Publication 538 - Accounting Periods And Methods (Page 13 of 18) in pdf

ness, you must use an accrual method of ac-

3) Goods ordered for future delivery if you do

Simplified dollar-value method. Under

not yet have title.

counting for your purchases and sales.

this method, you establish multiple inventory

However, see Cash Method of Accounting for

pools in general categories from appropriate

Qualifying Taxpayers, earlier. See also Accrual

government price indexes. You then use

Assets. Do not include the following in inven-

Method, earlier.

changes in the price index to estimate the an-

tory.

nual change in price for inventory items in the

To figure taxable income, you must value

1) Land, buildings, and equipment used in

pools.

your inventory at the beginning and end of each

your business.

tax year. To determine the value, you need a

An eligible small business (average annual

method for identifying the items in your inven-

gross receipts of $5 million or less for the 3

2) Notes, accounts receivable, and similar

tory and a method for valuing these items. See

preceding tax years) can elect the simplified

assets.

Identifying Cost and Valuing Inventory, later.

dollar-value LIFO method.

3) Real estate held for sale by a real estate

The rules for valuing inventory cannot be the

For more information, see section 474. Tax-

dealer in the ordinary course of business.

same for all kinds of businesses. The method

payers who cannot use the method under sec-

you use must conform to generally accepted

4) Supplies that do not physically become

tion 474 should see section 1.472 – 8(e)(3) of the

accounting principles for similar businesses and

part of the item intended for sale.

regulations for a similar simplified dollar-value

must clearly reflect income. Your inventory prac-

method.

Special rules apply to the cost of inven-

tices must be consistent from year to year.

tory or property imported from a related

Adopting LIFO method. File Form 970, Ap-

The rules discussed here apply only if

person. See the regulations under sec-

CAUTION

plication To Use LIFO Inventory Method, or a

they do not conflict with the uniform

tion 1059A.

statement with all the information required on

capitalization rules of section 263A and

CAUTION

Form 970 to adopt the LIFO method. You must

the mark-to-market rules of section 475.

file the form (or the statement) with your timely

Identifying Cost

filed tax return for the year in which you first use

Items Included in Inventory

LIFO.

You can use any of the following methods to

identify the cost of items in inventory.

Your inventory should include all of the follow-

ing.

Differences Between

FIFO and LIFO

Specific Identification Method

1) Merchandise or stock in trade.

Each method produces different income results,

Use the specific identification method when you

2) Raw materials.

depending on the trend of price levels at the

can identify and match the actual cost to the

3) Work in process.

time. In times of inflation, when prices are rising,

items in inventory.

LIFO will produce a larger cost of goods sold

Use the FIFO or LIFO method, explained

4) Finished products.

and a lower closing inventory. Under FIFO, the

next, if:

5) Supplies that physically become a part of

cost of goods sold will be lower and the closing

1) You cannot specifically identify items with

the item intended for sale.

inventory will be higher. However, in times of

their costs.

falling prices, the opposite will hold.

2) The same type of goods are intermingled

Merchandise. Include the following merchan-

Valuing Inventory

in your inventory and they cannot be iden-

dise in inventory.

tified with specific invoices.

The value of your inventory is a major factor in

1) Purchased merchandise if title has passed

figuring your taxable income. The method you

to you, even if the merchandise is in transit

use to value the inventory is very important.

or you do not have physical possession for

FIFO Method

another reason.

The following methods, described below, are

those generally available for valuing inventory.

The FIFO (first-in first-out) method assumes the

2) Goods under contract for sale that you

items you purchased or produced first are the

•

have not yet segregated and applied to the

Cost

first items you sold, consumed, or otherwise

contract.

•

disposed of. The items in inventory at the end of

Lower of cost or market

3) Goods out on consignment.

the tax year are matched with the costs of similar

•

Retail

items that you most recently purchased or pro-

4) Goods held for sale in display rooms, mer-

duced.

chandise mart rooms, or booths located

Goods that cannot be sold. These are goods

away from your place of business.

you cannot sell at normal prices or they are

LIFO Method

unusable in the usual way because of damage,

C.O.D. mail sales. If you sell merchandise

imperfections, shop wear, changes of style, odd

by mail and intend payment and delivery to hap-

The LIFO (last-in first-out) method assumes the

or broken lots, or other similar causes, including

pen at the same time, title passes when pay-

items of inventory you purchased or produced

secondhand goods taken in exchange. You

ment is made. Include the merchandise in your

last are the first items you sold, consumed, or

should value these goods at their bona fide

closing inventory until the buyer pays for it.

otherwise disposed of. Items included in closing

selling price minus direct cost of disposition, no

inventory are considered to be from the opening

Containers. Containers such as kegs, bot-

matter which method you use to value the rest of

inventory in the order of acquisition and from

tles, and cases, regardless of whether they are

your inventory. If these goods consist of raw

those acquired during the tax year.

on hand or returnable, should be included in

materials or partly finished goods held for use or

inventory if title has not passed to the buyer of

consumption, you must value them on a reason-

LIFO rules. The rules for using the LIFO

the contents. If title has passed to the buyer,

able basis, considering their usability and condi-

method are very complex. Two are discussed

exclude the containers from inventory. Under

tion. Do not value them for less than scrap value.

briefly here. For more information on these and

certain circumstances, some containers can be

This method does not apply to goods accounted

other LIFO rules, see sections 472 through 474

depreciated. See Publication 946.

for under the LIFO method.

and the corresponding regulations.

Merchandise not included. Do not include

D o l l a r - v a l u e

m e t h o d .

U n d e r

t h e

the following merchandise in inventory.

dollar-value method of pricing LIFO inventories,

Cost Method

goods and products must be grouped into one or

1) Goods you have sold, but only if title has

To properly value your inventory at cost, you

more pools (classes of items), depending on the

passed to the buyer.

kinds of goods or products in the inventories.

must include all direct and indirect costs associ-

2) Goods consigned to you.

See section 1.472 – 8 of the regulations.

ated with it. The following rules apply.

Page 13

Publication 538 - Accounting Periods And Methods Page 13

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