Publication 538 - Accounting Periods And Methods (Page 14 of 19) in pdf

process and finished goods on hand at the end

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

•

Goods you have sold, but only if title has

of the year to determine the raw material used to

dollar-value method of pricing LIFO inventories,

passed to the buyer.

produce finished goods that were sold during

goods and products must be grouped into one or

•

Goods consigned to you.

the year.

more pools (classes of items), depending on the

•

kinds of goods or products in the inventories.

Changing methods.

If you are a qualifying

Goods ordered for future delivery if you do

See section 1.472 – 8 of the regulations.

taxpayer or small business taxpayer and want to

not yet have title.

change to the cash method, you must file Form

Simplified dollar-value method. Under

3115. For an automatic change in accounting

this method, you establish multiple inventory

Assets. Do not include the following in inven-

method, you must follow the provisions in Reve-

pools in general categories from appropriate

tory.

nue Procedure 2002 – 9 in Internal Revenue Bul-

government price indexes. You then use

•

Land, buildings, and equipment used in

letin 2002 – 3, as modified by Revenue

changes in the price index to estimate the an-

Procedure 2002 – 28 in Internal Revenue Bulle-

your business.

nual change in price for inventory items in the

tin 2002 – 18, and Revenue Procedure 2002 – 19

•

Notes, accounts receivable, and similar

pools.

in Internal Revenue Bulletin 2002 – 13. For addi-

assets.

An eligible small business (average annual

tional guidance, see the provisions in Revenue

•

gross receipts of $5 million or less for the 3

Real estate held for sale by a real estate

Procedure 2001 – 10 if you are a qualifying tax-

preceding tax years) can elect the simplified

dealer in the ordinary course of business.

payer and Revenue Procedure 2002 – 28 if you

dollar-value LIFO method.

are a qualifying small business taxpayer. Those

•

Supplies that do not physically become

For more information, see section 474. Tax-

provisions also apply if you no longer want to

part of the item intended for sale.

keep inventories. You may file one Form 3115 if

payers who cannot use the method under sec-

you choose to make both changes.

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

Special rules apply to the cost of inven-

regulations for a similar simplified dollar-value

More information.

For more information

tory or property imported from a related

method.

about the qualifying taxpayer exception, see

person. See the regulations under sec-

CAUTION

Revenue Procedure 2001 – 10 in Internal Reve-

tion 1059A.

Adopting LIFO method. File Form 970, Ap-

nue Bulletin 2001 – 2. For more information

plication To Use LIFO Inventory Method, or a

about the qualifying small business taxpayer

statement with all the information required on

exception, see Revenue Procedure 2002 – 28 in

Form 970 to adopt the LIFO method. You must

Internal Revenue Bulletin 2002 – 18.

file the form (or the statement) with your timely

filed tax return for the year in which you first use

Items Included in Inventory

Identifying Cost

LIFO.

Your inventory should include all of the follow-

You can use any of the following methods to

ing.

identify the cost of items in inventory.

Differences Between

•

Merchandise or stock in trade.

FIFO and LIFO

•

Specific Identification Method

Raw materials.

Each method produces different income results,

•

Work in process.

depending on the trend of price levels at the

Use the specific identification method when you

•

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

can identify and match the actual cost to the

Finished products.

items in inventory.

LIFO will produce a larger cost of goods sold

•

Supplies that physically become a part of

and a lower closing inventory. Under FIFO, the

Use the FIFO or LIFO method, explained

the item intended for sale.

cost of goods sold will be lower and the closing

next, if:

inventory will be higher. However, in times of

•

You cannot specifically identify items with

Merchandise. Include the following merchan-

falling prices, the opposite will hold.

their costs.

dise in inventory.

•

Valuing Inventory

The same type of goods are intermingled

•

Purchased merchandise if title has passed

in your inventory and they cannot be iden-

to you, even if the merchandise is in

tified with specific invoices.

The value of your inventory is a major factor in

transit or you do not have physical pos-

figuring your taxable income. The method you

session for another reason.

use to value the inventory is very important.

FIFO Method

•

Goods under contract for sale that you

The following methods, described below, are

have not yet segregated and applied to

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

those generally available for valuing inventory.

the contract.

items you purchased or produced first are the

•

Cost.

•

first items you sold, consumed, or otherwise

Goods out on consignment.

•

disposed of. The items in inventory at the end of

Lower of cost or market.

•

Goods held for sale in display rooms, mer-

the tax year are matched with the costs of similar

•

chandise mart rooms, or booths located

Retail.

items that you most recently purchased or pro-

away from your place of business.

duced.

Goods that cannot be sold. These are goods

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

you cannot sell at normal prices or they are

by mail and intend payment and delivery to hap-

LIFO Method

unusable in the usual way because of damage,

pen at the same time, title passes when pay-

imperfections, shop wear, changes of style, odd

ment is made. Include the merchandise in your

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

or broken lots, or other similar causes, including

closing inventory until the buyer pays for it.

items of inventory you purchased or produced

secondhand goods taken in exchange. You

last are the first items you sold, consumed, or

Containers. Containers such as kegs, bot-

should value these goods at their bona fide

otherwise disposed of. Items included in closing

tles, and cases, regardless of whether they are

selling price minus direct cost of disposition, no

inventory are considered to be from the opening

on hand or returnable, should be included in

matter which method you use to value the rest of

inventory in the order of acquisition and from

inventory if title has not passed to the buyer of

your inventory. If these goods consist of raw

those acquired during the tax year.

the contents. If title has passed to the buyer,

materials or partly finished goods held for use or

exclude the containers from inventory. Under

consumption, you must value them on a reason-

LIFO rules. The rules for using the LIFO

certain circumstances, some containers can be

able basis, considering their usability and condi-

method are very complex. Two are discussed

depreciated. See Publication 946.

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

briefly here. For more information on these and

This method does not apply to goods accounted

Merchandise not included. Do not include

other LIFO rules, see sections 472 through 474

the following merchandise in inventory.

and the corresponding regulations.

for under the LIFO method.

Page 14

Publication 538 - Accounting Periods And Methods Page 14

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