visit, regardless as to whether they pay by credit card or by cash.  When a customer takes the paper guest check, it is an external piece of evidence of the transactions incurred at the restaurant.  If a tax auditor were to obtain copies of cash-paid guest checks for a restaurant or bar (perhaps during another audit), these could be used to match up with guest checks reported by the restaurant during a future audit. 

If the auditor is unable to exactly match the paper receipt with an identical guest check in the restaurant’s POS system on that date, this will be strong evidence indicating the use of a zapper.  In fact, this is exactly how a Revenu Quebec auditor stumbled upon a major tax evasion case involving the use of zappers.  The auditor visited a restaurant that had been selected for an audit and paid for the meal with cash.  During the audit, it was determined that the original guest check had been altered, by removing an item (the original food modifier was not zapped).  Note that the guest check number must be identical too.  Note also, it only takes one discrepancy to provide strong proof.

Original POS Reports

Every day a restaurant operates, a variety of POS reports may be generated.  As a minimum, each server will have a shift report showing the start and end times, total sales, by category, taxes collected, receipts by type, and balance owing to (from) the house.  In most cases, this is a printed report provided to the manager or owner for review.  Often the server retains a copy to keep track of tips owed.  In order to keep track of the server’s performance and to help identify theft, these reports must include all sales.  That is, they are pre-zapped reports.

The manager or owner also prints a day end report showing the aggregate totals for all servers for the day.  Other reports may include taxes collected, sales by item, inventory usage, etc…  Some reports may be provided to the chef for ordering purposes or inventory management, others may be provided to the manager.  Again, all of these reports are pre-zapped summaries of transactions during the day.  Effectively, all of these reports are a hardcopy “snapshot” of the POS transactions actually processed by the restaurant.  Even though they may be subsequently changed by a zapper, they are a permanent record that may be made available to an auditor.

Unless all of these reports are destroyed after a zapping operation, there will be a paper copy available to indicate the use of a zapper in the operation.  All that is required is a simple comparison of the original report with the current, zapped report. 

All it takes is one disgruntled employee who suspects the use of a zapper (or other means of skimming) to provide original POS reports to a tax authority.

Quebec Approach

Quebec has decided to take a different approach to combatting the use of zappers and other forms of technologically-assisted tax evasion.  They have started a pilot project involving the use of a Sales Registration Module (SRM), which will create a permanent record of each establishment’s transactions and guest checks.  The SRM will produce reports for preparing QST returns.  It will allow tax auditors to easily determine whether a specific guest check has been recorded or whether it has been tampered with by any means.  Every patron must be presented with a guest check, or the establishment will face substantial fines.

The full rollout of the SRM system is expected in 2011.  All but very small restaurants are expected to use the new SRM, which will be provide free of charge by Revenu Quebec.

 Conclusion

While you may get away with the use of a zapper for a while, there are too many ways you could be tripped up.  When it does happen, the penalties will be severe.  It is not worth taking the risk.

Recently, we’ve begun to hear a lot more about tax evasion in the restaurant industry.  More specifically, we’re talking about technologically-assisted tax fraud, using zappers or phantom-ware.  It made the news, again this past week, when it was disclosed that the Canada Revenue Agency had found more than $40M of unreported tax in the restaurant industry attributed to the use of zappers.  Today’s post looks at the issue of tax fraud in the restaurant industry and tries to determine how “rampant” it might be. 

While tax fraud can occur in many different ways, when we talk about the restaurant industry, it usually takes the form of cash sales “skimmed” off and not reported for tax purposes.

The Pre-zapper Era

Before the mid-1990s when zappers became available, restaurants, bars and other businesses with significant cash sales used other means to skim a portion of cash sales and under-report their sales and sales tax liabilities.  Manually prepared invoices or guest checks could be destroyed if the customer settled the bill with cash.  We don’t see too many places that still use manual guest checks, but there are a few. 

A restaurant with stronger internal controls would have kept all checks and monitored the sequence of guest check numbers, to ensure that all invoices were recorded.  This is why the tax auditors ask for all guest checks issued during the audit period.  When they are not kept, it helps the auditor conclude that the restaurant’s internal controls are inadequate for ensuring the accuracy and completeness of the sales and sales tax records.

Another method was to have phantom cash registers.  Typically, an establishment would maintain an extra cash register (or two) at a bar where the majority of the sales were likely to be paid in cash.  The sales rung into the phantom cash register would never be recorded in the accounting system.  The owner of the bar would need to keep track of any significant underreporting of sales, so that alcohol inventory could be repurchased off licence.  This would have been required, to make sure that the margins, based on licensee purchases, would appear to be reasonable.  More sophisticated frauds involved separate accounts with food suppliers, where a portion of the purchases were made in cash, to make the food margins appear reasonable, where a portion of food sales were not reported.  Finally, some of the servers/bartenders would have to be paid in cash, so that the labour costs would appear reasonable. 

As computerized POS systems became more affordable, their use in restaurants of all sizes exploded.  This gave rise to a couple of new, technologically-assisted methods for skimming.  The first was phantom-ware, which was built into the original POS software and could be programmed or activated to remove specific types of sales transactions.  While there was a legitimate use of such software (the ability to reset data in the system for a new user), in reality, it was quite rarely used.  Where phantom-ware was identified and used to commit a tax fraud, the tax authorities were able to convict the software developers as co-conspirators in the crime.  Consequently, their use is quite rare.  Instead, zappers were developed and their use appears to be on the increase around the world.

What does a Zapper do?

A zapper is a standalone software application that is attached to the POS system from time to time.  It is usually contained on a CD or a memory stick.  It is removable and only resides on the computer (or network) while it is doing its “work”.  Consequently, its use may be shielded from other employees (or even owners) of the restaurant or bar.  It can be extremely difficult to detect, though not impossible.

When a zapper is activated on a POS system, it allows the user to access the POS transactions database and make changes to the entries.  Zappers are designed to search for cash sales, because these have no independent audit trail outside of the POS system.  Whole guest checks can be deleted, items can be removed from the check, or the amounts can be modified.  The zapper keeps track of the amount of items “zapped” from the system.  Once the desired amount of sales has been achieved, the zapper renumbers the guest checks in the POS system and prepares adjusted reports for the day. 

Sophisticated zappers may also adjust inventory usage figures and employee time records to conform with the adjusted sales figures. 

How Prevalent is Zapper Use?

There is very little hard evidence of zapper use anywhere in the world, though some European countries believe that zappers are being used in cash-based industries and are taking steps to curb their use.  In particular, Greece, Germany, Italy, and the Netherlands. 

A limited study of tax evasion in the restaurant industry in Germany revealed significant underreporting of cash sales.  Closer to home, in Quebec, two studies were undertaken.  In the first, 41 zappers were found in 70 systems tested.  At first blush, this is a startling finding.  However, the sample was taken from the customer list obtained from a zapper distributor in the province!  Given the sample, it becomes startling that only 41 of the 70 systems were using the zapper!  In the second study, based on a random sample, the Ministry of Revenu Quebec found 16% of all sales were unreported.  They concluded that “tax evasion is rampant” in the Quebec restaurant industry.

Revenu Quebec has only released a summary of their findings, so it is difficult to comment.  For example, we don’t know how they determined that 16% of all sales were not reported.  We don’t know whether this underreporting of sales relates solely to the use of zappers or to the use of other means.  We don’t know the number of establishments using zappers or the percentage of establishments with zappers in use. 

Other countries, like Japan (no cases) and the U.S. (2 cases) have not seen the same level of usage, or their tax authorities have been unable to detect their usage.  In Canada, we have seen about 275 cases in Quebec, many of which were found on distributor client lists, but only 11 across the rest of the provinces.  The latest sweep by the CRA has identified a few more, but at this point we don’t know how many or where they are located.  Given that there are thousands of restaurants across Canada, even the number of zapper cases identified in Quebec does not justify calling their use “prevalent” in the restaurant industry.

You can not lump the entire restaurant industry together and say that zapper use is “prevalent” or tax evasion is “rampant”.  The industry is too diverse.

Tax evasion, with or without zappers, requires that a significant portion of the fraudulent restaurant’s receipts be in the form of cash.  Credit cards (including debit cards) create their own independent audit trail, making it nearly impossible to skim these receipts without being caught.  Some restaurant and bar operations tend to take in more cash from sales than others.  Nightclubs, bars, sports bars, pubs and fast food franchises tend to have significant cash sales.  Higher end, fine dining restaurants tend to have very few cash receipts, as few people carry around large amounts of cash and corporate entertaining is almost always supported with a credit card receipt.

Fast food operations, despite taking in large amounts of cash, are less likely to skim significant amounts of cash, because they are accountable, not only to the tax authorities, but also to the franchisor.  Franchisors have several methods of identifying unreported sales, because their franchise fee is usually dependent on gross sales of the franchisee.  For example, a franchisor could monitor the franchisee’s sales in relation to the volume of pizza boxes (or other packaging) consumed. 

While there are documented cases of fraudulent use of zappers, their use in Canada is no where near as prevalent as the tax authorities would have us believe.  Furthermore, as society moves toward less use of cash in commercial transactions, the potential for tax evasion using zappers decreases.

I recently commented on the NZ Angels blog about a post discussing the New Zealand Institutes report on ‘ lifting innovation ecosystem performance ‘

Check it out here.

On a similar note there have been a couple of other notable reports that have been published.

• a report released by the office of the PM’s science advisor presents the results from a recent workshop about what is needed to help translate NZ research to economic benefit. Download here.
• Driving Economic Growth through Bio-Based Industries: The 2009 Bioeconomy Industry Summit Report. View here. It was good to see them recognise the Bioscience Enterprise program at the University of Auckland, too bad they forgot about Chiasma despite it addressing some key issues highlighted in the report (point 9.5 and 9.6). It also excluded some other developments  e.g. the LENS classroom at the Liggins institute which is responsible for exposing high school students to careers in science (point 9.6); FRST industry fellowships for fresh grads, The Institute of Innovation for Biotechnology at the University of Auckland. It also includes some weird ‘progresses to date’ e.g. MoRST’s future watch program – does anyone even know about this? I am also getting quite concerned with the number of times (in addition to this report) I read about the need to keep PhD students in NZ following doctorate completion. Going overseas to pursue your science research is not a bad thing, in fact its actually good. Why? You get an international perspective, experience and connections working at the world’s leading research institutes with world leading researchers. The more important aspect of this debate is making sure individuals return to NZ following this experience and then capitalising on it (glad to see the report mentions this also). Also keep in mind at present NZ is oversupplied with science grads, there is simply not enough jobs out there. Go check seek.co.nz or trademe jobs if you doubt this. But wait it doesn’t stop there. Over supply typically = lower wages. Lower wages = less incentives to stay in NZ. A vicious cycle indeed.
• New Zealand’s research, science and technology priorities: feedback document. “ The government is currently setting priorities for research, science and technology and is seeking feedback from the sector. This document seeks your comments on the government’s proposed investment structure, the balance between investment areas and on the areas in which it is proposed research platforms might be established. “ Feedback due 18th Nov.

____________________________

Graeme @ graemefielder.com

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.

As a restaurateur, you probably have a general idea how your menus and prices have changed over the last few years.  Unfortunately, only having a “general idea” can land you in a big pot of trouble when your restaurant is audited.  This post reviews a few of the methods of documenting key changes to your menu and prices.  When the time comes, you will have accurate, credible information to support your actual margins and document the reasons for variances from the expected margins. 

Please note that we only need to track alcoholic drink menu items (wine, liquor & beer).  Auditors focus, almost exclusively, on alcohol sales, because they are able to verify alcohol purchases much more accurately than they can for food purchases.  Of course, you can track all other menu items, if you need this information for managing your restaurant (as opposed to auditproofing your restaurant). 

Most restaurants have a POS system that maintains a list of menu items.  Reports can be prepared from time to time showing all menu items and their related prices.  However, they don’t usually maintain a history of menu prices, which you will need when you are audited.  I recommend that you maintain an Excel spreadsheet of menu items and prices at various times during the year.  At this point, I would suggest a monthly tracking of prices, however, in a future post, I will recommend that this be done every four weeks, rather than monthly.

Thankfully, most alcoholic drink menus stay the same from one period to the next.  Most POS systems allow you to export your menu (with prices) to a file that can be opened in an Excel spreadsheet.  Once you have done this, we want to track all subsequent price changes and the effective dates for each menu item.  Typically, price changes will be implemented for an entire category of menu items about once a year.  For these items, it is important to document the exact date of the change.  When the auditor performs a mark-up analysis, average prices will be used.  If the exact date of the change in prices is known, along with the actual sales mix, you will be able to support an accurate weighted average price to be used by the auditor, instead of a rough average price.  The difference can be significant.

While most alcoholic drinks stay the same, wine lists usually change much more frequently.  In many higher end restaurants, wine represents a majority of all alcoholic drink sales.  Accordingly, more care and attention should be paid to maintaining an accurate weighted average selling price for this sales category.

For higher end wines, when the vintage (year) sells out, the wine will be removed from the list or a new vintage of the same wine will be added, usually with a new price and a new cost.  Some wines will not be replaced after they sell out, for a variety of reasons.  The point, here, is that a typical wine list can (and will) change drastically during any year.  Unfortunately, when the auditor tries to calculate an average wine price, there is almost no possible way that it will reflect the actual weighted average wine price experienced by the restaurant during the year.  When the auditor’s average price is higher than your actual weighted average price, there will be a finding of unreported sales of wine, which will result in a reassessment for unreported sales tax and income tax on the unreported sales.

This is one of the main reasons that we find drastically different unreported sales from one year to the next during a typical audit.  The actual sales mix of wines does change, but the auditor’s method of determining an average price of a “typical” wine does not reflect the sales mix accurately.  Instead, the auditor uses the restaurant’s menus to calculate an average price of “wine” during the year. 

As we all know, higher priced wines usually have lower markup percentages.  When the auditor calculates an average price, every wine used in the auditor’s sample is given equal weight.  This will tend to inflate the average wine price, because higher priced wines do not sell as frequently as the lower priced ones do.  However, higher priced wines sell less frequently than lower priced wines.  This is reflected in the actual purchases of wines.  As a result, the cost used in the auditor’s calculation will approximate the average cost of a bottle of wine purchased during the audit period, but the price of a “typical” bottle of wine will be inflated.  This will cause the auditor’s calculation to show unreported wine sales, even when there were none.  Consequently, it is crucially important to maintain an ongoing analysis of the sales mix and price changes for all wine sales.

One final note of caution.  If you wish to defeat the auditor’s use of rough average prices in the mark-up calculations, you will have to continuously and meticulously keep track of all sales by item and all price changes.  Infrequent or inaccurate analyses of sales and prices will not help you.  Unless you are able to demonstrate that your figures are more accurate than the auditor’s “average” figures, the auditor will rely on his or her own figures as being at least as good as yours, and you will run the risk of an inaccurate projection of sales by the auditor.

Today’s posting is the first in a series of articles about “auditproofing” your restaurant.  By this, I mean taking proactive steps to help ensure that your restaurant or bar is not unfairly reassessed for sales and income taxes when it is audited by the CRA or provincial tax ministry.  Please check back regularly for other methods of auditproofing your business.  If you have any questions, please post comments to the articles, and I will do my best to respond.  If you prefer, you can email your questions to me.

Most restaurants have a computerized point of sale (POS) system to keep track of items ordered by each guest, send orders to the kitchen or bar, and process guest check settlements.  Most systems can keep track of many other important transactions, such as discounts given (by type and employee), voids (with reasons, by type and employee), ingredient usage, and many others.  From a tax perspective, the POS system keeps track of every item ordered and calculates the appropriate sales tax.  Just like your car, the POS needs to be maintained properly. 

One of the first audit steps a tax auditor performs is to reconcile the POS sales and tax figures with the accounting records and with the actual sales tax returns that were filed.  The auditor will also check to ensure that the correct sales taxes were charged on each item sold.  Any discrepancies will cast doubt on the reliability of the procedures to accurately calculate and remit taxes and ensures that the auditor will be justified in using an indirect audit method to reassess sales (and income taxes) for the restaurant. 

Here are a few steps that you should perform before your restaurant is audited.

Recalculate Taxes on Sales

It would be incredibly time-consuming to check every transaction that the restaurant processes.  Luckily, we don’t have to check every one.  We can check them in bulk for a period of time.  If the figures are correct for the entire period, they are likely to be correct for every transaction processed during that period. 

Consequently, for each period, review the POS report that shows sales and taxes collected.  In Ontario, the report should show non-alcoholic sales (food and beverages), and alcoholic beverage sales, together with the total GST, PST (food at 8%) and PST (alcohol at 10%).  I suggest that this report be run monthly, but you could do it daily or weekly, too.  Once you have the report, multiply the total sales for each category (alcohol & non-alcohol) by the applicable PST rate, and compare this figure with the sales tax collected as shown on the report.  Total sales (both types) multiplied by the 5% GST rate should be compared with the total GST collected that is shown on the report. 

Explain Differences

Any differences between the calculated tax and the tax shown on the report should be investigated.  One reason for there being a difference is that some of the sales transactions were exempt from one or more taxes.  Examples include purchases by Status Indians and Foreign Diplomats and food sales less than $4.00 in Ontario. 

The more likely reason you will find a difference between the calculated tax and the actual tax collected is that the POS system contains errors in the tax setup for one or more menu items.  When this happens, the auditor will conclude that the POS system and the internal controls over sales are not effective to ensure the accuracy and completeness of the sales and sales tax figures.  Consequently, you want to ensure that all discrepancies are identified quickly and appropriate corrective action taken.

If you find discrepancies, you will have to check the tax codes for every menu item in the POS.  All food and non-alcoholic beverage menu items should be coded to charge 8% PST and 5% GST.  All alcoholic beverages should be coded to charge 10% PST (Ontario) and 5% GST.  This can be a time-consuming task, but if done properly, you should not have to do this again.

A POS Key for Every Item

You should ensure that every item sold has its own key in the POS system.  Ensure that a new POS key is set up prior to adding any new wine to the menu.  Do not let staff try to convince you that they “need” an Open Liquor key.  They don’t, unless you fail to set up keys for all menu items.  They may try to argue that they don’t have time to find the right key when they’re busy, etc…  If this is a problem, ensure that they are properly trained on the POS system and consider reorganizing menu items on the POS to make it easier to find items quickly.  Why is this so important?  Once you have an Open Liquor key, it will be used for a wide variety of customer purchases.  Wine, beer, alcohol and even food will be processed under this key.  This will distort the reporting of sales by category (and taxes collectible) and it will make it impossible for you to accurately track usage of ingredients based on actual sales.  As we will see in future posts, this will be an extremely important control when we need to rebut the auditor’s assumptions.

POS Menu Security

Once you have completed this task, I recommend that you change the security authorizations in the POS system to restrict all staff, except yourself or a trusted manager, from making changes to or adding menu items.  With this control in place, you will only have to check future changes and new menu items for accuracy.  Subsequent monthly reconciliations should reveal no unexplained discrepancies.

Other Housecleaning Tasks

While not the topic of today’s post, when you are checking each menu item, you can perform other useful steps that we will be using in future auditproofing tasks.  In particular, while checking the tax codes, you should also ensure that each menu item (focus on alcoholic beverages only) is summarized in the appropriate sub-category.  Here are a few typical sub-categories:  Domestic bottled beer, Imported bottled beer, martinis, shots, cocktails, Wines by-the-glass, Wines by the bottle, etc…  Accurate categorization of all menu items will make it easier to analyse sales data in the future.

Another step is to create recipes for menu items.  Usually, when we think of recipes, we might think of a cooking recipe for a dish.  While this can be programmed into most POS systems, this can be an extremely time-consuming exercise.  Most auditors are far more concerned about alcoholic drink sales.  Consequently, you should consider creating recipes for all alcoholic beverages.  Having a recipe for each menu item will allow you to prepare POS reports of ingredient usage, based on the actual items ordered for any period of time.  Depending on the level of sophistication required, these usage reports can also be used to identify inventory shortages and assist in placing orders to replenish stock. 

Recipes can be as simple as having an “ingredient” of one bottle of Heineken for a bottle of Heineken (menu item).  A glass of wine could have 6 ounces of Catena Malbec, or it could be described as 25% of a bottle of Catena Malbec.  Cocktails could have several alcoholic ingredients. 

Recipes can have a standard spillage factor built in or not.  If you do incorporate a spillage factor, it should be a fairly accurate estimate of the true spillage amount.  Note that this percentage will vary among the various liquor categories.  If the spillage factor is included in the recipe, it is one less factor that needs to be explained in future variance analyses.

This post has been concerned with the menu items in a POS system.  I have not discussed other issues such as discounts, voids, spoiled stock, and customer comps.  These will be discussed in future posts.

If you have been following the posts on this site (and several others on the internet), you know that your restaurant or bar business faces a serious risk when it is audited by CRA or the provincial auditors.  In most cases, your licenced business will be audited, it is just a matter of when.

As a restaurateur that will be subject to an audit, you have a number of choices concerning how you will respond:

1. Wait until the audit is complete and file an objection (appeal)
2. Attempt to refute the auditor’s assumptions during the audit, in hopes of minimizing or eliminating the additional taxes
3. Provide credible, accurate information at the beginning of the audit that will “force” the auditor to develop assumptions that will support the sales previously reported

The first two options will have varying degrees of success, depending on the accuracy, consistency and credibility of the information you are able to obtain to support your filing position.  These will also be the most expensive options – by far.  In the first case, once the audit is complete, the onus of proof is on you to prove that the auditor has used factually incorrect assumptions and/or has erred in the approach used to determine that there were additional taxes owing.  It is not enough to show that different assumptions would lead to a finding of no unreported sales.  The reasons why the “true” assumptions are more appropriate must be supported with factual evidence.  When you are trying to obtain this type of evidence, in many cases years after the fact, it may be impossible to disprove the auditor’s assumptions.  Even where you are able to obtain this evidence, it will be a very costly venture.

In the second option, you have an opportunity during the audit to change the auditor’s assumptions, before the findings are finalized.  In this case, you will be trying to refute the assumptions that the auditor made based on your comments during the initial interview and the documents you provided to the auditor at the beginning of the audit.  This information and the assumptions made by the auditor become the “facts” that will determine whether there were any unreported sales.  You have a much better chance of refuting the auditor’s assumptions during the audit than you have once the audit is finalized.  However, you must still provide evidence why the auditor’s assumptions are incorrect for your particular restaurant or bar.  If necessary, you may ask for a review by the auditor’s supervisor.  In order for this approach to be successful, you will undoubtedly require a consultant that is experienced in these types of audits.  This can be a very expensive option, too, because all of the information gathering and analyses that would be required to appeal an unfair assessment will have to be done prior to the end of the audit.  This will give you about 30 days to perform all of this work, which may not be long enough to do it properly.

The Best Option

It should be clear by now that the only way to effectively protect your business from an unfair reassessment of sales and income taxes is to be proactive.  Ideally, you want to be prepared for the day the auditor walks into your restaurant.  You need to know exactly which assumptions the auditor will be making and the numerical values that will properly support the sales figures that were previously reported.  You will need to know the reasons why your actual margins differed from the theoretical margins, for the entire audit period (usually four years).  Effectively, you need to audit your own business before the auditor arrives.  Ideally, you should be doing this continuously.

You can do most of this preparation yourself.  You may wish to retain an accountant or consultant to help set up internal controls over inventories, purchases, sales and receipts.  Ongoing monitoring and analysis of the controls can usually be performed by the restaurateur, at little or no cost other than your time.  It may be advisable to have the restaurant’s independent accountant monitor the controls and help document the margin variances on a quarterly basis.  The results of this work will provide the restaurateur with the answers to the questions that the auditor will ask at the initial interview.  Most importantly, the restaurateur will be able to support these statements with evidence in the form of analyses done prior to the audit taking place.  To the extent that an external consultant or accountant is involved in the analyses, the information should be considered more credible than uncorroborated internal reports.  The onus will be placed on the auditor to find evidence that your statements are untrue, in order to make an audit finding of unreported sales.

While there is a cost of implementing these internal controls, in almost every case, there should be significant savings that far outweigh the costs.  The ongoing savings will be through a reduction of staff theft and improved margins.  There will be a major bonus when the business is audited and there is a finding of no unreported sales.

Your business will be audited in the future.  While you do have options, in terms of favourable outcomes, you really don’t.  You must be proactive to protect your restaurant or bar from an unfair (and very expensive) audit.  The relatively low cost of controlling your costs and monitoring margin variances will be more than offset by an increase in profitability and a substantially reduced risk of an adverse audit finding.

I have had many chances to wear motorcycle gear, from my first ever setup of RST Synchro jeans and RST Electrik jacket to the effortless cool with a side-order of not practical with a Furygan Orona to the RST Paragon 365 textiles. In this time I have come to understand what it really means to have decent gear on your skin. Aye, you can plump for the cheap stuff and think “well with that £xxx I saved I can put it towards a set of Akrapovic cans and a mohican for my helmet.”

Or you can aim higher.

Now admittedly I have had issues with RST stuff in the past. Of course RST are siblings with Wolf, designed by the same house and brought to you in the same way. However, this time there’s something different.

Ladies and Gentlemen, I give you the brand new Wolf Titanium Textile setup:

Oh. Aye.

Now, after all my troubles with the RST/Wolf family, why would you be interested in anything they have to say? Well let me tell you, I opened my ears and I soaked it up, because this offering in it’s black and red war paint is something special.

This jacket is a touring jacket, but it has a definitive difference to other touring jackets, and that is it’s cut. Now with the Paragon jacket, it was quite long, going pretty much to my arse in length and this is really the only cut you got. However with the Titanium Jacket, the cut is a shorty. A concious decision by the designer to cut out bumfle when you sit on the bike which means no pools of water sitting soaking through the fabric which means….DRY.

When you first put your arms through the sleeves you feel like you are part of this jacket. The slick Outlast fabric allowing easy access down the arms. I’ll come to Outlast in a minute.

You put the other arm in and you feel a really solid fit around your shoulders. Zipping the main zip up brings the whole experience to a new level, as the fabric tightens around your upper body as if someone is standing with a ratchet strap clicking it over until you go “aye, that’s it.”

A comfortable fit? Most definitely. But you say the jacket is tight right? Well what about movement. I mean, with the Furygan, it was a nice tight fit, but those blasted foam bits made moving about a pain in the arse.

Well the Titanium seems to know just where you want movement, and yet it retains that snug solidarity that you enjoyed as you zipped it up. The shoulders sit square on your body, even shoulder-paddy, but definitely not in a bad way. It makes you look square, masculine to the point that I actually started to fancy myself…

Small of the back pocket, doesn't really offer anything but a nice visual

Heading down the arms, you find 2 levels of adjustment on the biceps and the forearm for wind flap. Side adjustment is available here as well but I didn’t need it. The cuffs have a lovely velvet finish (a material called Clarino) on them which makes skin contact joyous. Velcro closure makes putting summer race gloves or my A-Stars Goretex gloves a breeze and very comfortable. The arms were shortened to stop the dreaded cuff encroachment in to glove scenario. So many times I have wanted to put my gloves over my jacket only to find that the cuffs sit so far down my arm that it’s uncomfortable wearing gloves outside the cuff. The Titanium is perfect length.

Clarino cuffs. Gorgeous.

It's not really useful day to day (for me), but it still adds to the design

As you can see on the back view, you have stretchy panels on the backs of the arms and indeed the flanks of the back of the jacket. You’ll also notice the flap at the bottom, hinting at it’s touring credentials, although not really offering any kind of sensible storage. Perhaps documents or smaller items, but forget a set of gloves…well without upsetting the harmonious fit.

I love this reflective material and I love the design touch of the red outline.

Below the large WOLF logo which by the way is reflective. It’s this new type of invisible reflective stuff that looks sort of gunmetal grey, but as soon as you get light on it, it’s blazes in a white flash. Brilliant stuff…anyway below that is a popper which conceals a large cross shoulder vent. Never used this as I always wear my Kriega so no wind flow goes through it.

Metal badge oozes class. Not only that, but it re-inforces the feeling of wearing something special. It's like an insignia to make people aware that you mean business.

You’ll notice the gorgeously contoured neck profile, offering maximum draught exclusion without choking. Adjustment is available for pencil necks but again I never adjusted these. On the front you’ll see the red Wolf logo, smart as, and you’ll also see a wee tapered box shape, in some corduroy type fabric…you may notice a similarity between this and the Furygan chin patch I mentioned here…influenced? worth it? Aye. It’s these little flairs that make my day. So I say go for it. It’s not like it’s an identical steal either. It’s been enhanced, enlarged, improved and made out of a material better than the stuff you find on wet-suit pencil cases…. Wolf 1-0 Furygan.

The badges on the sides of the arms, made from metal and outlined with a Wolf emblazoned thick black line, make you feel like you are wearing something special. It oozes class and echoes the serious approach Wolf are taking to this product. It says “Aye, I mean business, and I intend to deal with you as soon as I have finished looking cool.” It’s an insignia to show that you are wearing a serious jacket. And I love it.

Cheeky chins? Perhaps...

Outlast.

Outcast?

In a sentence, Outlast is a fabric that regulates your body temperature to keep you at the perfect comfortable temperature no matter what is going on outside of you. In practice it does work, but it’s sometimes more noticeable than other times.

I have been riding along and I suddenly feel a surge of heat come from…from nowhere. From the air. It’s amazing really, and I really can’t describe it well enough to do it justice. But it is amazing stuff.

The tech of it is easily found on their website, but the way I understand it is this. When you are too hot, Outlast wicks the heat away from your skin and stores it within the fabric. When you get colder, Outlast gradually releases that heat back to you thus heating you up and the cycle is complete. The problem arrives when you don’t have direct contact with the material. I sometimes wear a long sleeved thermal top under my t-shirt and this limits the effect or perhaps the communication of the effect to the body. Anyway, when you feel this fabric with your hand, it doesn’t matter if it’s roasting inside or freezing, this fabric remains cold to the touch at all times. It’s a bizarre sensation but it just adds to the amazement.

Amazing technology in an amazing jacket.

An amazing piece of technology in this jacket and I am well chuffed that Wolf have had the vision to encorporate this in to their Titanium line. However, there is one pretty major area that, if not addressed properly, would instantly remove any and all good things about this jacket, and that is waterproofing. A pet hate of mine and something that I have dealt with since I first started riding.

Black bit warm, Grey bit COOOOOLLLLLLD. AMAZING!!!!

I’ve mentioned the great decision of the cut of the jacket to reduce bumfling and pooling of water. How does the rest of the jacket fair in the Scottish weather?

I have ridden in some of the worst weather imaginable. Side-ways rain, 50mph winds and ice. This jacket excels at keeping that shit out. Unfortunately there are a few material choices that have made the jacket and trousers susceptible to soaking water up and storing it, which is located on the shoulders and the shins. It’s called Clarino and I can see why the choice was made to use it on the jacket. It’s gorgeous. Soft, velvety and classy. But it soaks up water like nobodies business and it takes a day in a hot environment to dry it out again.

The jacket keeps water out brilliantly, with the only leaks being in rain that some cars would struggle with, so for this very reason, I will state that the Titanium jacket is as good as a Gore-Tex setup, because boys and girls, I have worn gore-tex in similar rain and it let water in. A plastic sheet would let water in on days like these…

Trousers.

The trousers of this ensemble are similar in look to the jacket but have two pockets on the thighs, like cargo jean pocket things. I use them for my wallet on the right and keys on the left, they are waterproof and a good size. The trousers have Clarino on the shins as mentioned before and a zip that runs up the back of your leg ( to just before the back of your knee) instead of the side. This keeps the water from entering the zip and makes putting boots on a breeze. You can also refrain from zipping them all the way down to get a good flair on the go…

I can’t post pictures as I have a pre-production set and are not suitable for internets. But believe me when I say – These jeans are comfy as feck and are as comfortable, warm and nice looking as the jacket. A great setup.

SOOOOO

To conclude then.

I am relieved. I am amazed. I am in awe. I am happy.

Wolf have made a set of motorcycle gear that would make even the most picky of us whimper with joy. The Titanium gear is some of the smartest gear I have ever seen. I may be biased in the sense that I wear it every day and have done for over a year, but as I stated at the outset, I have tested a lot of different types of gear from many manufacturers. These beat every other manufacturer hands down for looks.

• The fit is sublime. The touring cut does it’s job and reduces bumfle to the point of there is none…
• The design flairs are perfectly executed.
• The durability is second to none, a real bug-bear with me but thankfully RST/Wolf have upped their game with respects to manufacturing quality control.
• The utility of the gear, the placement of adjustment and pockets, vents and access points are all well thought out and perfectly placed for ease of use, daily.
• The waterproofing is completely successful.
• The Outlast is mind-boggling.
• The use of materials is gorgeous. Hard wearing materials for the important bits. Sexy materials for the flairs. Metal for the badges.
• Zips are solid.
• Velcro is heavy duty, no fluffing or stitch tearing.
• Front fastening is zip, velcro and poppers. A total overkill but it’s bullet proof. I would rather have 3 methods of defence over 2 or 1, even if they did the same job.
• Armour is all standard stuff, but secured extremely well to reduce movement over time.

In a word then, how do I rate the Wolf Titanium gear?

Love.

Here is my list of words for the RST Constant Consonants puzzle posed on Monday (I found 15):

Airiest, arrest, eeriest, erst, reseat, rest, risotto, roast, roost, roseate, rosette, roust, russet, rust, and rusty.

In addition, there’s resto (obscure for an antique, or the remainder), and Rasta (which is capitalized and doesn’t count).

How many uncapitalized English words can you think of that use the consonants RST, in that order, and no others? You may insert vowels anywhere in your words, and you may repeat consonants, as long as you repeat them without any other letters in between. (For example, ARREST counts but RESIST does not). For full rules, see the link at the upper right.

I will post my answers on Wednesday. I expect to have a list of 15-20 words.

I’m often asked by my clients and fellow restaurateurs how the tax auditors arrive at their reassessments for unreported sales.

It is a pretty simple approach, though the calculations will boggle the minds of those who don’t know how to use Excel!  In a nutshell, the approach is the same, regardless of whether it is an audit for PST, GST or income taxes. 

1. The auditor obtains a report of all known purchases from the LCBO and Brewer’s Retail.  I’m using Ontario as an example, but each province will have similar procedures in place.  With a bit of analysis, the auditor will be able to calculate a fairly accurate breakdown of the cost of sales (and the volume) for each major category of alcoholic beverage that the restaurant sold.  Typical categories include:  domestic, imported and draft beer, domestic and imported wine, and alcohol.  Using these figures, the auditor is able to estimate the average cost of sale per serving for each type of alcoholic beverage sold by the establishment.
2. Now the auditor requests copies of the restaurant’s alcoholic beverage and wine menus that were in effect during the period under audit.  This allows the auditor to estimate average drink prices for each beverage category, for each year.
3. Standard drink portions are determined from the menus, with input from the owner/manager during the initial interview.
4. The auditor applies a standard theft/waste/shrinkage/spoilage allowance to each category of alcohol, to arrive at figures that represent what the auditor believes your true cost of sales per serving were likely to have been during the audit period.
5. Now, it is a quick calculation to take the cost of sales in each category and project the total amount of sales that should have been realized by the establishment for each catgegory.
6. The projected sales for each category is totalled and compared with the restaurant’s reported sales.  Any excess of projected sales over reported sales is considered to be unreported sales of the establishment. 
7. In Ontario, the restaurant will be charged a 10% sales tax on the unreported sales, plus penalties and interest from the date when the sales were under-reported.
8. Oddly, Ontario does NOT usually consider the unreported sales as additional taxable income of the restaurant (though there is no reason why they couldn’t)!
9. The CRA will apply the same approach and charge 5% for the GST under-reported.
10. The CRA will also consider the unreported sales as an increase in the taxable income of the restaurant, again, subject to penalties and interest.
11. When the CRA reassesses the taxpayer for income taxes on unreported sales, Ontario will issue a reassessment for Ontario income taxes.
12. Finally, and this is the scariest of them all, when a company is reassessed for unreported income, CRA may also attempt to reassess the individual officer or shareholder of the company with a benefit equal to the amount of the unreported sales.  This can have extremely unfavourable tax consequences, as the individual is taxed on the unreported sales, the company does not get a deduction for this, and the company is taxed on the full amount of the unreported sales.  In short, double taxation, combined with huge penalties and interest. 

If these audit tactics don’t scare you, I don’t know what will.  In future blog entries, I will address some of the more important areas of your restaurant operations that require attention, in order to avoid having a tax auditor present you with an unjustified tax bill.

If you operate a restaurant or bar that serves alcohol, you can be certain that you will come face to face with one or more government auditors, about every four years.

Why?  Provincial and federal tax authorities truly believe that under-reporting sales is rampant in the hospitality industry.  Tax authorities are statute barred from reassessing returns more than four years old, in most jurisdictions.  So, every few years, you can expect a visit from the provincial sales tax auditor, who will audit two to four years’ worth of sales returns during each visit.  Canada Revenue Agency audits GST returns, but not nearly many or as often as the provincial authorities audit RST returns.  Undoubtedly, this is because there are far more GST registrants than RST vendors, and the GST registrants are much larger tax collectors.  However, with the coming harmonization of Ontario and BC sales taxes with the GST, both provinces’ licenced restaurants should expect a dramatic increase in sales tax audits (covering both taxes).

The harmonized sales tax (HST) is expected to generate a frenzied wave of provincial sales tax audits during the next four years or so, as the Ontario and BC tax authorities conduct their final audits, covering the period up to June 30, 2010.  If they miss this opportunity, they will be forever barred from trying to reassess these taxes in most circumstances.

Selling Your Restaurant?

When you sell your restaurant, this will trigger a provincial sales tax audit.  The government wants to make sure that they received every penny of taxes that should have been collected by you and remitted up to the date you sold your restaurant.  You will not have access to your sale proceeds until the audit is completed and you have paid any additional taxes, penalties and interest.  Even if you disagree with the reassessment, you will be required to pay the additional tax, penalties and interest. 

Type of Establishment

Licensed establishments attract the vast majority of tax audits.  Establishments that sell food and non-alcoholic beverages will rarely, if ever, see a tax auditor.  Why?  The costs of trying to audit food sales is high compared with the potential finding of under-reported sales.  The reasons are many, but include:  frequently changing food menus, subjective or informal food recipes, and an inability to ensure complete and accurate food purchases.  Also, the RST on food sales is 8% in Ontario (versus 10% on alcoholic drinks). 

In contrast, alcohol purchases are easily verified through LCBO and Brewer’s Retail purchases under the establishment’s license.  Alcoholic drink recipes are fairly standard and primarily based on the volume of the alcohol served.  This makes it relatively easy to estimate alcohol usage, based on sales.  Alternatively, it is relatively easy to project likely sales based on actual usage of purchased alcohol.  By the way, this is the premise underlying the tax auditor’s approach to auditing your sales tax returns.

The type of establishment you operate will affect your odds of being audited.  The more likely your establishment is to receive cash sales (as opposed to credit cards), the more likely it is that you will have frequent audits.  Clearly, bars, nightclubs, lounges, sports bars and pubs will generate significantly more cash sales than fine dining restaurants, where most patrons pay by credit card.

If establishments like yours typically generate significant cash receipts, expect to be audited regularly, even if your operation takes in little cash.  You may have heard about “zappers” that can be used to remove cash sale transactions from a POS system.  Tax auditors are onto this tax evasion ploy.

These are this Monday’s top day trader and active stock alerts.  We have more detailed data on volume and price analysis with links through to VSInvestor.com on each stock:

Becton Dickinson & Company (NYSE: BDX) is trading higher as a new position for none other than Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK-A).

BioSante Pharmaceuticals, Inc. (NASDAQ: BPAX) is one of this morning’s few big winners on a presentation of H1N1 vaccine results.

First Solar Inc. (NASDAQ: FSLR) is getting clipped by almost 5% on a Barron’s report.

Guaranty Financial Group Inc. (NYSE: GFG) looks busted.

InterDigital, Inc. (NASDAQ: IDCC) is down by almost one-third on active volume this morning (and Friday evening too) on a patent ruling.

Lowe’s Companies (NYSE: LOW) is down about 10% after the home improvement and hardware giant posted light earnings.  This one is enough that it is affecting Home Depot (NYSE: HD) as well.

Rosetta Stone Inc. (NYSE: RST) was down over 10% after warning of higher operating expenses.

-The 24/7 Wall Street Team

August 17, 2009

Rosetta Stone Inc. (NYSE: RST) has just filed with the SEC for a public offering of common stock.  The language learning software leader filed to sell some 4,697,750 shares, which it listed as being worth approximately $138,959,445.  Technically, this is 4.085 million shares and the rest is an overallotment.  Be advised here that the company is receiving essentially none of the proceeds which are going to the backers.

Rosetta is selling 40,000 shares of stock, although that may be just to cover expenses.  Lead underwriters are Morgan Stanley and William Blair.  Co-Managers and other underwriters are Jefferies, Piper Jaffray, R.W. Baird, and Lazard.

The use of proceeds does confirm that Rosetta intend to use the proceeds received from this offering primarily to fund the expenses of this offering.  It does not anticipate having significant net proceeds remaining after the underwriting discounts and commissions are deducted with respect to the shares it sells and after the estimated offering expenses.  Rosetta will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

The two key sellers are listed as ABS Capital Partners (entities tied to it) and Norwest Equity Partners (entities tied to it).  The ABS stake, assuming no overallotment is taken, will go from 25.1% to 13.2%.  the Norwest stake, assuming no overallotment, will got from 16.4% to 8.6%.

As far as how this fits in with the overall capitalization and float, Rosetta noted that its authorized capital stock consists of 190,000,000 shares of common stock and 10,000,000 shares of undesignated preferred stock. As of June 30, 2009, the company had outstanding 20,342,252 shares of common stock and noted that it had 765 common stockholders of record.

Rosetta closed up0.17% at $29.91 and shares are down only 2.2% at $29.25 on the news.  Its post-IPO range is $21.33 to $32.97.

FULL SEC FILING

JON C. OGG

Rosetta Stone, Inc. (NYSE: RST) just gave us its first earnings report that had a full quarter’s worth public data in it.  The language learning software solution provider did not disappoint.  In fact, this is a solid report.

The company posted quarterly figures of $0.23 EPS on $56.5 million in revenues.  The estimates from Thomson Reuters were $0.13 EPS and $54.7 million in revenues.  If you include the costs associated with coming public and some other items, its loss was -$0.42 EPS.

Guidance looks ample here as well. The company sees the coming quarter coming in at $0.33 to $0.35 EPS and revenues of $64.5 million to $66.5 million.  Thomson Reuters has estimates listed as $0.30 EPS and almost $65.3 million in revenues.

For the fiscal year, these figures were put at $0.56 to $0.60 EPS net, but $1.22 to $1.26 non-GAAP EPS.  Revenues were put at $245 to $248 million.  Thomson Reuters had those figures listed as $1.04 non-GAAP EPS and $242.8 million in revenues.

Rosetta Stone shares closed up 5% at $27.31 with the strong market today, and shares are up around $28.75 in the after-hours session.  Its post-IPO range has been $21.33 to $32.54.

We now have some forward valuation figures to throw out there.  The market cap before the effect of after-hours trading was $555 million.  For this year at the mid-point of guidance, we have forward multiples of 22-times earnings and right at 2.25-times revenues.

JON C. OGG
JULY 30, 2009

By now just about everybody knows who Rosetta Stone, Inc. (NYSE:RST) is for its leadership in language learning and translation software.  It seems that Google Inc. (NASDAQ: GOOG) has gotten caught up on the wrong side of the line in an advertising-related case.  Rosetta has  sued  Google and is seeking to prevent the search engine giant from infringing upon its trademarks. The suit alleges that Google is allows third parties, including individuals involved in software piracy operations, to purchase the right to use Rosetta Stone trademarks or other terms confusingly similar in Google’s AdWords advertising program.

The case has been filed in the United States District Court for the Eastern District of Virginia.  This comes on the heels of Google changing its policy  to allow advertisers to use trademark terms in their ad text without owning the trademark and without permission from the trademark holder.

Rosetta Stone says that Google’s search engine helps third parties to mislead consumers and misappropriate Rosetta Stone trademarks by using them as ‘keyword’ triggers for paid advertisements.  It also notes that advertisers can use these terms within the text or title of paid advertisements.  The basis of the suit is that Google and its advertisers benefit financially from and trade off the goodwill and reputation of Rosetta Stone without incurring the substantial expense that Rosetta Stone has incurred to build its popularity, recognition, and brand loyalty.

Rosetta Stone is seeking injunctive relief to stop Google from selling the Rosetta Stone trademarks or other terms confusingly similar for use in Google’s AdWords advertising program.  If you search the term “Rosetta Stone” on Google, there are other ads there in the sponsored links.

There are many issues in trademark and copyrights out there.  What is fair use and what is capitalizing off of the work of others is still in the push and pull battle out there on the Internet and in the legal system.

Jon C. Ogg
July 10, 2009

We will have some changes or further additions and deletions coming today from Russell for the highly awaited Russell rebalance and reconstitution taking place late this month.  What is interesting about the group’s additions and deletions is that there are many of the hot (and not so hot) companies which came public via an IPO that are in the Russell index changes.

Bridgepoint Education Inc. (NYSE: BPI) is being added to Russell 3000 and to the Russell Global.  DigitalGlobal Inc. (NYSE: DGI) is actually trading as a busted IPO and it is being added to Russell 3000 and to the Russell Global.  OpenTable (NASDAQ: OPEN) is being added to Russell 3000 and to the Russell Global.  Rosetta Stone Inc. (NYSE: RST) is being added to Russell 3000 and to the Russell Global.  RHI Entertainment (NASDAQ: RHIE) was a distant IPO but it is being added to Russell 3000 and to the Russell Global.  SolarWinds Inc. (NYSE: SWI) is a very fresh IPO and is being added to Russell 3000 and to the Russell Global.  There is also a list of other key IPOs which were not included for certain issues.

Changyou.com Limited (NASDAQ: CYOU) was not listed in the first preliminary list for the Russell 3000 but that could be from an ADR status, the percentage of the free float to total shares, and the recent spin-off.  Grand Canyon Education (NASDAQ: LOPE) was not listed on the preliminary list, and that may be a free float issue versus total shares.  Mead Johnson Nutrition Co. (NYSE: MJN) was also not on the Russell 3000 preliminary list, but that may be an issue over the total float and spin-off. RackSpace Hosting Inc. (NYSE: RAX) was not on the initial list.

As noted with the speculative energy stocks getting booted off the list, there will be changes and adjustments announced today and next Friday before the final-final lists are posted on Monday June 29, 2009.

Jon C. Ogg
June 19, 2009

Challenging times impose their particular burdens on our political leaders. When hard work, ingenuity and perseverance aren’t enough to bring us prosperity, we turn our gaze to them in the expectation that their choices will improve our well-being. And every once in a while we are rewarded by public policy decisions made with firm resolve, not a moment too soon. When we think of courageous public policy, we probably think of historical measures like the Emancipation Proclamation or the Canada Health Act. We don’t generally view tax reform measures in that same heroic context. But I believe that Premier Dalton McGuinty’s recent decision to harmonize Ontario’s Retail Sales Tax with the GST, while it may not be historic, was indeed courageous. It is a wise public policy whose positive impacts will be felt for some time to come.

Ontario has long enjoyed an excellent reputation as one of the best places to do business in Canada. We boast the right combination of an educated population, excellent infrastructure and access to the industrial heartland of the U.S. that has served as a magnet for business investment. Ontario used to compete effectively with other Canadian jurisdictions and many U.S. states for that investment. But tax burdens have crept up on us in recent years to the point where it has become harder to justify the business case for Ontario-based operations, giving our business leaders serious concerns about the strength of the economy we are bequeathing to future generations.

 Many of us have taken that concern and advocated strenuously for a more competitive tax structure. And recently both the Federal and the Provincial Government have recognized the need for a more competitive tax structure by making significant reductions to taxes on investment.

 In Ontario, however, the predominant focus of concern has been the retail sales tax. Business has long viewed the RST as an outdated tax, preferring instead a value-added tax such as the GST. Under the Retail Sales Tax structure, business must pay tax on the inputs it uses to produce goods and services at every stage in its supply chain. That’s why almost all jurisdictions have abandoned this approach in favour of a value-added tax. So basically there is a built-in cost disadvantage for every Ontario business. We have to sell our goods and services at a higher cost as a result and so we share this burden with our customers. This places Ontario goods and services at a competitive disadvantage with goods produced in jurisdictions that can offer lower costs or more progressive tax structures. And, incidentally, this also means that goods and services produced for consumption in Ontario are priced at a higher cost.

Value-added tax structures permit businesses to reclaim the tax they pay on inputs to their production processes, so there is only one tax on the end-product. Businesses and economic experts have argued for many years now that no measure could do more to restore the competitiveness of the Ontario economy than to harmonize Ontario’s RST with the Federal GST. In addition to lightening the tax burden, harmonization will also reduce the red tape involved in complying with and filing two separate sales taxes, a burden that is particularly daunting for our SMEs. Harmonization will save businesses more than $500 million per year. This is money that was being wasted on unproductive paperwork and can be redirected to jobs and growth.

But harmonization is a tough sell for political leaders, particularly in difficult times. The impact of the RST was a hidden tax in addition to that paid at the point of sale that was buried in higher sticker prices. Prices will drop with harmonization and consumers will benefit but the benefits they enjoy may not be as obvious.

These are challenging times. We are confronting worrisome unemployment statistics. And most other financial news is gloomy. We need investment and growth. We need this measure now more than ever if Ontario is to return to the strong competitive position it traditionally held in Canada and in North America. For not only will it equip our businesses to compete better with their global rivals, it will also allow them to compete smarter. Information and communications technology investments are viewed as absolutely critical to strengthening the productivity and capacity for innovation of our businesses. Yet Canadian businesses persistently under-invest in this technology in comparison with their U.S. counterparts. There are a number of reasons for this but we must number the additional cost the RST structure poses on ICT investments among them.

Harmonization couldn’t come at a more propitious time. The leadership shown by the Premier, the Minister of Finance and their counterparts in the Federal Government could not be more welcome.

Bernard Courtois

President and CEO, ITAC

We have been keeping track of the 2009 IPOs that made it to market, and while one is barely broken, a portfolio of the IPOs from the pricing level gives a solid performance that might allow more and more IPOs to come to market.  For the 2009 IPOs we have only Changyou.com Limited (NASDAQ: CYOU), Rosetta Stone Inc. (NYSE: RST), Mead Johnson Nutrition Co. (NYSE: MJN), DigitalGlobal Inc. (NYSE: DGI), and Bridgepoint Education Inc. (NYSE: BPI).

Here is how each has done on a per-IPO basis, with the strongest performers first.

• Changyou.com Limited (NASDAQ: CYOU) priced at $16.00 and hit $29.00 today.
• Rosetta Stone Inc. (NYSE: RST) priced at $18.00 and hit $23.80 today.
• Mead Johnson Nutrition Co. (NYSE: MJN) priced at $24.00 and hit    $28.80 today.
• DigitalGlobal Inc. (NYSE: DGI) just last week priced at $19.00 and hit $19.75 today.
• Bridgepoint Education Inc. (NYSE: BPI) is only busted IPO that priced at $10.50    and is trading at $10.29 today.

We tallied up a $10,000 investment in each of these at the pricing to derive what a portfolio would look like from the pricing.  This is only 5 stocks, but this is all we have to work with from 2009 IPOs.  So a $50,000 investment in all of the 2009 IPO’s would be worth $63,541.00 today (pennies rounded down).  That is a gain of 27% on average.

Obviously, it is not fair to say that this portfolio would have netted out secondary market investors the same as many trad up from the IPO pricing.  But this is what drives IPO investors in their decision making, and this may be what gets the investment bankers and private companies off the fence to start issuing more and more IPO’s if the market remains strong or stable.

JON C. OGG
May 18, 2009

The IPO market has been really slow this year (this is only the fourth one), but that’s what happens when things aren’t going so hot in the economy.

Anyway, today marks the first day of trading for Rosetta Stone (RST), a company that makes computer software to help you learn a new language. 

You’ve never heard of them? Get with the program, people! These guys are considered one of the premier software makers in this space. The military gives this software away to its members to help them learn the lingo before they go out into world to do their thing (thanks to @crosberg for that little tip!).

The CIA and FBI also use the software—sound legit enough to you now? 

If you want to start the dialogue on Rosetta Stone or share what your experiences have been with the site, head on over the Rosetta Stone company page and spread the word.

Rosetta Stone I.P.O. Prices Above Estimate Range – DealBook Blog – NYTimes.com.

Rosetta Stone Inc. (NYSE: RST) has priced its initial public offering of 6.25 million shares of common stock at $18.00 per share.  Of the offering, Rosetta Stone is selling 3.125 million shares of common stock and its selling stockholders are also selling 3.125 million shares in this offering.  What is interesting here is that Rosetta Stone’s pricing is actually better than what many were expecting.

Morgan Stanley and William Blair are the joint book-running managers; and co-managers are listed as Jefferies & Company, Piper Jaffray & Co. and Robert W. Baird & Co.  The underwriting group also has a 30-day over-allotment option to purchase up to an additional 937,500 shares from the selling stockholders.

Earlier this month we saw a price range indication of $15.00 to $17.00 per share.   We have early whisper indications for a premium open to a premium pricing.

The company will have an implied market capitalization of roughly $400 million based upon the pricing, but that will adjust with the share price throughout the day.

Rosetta Stone is the leader in software-based language learning under the Rosetta Stone brand, with more than 30 languages in its self study portfolio.  While individuals are a large portion of revenues, it is also used by education institutions, government agencies, armed forces, and corporations.

Jon C. Ogg

Since the the last time I wrote on the Right Side of the Tree, they were in the midst of recording a full length album, The Novo Project. The album became to be a musical album for any party that a college night needed. But they did not disappoint featuring some great drinking songs. The whole album was actually done really well with the production of Matty P. The Novo Project has been out for a while and is available on iTunes. From their parody videos with Payne and Jones’ friends and  their fans new they had skill to produce a full album in complete length. The parodies were made for their fans but also themselves to enjoy. Yet they are still hilarious to this day. And now the RST boys have uploaded all their original content once more for our viewing pleasure. Form the “Beer Pong Anthems” to the unbelievable cover of Soulja Boy’s “Crank Dat”…

Though all these songs were hilarious and also great, only one song made their presence known. After everyone was splitting their ways from the original Right Side of the Tree, including everyone’s fave Bizz, Payne and Jones made a new cover. This time it had nothing to do with beer pong or drinking, but it was about the music. It became the new age of RST and their new sound and presence was to be reckoned with. They decided to make a an electric acoustic sounding cover of Lil Wayne’s “Lollipop”. Jones and Payne recorded a short version along with a video that now has over 1 million views. The song was gaining so many fans in their area that it actually got on the radioand people were calling in to request live on the air. So here is the video for “Vanilla Lollipop”…

Right now the doors have been open for Right Side of the Tree to even go into more of a hip-hop/rock genre. On their last album they were many songs that stood out especially a track with the R&B singer Lloyd. But my two favorite songs are “Beer Pong Kings” and “Can’t You See”. I actually played the “Beer Pong Kings” track at a party last weekend it everyone in that time had to know who sang that song. We had to play it at least 5 times that night. The lyrics are absolutely perfect for the beer pong sport. As for “You Can’t See” the song is just a great summer acoustic song for eveyone to enjoy. But this is where the news is flying. Since there has been well received attention to RST they are actually going to work on a new album for this summer. Not only Matty P. is back to produce and rap  on the album but a good friend is back to join. That’s right Bizz is back in the building everyone or he’s just back in Right Side of the Tree. Listening to Bizz’s new stuff he’s ready to come back with a vengeance. Even though his style was shown on the older songs his flow has been mastered and Bizz is ready to record. The RST boys and Bizz already made one track together and a video will soon follow. But here is the new track, “Double Shot” featuring not only Payne and Jones but Matty P. and Bizz on the verses. So check this out…