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Retail Industry ATG - Chapter 3: Examination Techniques for Specific Industries (Auto Body/Repair)

NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.


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Retail Industry ATG - Chapter 3: Examination Techniques for Specific Industries (Auto Body/Repair)

Introduction

Overview

Most auto body shops are small to medium sized businesses operated as sole proprietorships, small partnerships, or closely held corporations. They range in size from the corner shop to large franchises with many locations. Specializations range from domestic or foreign vehicle repair to classic vehicle restorations. They are combinations of service type businesses with retailing aspects mixed in. Although they provide the labor and skill, they must also purchase and resell the needed parts.

A body shop is also regulated by environmental agencies. Because of today's tighter air quality restrictions, the amount of hazardous materials it may use on a day-to-day basis is limited. Hazardous emissions include paints, toners, and thinners which are used in spray form. Because violations of air quality regulations can bring stiff penalties, these regulations are often closely adhered to.

Description of Auto Body Repair Process

Repair/Replacement

A distinction should be made between the term "repair" and "replace." These two terms involve separate processes. If a body component has been completely mangled, it will simply be "replaced." This is the easiest type of body work since the process involved is simply purchasing the part, installation, and painting. "Repair" work may involve pounding out a dent if it is simple, or it may involve straightening the frame which is the most extensive and complex type of body work.

With the advent of unibody construction, the repair process has been made even more complex. In the older domestic vehicles, components were bolted to a frame which acted as the support for vehicle road shock. In unibody construction, the components act as the frame. If a unibody vehicle has been damaged, simply replacing the component may not be enough to restore the vehicle. Other components must be checked to determine if they have been shifted from the original positions.

Another change is the safety concept of "energy absorption." Essentially, this allows the body to absorb a higher percentage of the impact from a high speed collision. This also means that the body collapses more easily. This makes the vehicle more susceptible to damage at lower speed impact as well. In the chapters to follow, the term "repair" refers to either the repair or replacement process unless another specific distinction is made.

Paint Process

Once the vehicle has been repaired it will be painted to match the original color as nearly as possible. If the vehicle has the factory original paint, the "formula" for that color may be available by the manufacturer. Paint mixing systems vary with each body shop. Some maintain the formulas on microfiche while others keep them in a computer database. Smaller body shops may depend on the paint stores to mix the needed paint. Before the paint is applied, the repaired part is sanded and sealed to remove scratches and prepare the surface. After it is painted, a clear coat is applied to give the paint a shiny or metallic look.

Other Processes

A collision may not only damage the body exterior but also the mechanical functions inside. Some body shops will perform minor mechanical work, such as radiator replacement or easy electrical work. Major mechanical work is usually sublet out to an auto repair shop.

Other processes include tire and glass replacement, upholstery repair, and cleaning of the vehicle which involves washing and waxing the exterior and cleaning ­and scenting the interior.

Estimation Process

An examiner should be familiar with the estimating process since gross income is based on this Concept. An estimate is used to provide the customer with the final cost or as an agreement between the shop and the insurance company as to how much will be paid for the job.

The estimate may be prepared by the body shop, the insurance company, or an independent appraisal company. The major sources of information from which estimates are prepared are the Mitchell Collision Guides. These guides are available in book form or as computer software. They provide the auto body shops with the information required to estimate repair costs. The actual process of estimating is very easy for the replacement of a particular part as opposed to repairing it. This is due to industry standards provided by services such as the Mitchell Collision Guides. Insurance companies also have their own in-house standards and rates. Smaller insurance companies use independent appraisal companies that specialize in auto repair estimates

If an estimate has been prepared by the auto body shop, it must still be approved by the insurance company which is paying the claim. These estimates are subject to some negotiation between the body shop and the insurance company. Usually, the negotiated items will include the labor charges and the use of used or "after market" parts.

Some of the differences between body and repair shops:

Body Shops

  • Auto body work is mostly reimbursed by insurance companies.
  • Body shops buy parts primarily from dealerships.
  • Body shops generally buy what is needed for a specific job but may stock some paint materials and small supplies.
  • Body shops see their customers far less often.
  • Body shops usually use estimate forms with their repair orders.
  • Body shops generally charge a different rate for metal, paint, and frame labor.
  • Body shops sometimes pay all or portion of their staff on a based percentage of labor billings.
  • Body shops generally have work- in-process but little parts, materials and supplies inventory

Repair Shops

  • Repair shops have some insurance work but most of the costs are paid by the owner of the vehicle.
  • Repair shops buy parts from dealerships but frequently buy bulk parts from other suppliers at lower costs and may also stock items such as batteries, etc., on consignment.
  • Repair shops often order common parts in bulk as well as lubricants and fluids.
  • Repair shops are likely to have a steady clientele and a lot of repeat and family business.
  • Repair shops may not use the estimate forms seen in a body shop.
  • Repair shops may charge a flat rate for mechanical labor which is usually billed at a higher rate.
  • Repair shops usually pay an hourly wage.
  • Repair shops usually have less work-in-process and stock parts, materials, and supplies.

Initial Interview

Since the Auto Body and Repair Industry is also a service operation, question the Auto Body Shop regarding the processes involved. Ask about the type of vehicles repaired. Find out how much time it takes to complete an "average" job. Determine how the Auto Body Shop treats the workers, that is, employees or independent contractors.

Find out what function the officers, shareholders, and relatives have in the corporation. Officer salaries may be subject to excess compensation issues. Ask if shareholders or their relatives have dealings with the corporation as perhaps landlords, suppliers, or customers.

Questions about the accounting records should be directed to the bookkeeper, controller, secretary, or accountant unless the principals are involved directly in the record keeping. It is important to know exactly how the records are kept and become familiar with any unfamiliar notations used by the Auto Body Shop. This is particularly true of computer maintained records that may use many different sets of reference codes.

The acquisition of substantial new machinery and equipment might suggest a shift in operations. A number of luxury autos on the depreciation schedule could prompt specific questions about the use of the cars in the business and such events as ownership changes, theft losses, and asset sales would merit specific inquiry.

Some questions to incorporate into your auto body/repair interview follow below. The listing includes only items relating to the repair process, sales, and officer/shareholder duties. Questions about the business history, accounting methods, internal controls, and mandatory items should, of course, be added:

  • When are initial estimates made? Is any charge made for them?
  • After the initial estimate is made, how are contacts made with the insurance company?
  • Does the estimate vary with the final bill?
  • Are repair orders used in sequential order?
  • When is the repair orders dated? (Is it dated when the customer authorizes the repair either orally or in writing, or is it only when the customer signs the order, etc.)
  • What happens if a repair order is voided? Is it thrown away or retained? How many are voided?
  • Do some repair orders require supplements? Is a new repair order written for the supplement? When will the supplement be paid for? Is the vehicle released prior to the receipt of the supplement? When will the supplement be recognized as income?
  • When are parts ordered for a repair job?
  • How often is paint purchased?
  • At what discount do you purchase parts? (will vary with make of vehicle)
  • What are the labor rates charged for repair (will vary depending upon type of work needed)
  • Do you supply loan cars? If so, do you get rebates from rental companies for the loaners?
  • When will a job be booked as a sale?
  • Do you have steady referrals from dealerships?
  • Are deductibles ever waived? What would be the circumstances?
  • Are liens ever placed on vehicles for sale or recovery of expenses?
  • If the Auto Body Shop maintains inventory on the return, ask how the inventory has been computed and of what it is comprised. Any consigned items?
  • How is the payroll determined for the repair staff? (hourly wage, salary, percentage of labor charge or a combination)
  • How the repair staff is treated - employees or independent contractors?
  • If Auto Body Shop is a C-Corporation, what are the duties of the current shareholders?
  • What is the current percentage ownership of each shareholder?
  • How is officer compensation (salary, bonus, fringe benefits) determined?
  • Does any officer, relative, or group of which an officer is a member, have dealings with the corporation other than as an employee? (that is as a lessor, vendor, consultant)
  • Does the corporation own or lease vehicles assigned for the use of specific officer/shareholders?

Tour of Business

A typical auto body shop will usually have a parking area where estimates are made, for storage of vehicles, repair stalls for light and heavy work, storage areas for paints and other supplies, and offices where the officers can order parts and perform day-to-day paperwork.

If the Auto Body Shop has not shown any inventory on the return, are there parts lying around the premises waiting to be installed? Does the storage area for paint hold cans of paint? Does it appear that there is adequate space for vehicles to be stored for a few days or even weeks at a time? Note any major equipment lying around and which appears to be no longer in use.

If the Auto Body Shop has stated that the workers are independent contractors, notice if they are wearing uniforms of the Auto Body Shop. Are they utilizing the major equipment provided by the Auto Body Shop? Are they actually working on the premises of the Auto Body Shop?

Take a look at the size of the lot and any adjacent areas which may not appear to be related to the Auto Body Shop and note the addresses. The Auto Body Shop may rent the adjacent area and may be actually sub-leasing it to a third party. A review of the lease agreements at a later date should show the addresses under lease. This should show up as other income or a credit to rent expense.

Ask the Auto Body Shop to explain the repair process from the tear down process to the final drying of the paint. With an adequate understanding of the repair process, the documentation reviewed during the audit may be easier to interpret.

Books and Records

General Books and Records

Distinctive journal encountered fairly consistently was the sales journal which will usually break sales down into the following categories:

  • Parts/Paint/Material sales
  • Labor Sales: Further break down will be metal labor (body work), paint labor, and frame labor
  • Sublet Charges
  • Towing Charges
  • Storage Charges
  • Sales Taxes

Specific Documents

In performing an effective audit, it has been noted that many documents beside the usual purchase invoices, cancelled checks, etc. are helpful:

  • Estimates: Estimates may be prepared by the auto body shop, the insurance company, or an independent appraisal company hired by the insurance company. Information available will be on an item by item basis. The following may be included on the estimate:
    • Insurance Company - Name, address, and telephone number of specific office handling the claim.
    • Date of Estimate - This date may be important in determining when the vehicle was actually brought in for inspection.
    • Date of Loss - Date vehicle was in the accident
    • Vehicle description - Vehicle type, model, year, identification number, license number and mileage when brought in.
    • Customer name and whether that person is the claimant or the insured party. An address and phone number may also be listed.
    • Part description - Details whether the part fits on left or right side of vehicle, front or rear, and the specific name.
    • Part Number assigned by the manufacturer.
    • Suggested retail price of the part.
    • Allowed labor hours to install the part.
    • Paint materials, their cost, and the allowed labor hours.
    • Sublet expenses such as mechanical repairs, glass replacement, anticipated costs, and allowed labor hours.
    • Towing and storage charges
    • Sales Tax on parts and material.
  • Repair Orders: These vary in detail and complexity. This document differs from the estimate in that it records the actual costs associated with the repair of the vehicle. It will usually summarize the information rather than list the individual items. The following items may be listed:
    • Customer Name, address, and phone numbers.
    • Repair Order Number - Repair orders are usually sequentially numbered and may be used as a basis for recording the sales.
    • Repair Order Date - This may be the date that the vehicle is picked up by the customer. However, this date may vary depending upon when the repair order is prepared.
    • Customer Authorization - The customer will sign the repair order to begin the work. Note that several signatures may be required on the repair order depending upon whether the customer is also authorizing the body shop to sign or endorse any checks made payable to the customer.
    • Actual parts cost to repair the vehicle. These figures will usually be summaries of the parts purchases. Vendors and invoice numbers may also be listed. In some cases, the net price (wholesale) and the list price (retail) may be listed.
    • Sublet Charges - Mechanical repairs, glass replacement, tire replacement, etc.
    • Labor Charges - Repair Orders will usually list only the final totals and omit the actual hours worked or allowed.
    • Towing Charges - Usually listed as a separate category.
    • Checks paid - Body shops will often record the payments received from the customers (deductible payments) and insurance companies. Information will often include the specific check number, the date the check was received and the amount of the check. This information is often needed to determine when the sale should be recorded.
  • Supplements: Supplements can be written on estimate sheets, repair orders, sales invoices, or body shop correspondence. Essentially, supplements summarize the additional parts, sublet, and labor charges that are incurred after the original estimate was approved. Supplements should have the following information:
    • Customer Name and the Date supplement was either written up or approved,
    • Vehicle description,
    • Insurance Company authorization.
    • In some cases where the body shop has a good relationship with the insurance adjusters, only the shop owner's signature is required.
      It should be noted that supplements are generally paid by a different check from the original insurance payment. There may be a significant time lag between receipt of the original insurance check and the supplemental payment.
  • Sales Invoices: In some cases, a sales invoice may be prepared for the customer and all charges are recorded separately. For instance, parts, labor and sales taxes may appear as three separate items. Trace parts purchases and other costs from the vendor invoice to a specific job.
  • Parts Invoices: These invoices are mentioned to point out that the parts costs are recorded at both wholesale and retail. It is important for the examiner to note these differences when inventory is an issue. Moreover the determination of the discount received by the shop is important if he is planning to extrapolate inventory adjustments or parts revenue.

The Mitchell Guides

The Mitchell Guides and Mitchell Software provide information which is one of the primary tools of the industry; so the examiner should understand how the reference works. The Mitchell Guides are essential for both auto body shops and insurance companies to prepare estimates in a quick and efficient manner.

The Guides are a series of volumes which contain pricing and repair information for automobiles. They are broken down into specific years and vehicle manufacturers. The specific title used by the auto body industry is the Collision Estimating Guide (Either Domestic or Foreign). Volumes and software are updated several times each year depending upon pricing changes.

The user is provided with general parts information such as illustrations, parts numbers, and whether interchangeable or discontinued. The Guide includes the cost of the parts at manufacturers' suggested retail prices at the date of publication.

Mitchell also supplies the suggested labor time (in tenths of an hour) it will take to replace a particular part. These times will be broken down into the complexity of the labor involved (that is, body, frame, paint etc.). Labor times will also be provided for replacement of glass, application of stripes and decals, and for things such as sanding and grinding.

Organization of Records

It is important to identify how the records are organized since the nature of the examiner's request will depend on the method used:

  • Current Jobs: Auto Body shops usually maintain current jobs in folders (job jackets). The information contained will include the estimates for that particular job, the repair order, the dealer invoices for the parts, correspondence with the insurance companies, and the flag sheets which keep track of the number of labor hours spent on the job.
  • Usually the above information is kept together in one package by customer. This allows the shop to answer most questions which may arise once the job has been completed.
  • Sometimes the Auto Body Shops will separate the invoices by vendors. This is especially true where shops have established a credit line allowing all invoices accumulated in one month to be paid off at one time.
  • In smaller body shops it is not unusual for all information to be accumulated by the month. Invoices paid and sales collected in a single month will be filed together in an envelope.

Income

Introduction

The repair process in a body shop typically begins with the preparation of an estimate by the shop, either on the premises, or in the field if the car is not drivable. The estimate includes detailed categories of expense for labor, parts (at the retail list price), the cost of work to be done off the premises, and towing, if necessary.

If the owner of the vehicle is to bear the full expense of the repair and chooses to deal with the shop, a repair order is written reflecting the figures already on the estimate with any additions or deletions specified by the customer. The customer signs the repair order to authorize the indicated work to be done.

If there is an insurer, the company is notified and dispatches an adjuster to the shop to make its own inspection and estimate of repair costs. This estimate is often lower than the one written by the shop because the insurer may not allow the full labor rate customarily billed and may eliminate part of the standard time to repair as duplication. For instance, the time required painting a fender and the adjacent door panel may be considered less than the sum of the times needed to paint each section alone. Further reduction can be made for "betterments" and the cost to repair rather than replace parts or the use of "after market" or used parts instead of new factory parts.

The cost of new auto body parts and the suggested installation time are listed in the Mitchell Manual, which is invariably used by both the shop and the insurance adjuster, but judgment about what needs to be replaced and what does not often leads to substantial variation in quoted and approved repair costs. The estimates in the example below, illustrate the differences possible. The insurer's estimate shown is the final figure agreed to by the claimant and the areas of alteration from the initial offer are noted below the chart.

To secure the work, body shops will generally accept insurance company rates, which can vary from company to company and by geographic area. They can negotiate with the adjuster on other points to obtain concessions, however, as was done by the insured to obtain the settlement charted. Once the insurance company has approved an estimate, work on the job can proceed and a repair order is generated echoing the approved amounts. Approval by the insurance company fixes the amount that will be paid by them and a check or draft is issued to cover their portion of the liability. In the case of collision, or a finding that both parties to an accident are at fault, the insurer's payment will be net of any deductible stated in the policy.

Some shops openly advertise that they will "save your deductible" and others will offer the option if pressed, or at least offer some concession. This is generally accomplished by repairing versus replacing or by installing used or after market parts instead of factory replacements. Other shops will make no such arrangement and require full payment of any deductible on delivery of the completed job. This practice however, since it is fairly common, opens a door to considerable abuse in reporting income when a deductible is shown as waived in the accounting records, but was actually collected.

An interim step may be taken between the approved estimate and repair order and the completion of the job. If a complete tear down was not done before the estimate was made, previously hidden damage may surface once damaged sections are removed. Parts prices may also have increased since the last issued Mitchell Manual. When this occurs, the customer or his or her insurance company must be notified and approval to perform additional repairs secured. If an insurance company is involved, an adjuster may again be sent out to inspect the damage, or approval may be given over the phone, particularly in the case of price increases. In either case, a second supplemental payment will be issued by the insurer and receipt of this payment may be delayed some time beyond both the originally approved charges and the completion of the work. Whereas supplements are not common, neither are they rare. There should be a new repair order written for the supplement, with payment separately accounted for, though occasionally only an addendum is made to the existing file.

Auto Body Shops example of expenses illustrating the differences possible between shops and Insurer
Parts Expenses: Shop 1 Shop 2 Shop 3 Insurer
Front Lamps Assembly $61.73 $61.73 $81.82 $61.73
front Fender $159.17 $159.17 $150.60 $159.17
Front bumper cover $32.43   $30.68 $32.43
Splash Shield $29.95     $33.85
Moulding - protective     $22.98  
Front bumper cover     $219.05 $231.53
Parts Totals: $283.28 $220.90 $505.13 $518.71
Labor Expenses: Shop 1 Shop 2 Shop 3 Insurer
Labor:
Sheet Metal Expenses
       
Hours

8.1

15.3

17.0

8.0

Rate $28.00 $28.00 $28.00 $26.00
Sheet Metal Total $226.80 $428.40 $476.00 $208.00
Labor:
Refinish (paint) Expenses:
       
Hours

4.4

12.3

11.0

5.9

Rate $28.00 $28.00 $28.00 $26.00
Refinish Total $123.20 $221.40 $198.00 $153.40
Labor:
Mechanic (frame) Expenses:
       
Hours

0.0

1.5

1.0

1.0

Rate $- $45.00 $45.00 $35.00
Mechanic Total $- $67.50 $45.00 $35.00
Labor:
Sublet Expenses:
       
Paint Materials $79.20     $88.00
Cover Car $10.00 $10.00   $10.00
Wheel Alignment $65.00      
Undercoat $8.00      
Wash & Wax   $25.00    
Hazardous Waste Fees     $26.80  
Sublet Totals $162.20 $35.00 $26.80 $98.00
Total of all expenses: Shop 1 Shop 2 Shop 3 Insurer
Parts Totals: $283.28 $220.90 $505.13 $518.71
Labor Totals: $512.20 $752.30 $745.80 $494.40
Sales Tax: $31.39 $36.49 $45.70 $50.92
Total of all costs: $826.87 $1,009.69 $1,296.63 $1,064.03

Categories of Charges

Parts and Materials

Parts include any replacement to a vehicle component done by the shop. For a body shop, that usually means metal sections, such as door skins and fenders, headlights, bumpers and covers, skirts and trim. Anything more than the simplest mechanical, glass, tires and wheels, and upholstery work is generally sublet. Materials include the cost of paint materials, primer, and clear coat used to refinish a vehicle. The costs should be separately shown on an estimate and segregated on a repair order.

In a repair shop, parts include any mechanical replacement or betterment from water or fuel pumps and rebuilt engines, to spark plugs, glow plugs, and gaskets. Tires and batteries and accessories may also be included if the shop deals in them.

Labor

Labor is usually broken down by category in a body shop since rates differ for each category of service. The distinction is usually made between metal and less highly compensated paint or finishing labor. Frame labor, if not sublet, may also be stated separately and will command the highest hourly rate. Mechanical labor in repair shops is generally billed at a flat hourly rate for all services without the distinctions made in body shops even though the skill level required to perform different tasks varies.

Sublet

Repair of glass, tire replacement and wheel balancing, radio and accessory replacement and repair, body striping and upholstery work, as well as most mechanical work are sublet by body shops. Repair shops sublet the preceding, except mechanical work, and most body and paint work.

Towing

Towing is occasionally included in sublet accounts but usually listed separately. Tow charges needed to deliver the vehicle to the repair shop and billed to the facility are rebilled to the customer at cost or with a small markup. Significant payments to towing companies, especially a single company, can be a signal of an abusive practice in the auto body industry, explored in the Expenses section of this guide.

Storage

While not usually a major source of income, all body shops will have some income from storage fees. Charges vary, but can be levied at $20 to $25 a day and arise when 1) a car towed in for repair is totaled out but the insurance company does not promptly assess and remove the vehicle 2) a car is left for an estimate and the owner declines to authorize repair or remove the vehicle and 3) a repaired vehicle is not picked up promptly after notification that the work is complete. In the last case the usual charge levied is less and a grace period, usually 3 days, is allowed before fees are billed.

Vehicle Sales

Shops occasionally repair and resell damaged vehicles purchased from individuals, salvage yards, and auctions. Vehicles left for repair or estimate that have not been claimed are subject to lien sale. The cost of filing ranges from $45 to $70 through a company providing this service, depending on the value of the vehicle, and can be recovered from the customer redeeming the vehicle prior to auction. Lien sale filings can also be made directly through the State Department of Motor Vehicles. It is unusual to find more than a handful of lien sales filed in the course of a year at a shop

Other Income Sources

Rebates and Refunds of Expense

Car rental agencies may rebate a portion of the fees paid by the repair or body shop or customers referred by them.

Insurance dividends and cancellation adjustments may be treated as an expense account reduction but may be reported as miscellaneous income, especially if applicable to a prior period expense.

Vendors issue checks for merchandise returns when the shop does not maintain an account. In some cases, refund check is issued for larger items even if a credit line is maintained. These refunds may be reported as a credit to the expense account rather than income.

Supplemental Payments:

The Auto Body Shop may record their sales based on the final repair orders which listed the income to be received from the customer's insurance company. If supplemental work is required afterwards a separate repair order is prepared. During the last month of the year, the Auto Body Shop could record the initial income as stated on the original repair orders but would omit the supplemental payments. They would record those as income when the supplemental payments were received. A comparison of the year ending cash receipts journal with the subsequent year's cash receipt journal often revealed the same customer names. Question the owner why the supplemental payments were not recorded with the original repair order. The Auto Body Shop may respond that supplemental payments were not assured of being paid. However, in many case, the supplemental payments were almost 100 percent guaranteed of being paid especially if an insurance companies approved them in the first place. In this situation, the accrual basis Auto Body Shop should have recorded the entire sale since all work was completed. Although this is essentially a timing difference, this can result in a significant adjustment in the first taxable year corrected.

Other Sources

Repair shops may also sell gasoline or issue smog certificates. The number of certificates issued to any location should be traced.

Indications of Underreporting

Estimating Sales

In the auto repair business there are some calculations that can be made to give an idea of the range of sales that should be expected given a claimed level of costs, if those costs are accurately categorized.

The average discount received on factory parts by body shops and the repair shops examined was 20 percent to 25 percent off retail. This is equivalent of a markup of 25 percent to 33.3 percent. Examination of purchase invoices from a cross section of suppliers used by a specific business will enable the use of a more accurate figure, but the preceding percentages will put you in the ball park.

Parts other than factory parts, especially those purchased in bulk from large supply houses have a much higher markup, though the shop may not bill at the suggested retail as shown on the invoice. Markups can range over 100 percent on parts like water pumps and much more on smaller items like gaskets and filters. An average can be obtained by inspecting the detail invoices from the suppliers used and repair orders.

In auto body shops, management will try to keep labor costs down to 40 percent of labor sales, including any down time. Some shops pay wages based on this sales percentage. Some body shops may pay body men at a 50 percent rate during the time it treated them as "outside labor," but changed to 40 percent when the status was changed to that of employee. Double labor costs to initially estimate labor income. If the owner works on the vehicles, the value of his or her labor should be added to the labor costs ­reported in cost of sales .Using these figures from the return or the trial balance as a starting point, it is possible to determine a range of income expected. If the income actually reported is outside of this range, find out why. One reason is underreported income, but there are ­others, some of which are:

  • The above percentages are invalid for this particular business, especially for labor.
  • Costs have been mis-categorized.
  • Some labor costs may be paid "off the books”. This will make imputed income from labor lower.
  • There may be a large unreported inventory variance.

Once the examination is under way, the direct expenses can be categorized and the above percentages refined depending on costs at the shop under examination. If the calculations have been done correctly and there is still a significant difference between what expected sales should be and what was reported, an attempt to reinforce the findings using another method or consideration of another factor should be made.

Repair Orders

These are usually numbered and used consecutively just like checks in a checkbook. Having asked earlier what is done with voided orders and how many are voided, ask for the voided orders if they are retained and set up a series of work papers to cover all of the numbers of the earliest through the final repair orders reported for a quarter or the year. The numbers of the orders included in sales can be marked and any gaps will become apparent. Some of the skipped numbers may be accounted for by voided orders, if they have not been supplied, but this should not be a substantial amount. At the beginning and the end of a period, work may have been completed in the prior period or remain in process until the subsequent period. After consideration of these factors, substantial numbers of invoices missing from the sequence can be another indication of unreported amounts. This can't show how much is not reported, but unexplained missing repair orders may account for the difference between the estimate of expected income and the amount reported.

Conversely, if there are no gaps in the reported repair order sequence, it does not necessarily confirm that no sale went unreported. If repair orders are not numbered, a schedule of the number written by date may provide indications of omission, especially in a repair shop.

Other Income Issues

Waived Deductibles

As stated earlier, saving or waiving a deductible in whole or part, in order to attract business is not uncommon among auto body shops. This is usually accomplished by repairing rather than replacing a part or substituting used or after market parts for factory parts or just by shaving the profit margin in some cases. The repair order may echo the insurance estimate, with the deductible marked "waived" and the sale entered into the sales journal at net, or the waived portion may be accounted for as customer allowances or concessions.

An insured collision repair is payable in two parts, the insurance company's check or draft and the insured's deductible payment. If the copayment is fully waived, the insurance payment is considered as payment in full and either method of accounting for the income outlined is an accurate representation. If, on the other hand, the repair cost is fully paid in the usual manner and the deductible is shown waived on the accounting records only, considerable income can be unreported.

If deductibles are routinely shown waived and you suspect that they have actually been collected, third party contact with some of the customers is facilitated by the phone numbers customarily included on all repair orders.

Cash Payments

Most customers pay by check or credit card. Check the detailed duplicate deposit slips usually attached to the appropriate repair orders. The duplicate deposit slips correspond to the bank deposits shown on the statements, though the posting date was often delayed. Many body shops insist on payment by a certified or cashiers check or cash.

Cost of Sales

Introduction

Cost of sales for an auto body business will be the largest category of costs shown on the return. Because of the large dollar amount relative to the other expenses, cost of sales warrants special attention. It encompasses at least three major costs categories which are:

  • Purchases
  • Labor
  • Sublet Expenses
  • It may also include inventory totals for the beginning and ending of the year.

Purchases

The major cost associated with the purchases account will be for parts used in the replacement or repair process. These can be purchased new from auto dealers or parts stores, or may be purchased used from auto dismantling businesses. In some cases, entire automobiles may be purchased for the sole purpose of obtaining parts. Depending upon the services provided by the body shop, parts may include items such as panels, doors, bumpers, fenders, hoods, etc. as well as minor engine parts such as water pumps, radiators, etc. Purchases accounts also include the cost of materials used to restore the vehicle to its original state once the parts have been replaced or repaired. This category includes bond, primers, thinners, paints, sandpaper, etc. These will usually be purchased from businesses which specialize in automotive paints. Since the majority of jobs are paid for by insurance companies, the amount the auto body shop will eventually receive for the repair of a vehicle will be determined before the job is actually started. Insurance companies allow retail list price for parts, paint, supplies and other items. Vendors will normally provide discounts to auto body shops ranging from 15 to 40 percent of the retail price. If an Auto Body Shop can purchase so called "after market" parts (which are usually encouraged by insurance companies) the discounts will range even higher resulting in greater profits for the body shops. Parts purchased locally can usually be delivered in a matter of days or even hours. However, in some cases, parts need to be ordered directly from overseas factories which can result in delays of several weeks or even months. If a part is no longer manufactured, the auto body shop may have to search the various dismantling businesses to find one. Some fabricate parts for high end or classic vehicles.

Records to Request/Examine:

  • General Ledger
  • Disbursements and/or payables journals
  • Journal entries or accruals
  • Original Estimates - These documents may be prepared by the Auto Body Shop or by the insurance companies. The estimate is their authorization and agreement to pay. They also provide the "expected" parts, supplies, and labor costs needed to complete the job based on the Mitchell Collision Guides or the insurance companies own in-house pricing systems. The actual prices paid by the Auto Body Shop may differ depending upon whether original factory parts, "after market” parts or used parts are installed. Once the estimate has been approved, the total costs should agree with the total costs shown on the repair order.
  • Repair Orders - This document should have the customer's authorization to begin the job. It can also provide other important information such as the customer's name and phone number, date a job was started, itemized listing of parts, supplies, labor, sublet expenses incurred at retail or wholesale, make, year, model of the vehicle, and the date of payment. It provides a useful summary of costs for each job.
  • Vendor Invoices - These invoices will list the parts prices at retail and wholesale. This allows an examiner to compute the discount provided to the auto body shop for inventory and income probe purposes. Since many body shops can purchase parts on credit, individual invoices may be collectively paid in one lump sum at the end of the month and may be accompanied by a summary statement. Information which may prove useful is that these invoices will often list the model and year of the vehicle which is associated with the parts purchased.

Purchases Audit Procedures

Auto Body Shop's method of filing their records may require modification of the examiner's transaction selection process. Because these situations may arise, they are mentioned here:

  • Source documents maintained by customers. In this situation, the Auto Body Shop will maintain all source documents estimates, repair orders, vendor invoices, and sales invoices by customer. This type of arrangement makes transaction selection from the general ledger or disbursements journals difficult since vendor invoices which may comprise a single transaction in the general ledger may be separated if pertaining to several customers. If this type of arrangement is encountered, the transaction selection process may need to be made from the sales journals in conjunction with the income test work. It should be noted however, that this type of arrangement makes the inventory test work easier.
  • Purchase invoices maintained by vendors. This is the "standard" situation encountered. This arrangement allows the examiner to trace entries made into the purchases account directly to specific source documents. However, repair orders and estimates may still be filed by customers. In contrast to the preceding situation, inventory test work is more difficult.
  • Source documentation filed by month. This situation is commonly encountered with smaller businesses. The estimates, repair orders, vendor invoices, and sales invoices are all filed by the month that the transaction was paid or that monies were received. It should be noted that in order to test the accruals, the subsequent year's first month documentation will need to be requested.

Labor

The labor involved in restoring a vehicle to its original state after a collision can be quite extensive. If the damage to the vehicle is limited to its exterior, then the replacement of a part can proceed quite quickly with very few hours or even segments of an hour. However, if the frame of the vehicle has been damaged then the amount of labor involved can escalate. Usually labor is broken down into several primary categories. Labor personnel can be paid either by the hour or on commission. The commission may be a percentage of the allowable amount determined by the insurance companies.

Metal Labor

Metal work usually involves the process of replacement or the repair of a part if possible by either straightening or pounding or a combination of both.

Frame Labor

Frame labor is the most highly skilled and compensated of the total labor involved. Special equipment and skills are needed to correctly straighten or correct a frame. The work involves continuous alignment of points on a vehicle so that it rides as it did in its pre-damaged state.

Paint Labor

Painting or finishing may or may not be a separate labor category since some auto body shops have body workers who also act as paint personnel. In most cases, however, the paint labor will be separate. In situations where the auto body shop has its own paint mixing system, the personnel in charge must be able to mix paint, toners, and thinners to match the original paint of the vehicle. In some cases the personnel must be skilled in the art of "blending" which means gradually lightening or darkening the mixed paint so that any mismatching due to fading in the original paint is not so striking. Paint labor also involves the actual sandpapering, wet blocking, application of the bond, and the eventual spraying. This is the least skilled and compensated of the labor involved.

Minor Mechanical Repairs

Some body shops will do minor mechanical and electrical work. This will involve replacement of water pumps, radiators, lights, etc.

Audit Procedures

Because of the rise in labor related costs such as worker's compensation, health insurance, and employment taxes, some Auto Body Shops treat all or part of their labor force as independent contractors. The actual determination of whether individuals are employees or independent contractors should be discussed with your Employment tax specialist. The examiner should be aware of certain signs which may indicate an employment tax issue.

  • During pre-audit of the return, compare the employment tax deduction with the respective labor, wages, and salaries. Therefore, an estimate (restricting officer's salary to FICA maximum if it is large and the shop is small) of the wages should give a rough approximation of the true employment taxes. For computational purposes, the examiner can make the assumption that all wages are subject to FICA but no more than one-half subject to unemployment taxes.
  • Package Audit Steps - This includes a reconciliation of the wages per the books to the employment tax returns. This reconciliation is recommended since this may highlight labor deductions which do not hit the employment tax returns. Another suggestion is the comparison of the employment tax returns associated with the year of audit to the subsequent returns filed up to the current year. Some Auto Body Shops convert their "independent contractors" to employees when they moved locations. This was highlighted by a sudden jump in wages and employment taxes. The reverse may also be true.
  • The examiner should inspect the general ledger for a breakdown of the various labor costs being booked. The source of the entries should be some sort of payroll register. If the entries are flowing directly from a cash disbursements journal, this may indicate that straight disbursements without withholding have been made.
  • Examine the Form 1099 statements issued by the Auto Body Shop. For example, if the Form 1099 statements were made out to "A…'s Auto body" or "B…'s Auto body." Consider them unusual since auto body shops normally do not subcontract work out to other auto body shops.
  • During the walk through of the place of business, notice if the personnel working in the paint department, frame area, or repair area, are wearing uniforms with the Auto Body Shop's business name on them. This indicates that they are representing the Auto Body Shop. Then check the employment tax records to see how they are being treated.

Sublet Expenses

Sublet expenses are those costs incurred for services and supplies which are not normally provided by the auto body shop either because the shop is not equipped to handle them or the cost would be prohibitive. As with the parts, insurance companies allocate reimbursement based on Mitchell Guides or their own in-house studies.

Some common sublet expenses are

  • Tire Replacement - If a vehicle's tires were damaged then the body shop will sublet the vehicle out for replacement and wheel alignment.
  • Window Replacement - Replacement of glass or mirrors and tinting.
  • Detailing - Involves car washes, waxes, cleaning of the vehicle, and "scenting" the interior.
  • Pin striping -Involves specialized painting or application of decals to the vehicle for enhancement purposes.
  • Upholstery Work -Replacement or recovering of seats.
  • Mechanical Repairs - Involves any major mechanical work which is not performed by the body shop.

Many other costs may be classified as sublet depending upon the accounting organization of the Auto Body Shop. The purpose here is to make the examiner aware of the different type of costs incurred by the Auto Body Shop.

Expenses

Uniforms

Occasionally an employer will buy uniforms or T-shirts for use by his or her employees. More often, however, a service will be used to supply and clean uniforms, cloths, and towels. Inspection of the invoices can show the quantity supplied on a regular basis and the number of persons working on the premises may be inferred. Some shops withhold a moderate uniform charge from compensation paid with the withheld amounts generally offsetting the expense account. Such withholding indicates work performed on the premises and a degree of control exercised by the employer.

Other Investments Account of the 1120 Balance Sheet.

For example, the ending balance for a 2006 year listed the balance as $190,000. The beginning balance for the 2007 year listed the amount as $30,000, a decrease of $160,000. The examiner determined that this decrease was due to three classic automobiles held for investment being taken off the corporate balance sheet and transferred to the shareholder. The assets were taken off because the company was in the process of being sold and the shareholder wanted the assets for his personal investment. Corporate costs were involved in the restoration of the classic automobiles.

Non-cleared Checks

Examinations of the bank reconciliations at the end of the year will allow the examiner to determine if some checks are still outstanding after a substantial amount of time has passed since originally issued. This is especially prevalent with payroll checks which for some reason were never cashed or deposited by the payee.

Other Receivables

An examination of the employee advances account may reveal that these advances were cleared out by the corporation by forgiving the debt and booking the amount as an employee bonus at the end of the year. This amount appeared as a deduction in the salaries account but was never accounted for as far as employment taxes and Form W-2 wages were concerned. Sometimes employee advances are simply transferred to salaries and wages, and again, never accounted for on the employment tax returns.

Automobile Rental

Rebates on auto rentals are one practice an examiner may see at body shops and, to a lesser degree, repair shops. For example, payment was made to the business by the rental company based on the volume of business placed with them. It was not necessary that the shop supply the rental car to the customer, only that they refer the business to the rental company. When the body or repair shop did incur the expense, however, they were likely to credit the expense account with the rebated amounts. A lack of such an offset to a car rental expense account would be unusual, though the amounts involved are generally fairly nominal.

Finders or Referral Fees

These are called "bird dog" fees and are paid to individuals by body shops for referring customers to the shop. This is illegal in some states and not allowed under the Insurance Code if the individual receiving the payment is an independent adjuster, insurance agent, or broker. The finder’s fees ranging from $50 to $500 per vehicle that can be paid to a cadre of individuals that may included insurance agents and adjuster. The fees tend to mount up over the course of a year and sometimes no Forms 1099 are filed. Both the Form 1099 penalties and backup withholding are appropriate in such a case.

Lien Sale Filings

Notice of lien sales can be filed when work has been done or storage charges incurred at a repair or body shop or a towing service, and the vehicle has not been retrieved and the charges paid. Notice is given to the owner prior to lien sale and he or she may redeem his or her property by satisfying the debt plus filing costs.

A lien sale service is generally employed to process the paperwork for a usual charge of $45 or $75 depending on whether the value of the vehicle is under or over $1,000. Recovery Income would be anything over the amount charged.

Towing Service Payments

Tow truck operators may be paid to deliver wrecked vehicles to a particular body shop. This payment is made in addition to normal towing charges and need not be made directly. For example, the payment may be made indirectly by allowing the towing service to operate their business rent free using a portion of their leased premises and one of the two addresses assigned to the property.

Insurance Fraud

Insurance and consumer fraud receive a great deal of media attention If the Body Shop being examined reports an extremely high profit margin on parts, but the inspection of the purchase invoices from its suppliers indicated that the shop received only the usual 20 to 25 percent discount, they could be billing for parts that were neither required nor replaced. Although the shop appears to have reported the profits, an understatement of parts sales revenues would not have been easily detected based on costs.

Smog Certificate Sales

This issue involves selling the smog certificates at a premium price without any inspection of the vehicle. It is even possible to purchase a certificate for a purely fictitious automobile. The fee charged for this kind of "service" is higher than the cost of a legitimate inspection, but less than the cost of bringing many vehicles into a state of compliance.

Glossary

Adjuster - Individual qualified in performing estimates and appraisals. This individual may be an insurance company representative or an individual who works for an independent appraisal company.

“After Market” Parts - Discount parts which are copied from factory original parts. These parts are of lower quality but may be lower in price by as much as one third the original part's price.

Betterment - Term used to describe additional benefit which may accrue to the party whose vehicle is being repaired. For instance, a tire may need to be replaced. But at the time of the accident, the wear and tear had only reached a certain percent. The insurance company may decide that they are only responsible for that certain percent of the replacement cost. Another example is with an upgrade in equipment such as a radio. If the customer is obtaining a higher quality radio than the damaged one, the insurance company may only cover the cost of the damaged radio.

Blending - Process whereby paint is gradually lightened or darkened on a repair vehicle to eliminate spottiness.

Bondo - Compound applied to the vehicle to smooth out and fill the exterior so that paint may be applied.

Claimants -Term used to describe third party responsible for handling the damage payments. For instance, individual A's vehicle was damaged by individual B. If individual B's insurance company is responsible for the payments to the auto body shop, then individual B would be the claimant. In other situations, the term "claimant" may also be used to describe the individual making the claim.

Clear Coat - Finish added after paint job to give the vehicle a high luster look and protection.

Criteria Sheet - Agreement form between body shop and insurance company. Items listed will be use of “after market” parts, overlap systems, etc.

Deductible - The portion of the repair cost for which the customer is personally responsible.

Detailing - After body repair the vehicle may be enhanced by washing, waxing, interior cleaning, shampoo treatments, etc.

Direct Repair Program - (DRP Shops) Program where insurance companies contract with certain body shops and agree to send work to those shops in exchange for the body shop using “after market” parts, and giving cost reductions on certain types of labor.

Drive in Claim Center - Concept where the customer drives their vehicle to the insurance company to have an estimate performed.

Estimate - Process whereby the insurance company or the auto body shops project the cost of the parts, labor, and other supplies needed to repair a vehicle. These projections are based on previous studies done under optimum conditions.

EZ Liner - Trade name of the most common type of frame straightener. This is actually a workbench to which the vehicle is attached. Certain points are lined up on the frame and the vehicle is then "pulled" until the frame is straight.

Flag Sheet - Sheet used by auto body employees to record the number of hours spent on a specific vehicle.

Frame - The structural component of the vehicle to which the body components are bolted or attached. This differs from unibody construction in that the components are attached to the frame rather than the components acting as a frame.

Hidden Damage - Additional damage which was not discovered during the teardown and not approved in original repair order. Usually found during later stages of repair. Must be approved for repair separately.

Insured - Term used to describe the individual whose vehicle was damaged. The individual's insurance company would be responsible for submitting the final payment to the auto body shop.

Job Jackets - Folders used to keep paperwork together for ­current and on-going jobs.

Mask - Bumper Cover.

Masking - Protection of glass, chrome, and other parts when the vehicle is being painted.

Mechanics Lien - A filing with the Department of Motor Vehicles on vehicles with unpaid charges for repairs and/or storage. If the delinquent amounts are not settled within legally prescribed periods the vehicle can be sold in satisfaction of the debt.

Mitchell Manuals - Set of guides which contain the suggested retail and wholesale prices for parts and the suggested labor and paint hours needed to install and paint the various parts. May be in book form or computer software.

Overlap - Concept used by insurance companies to designate common times used to repair a vehicle. For instance, assume the Mitchell Guide states that it takes 8 hours to remove a section of a vehicle to work on parts A, B, and C. It then takes 6 hours to replace part A, 2 hours to remove part B, and 2 hours to remove part C. The time to remove part B and part C will be reduced by 2 hours because theoretically, the section needed to be removed to work on the parts only needs to be done once.

Overspray - The spray or mist of paint or primer that settles on parts of the vehicle other than those intended to be sprayed.

Panels - General term to describe body components. May be described as side panels, quarter panels, etc.

Pin Striping - Specialized painting or decaling.

Primers - Chemicals used to coat the metal surface of the vehicle to avoid rust and to fill in scratches.

Repair Order - Document which usually contains the charges for parts, labor, and other costs. This is approved by the customer before actual work is performed on the vehicle.

Replacement Repair - In cases where a body part is completely mangled it will need to be replaced. Frame work is considered repair work. Replacement work costs can generally be obtained from the various pricing guides. Repair work costs may be negotiated between the shop and insurance company or customer.

Restoration - Process used for classic, expensive, and antique automobiles whereby the vehicle is restored to its original condition or even better. Involves high quality paint jobs, major engine and transmission replacement, and body parts fabrication.

Shroud - Cover for many parts - for example, radiator shroud.

Skin -That is "door skin." Refers to the visible metal covering a constructed component.

Sublet Expenses - Generic term used to describe services not ordinarily performed by the autobody shop. Includes services like upholstery work, radiator repair, tire replacement, etc.

Supplemental Payments - Payments issued by insurance companies which account for additional damage which may not have been spotted during the initial estimate. May also cover price increases of parts not yet updated in the Mitchell Guides. Usually separately issued after regular payment.

Tear Down -Removal of surface damage to assess total repair needed.

Undercoat - Coating given to the bottom of the vehicle to protect from rust and corrosion.

Unibody Construction -Concept where the body parts act as the frame of the vehicle. The parts actually support the weight of the vehicle. The parts are actually bonded together rather than bolted.

Warranty Work - Additional work performed after the job has been completed and paid for. In this situation, the autobody shop is responsible for the additional costs.

Wetblocking - Sanding done after primer is applied so that paint can be applied.

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Page Last Reviewed or Updated: 21-Jul-2014