Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

f. Dealer Reserve Holdbacks
3. Inventory
Dealers sell the majority of new vehicles under some form of note that includes the unpaid
balance of the vehicle, plus finance charges. These contracts are sold or endorsed to a
finance company. This transaction normally creates the "dealer’s reserve." See Financing
above.
If the note is transferred in a non-recourse transaction, the finance company owns any cars
which are repossessed. The dealer receives the purchase price of the automobile and a
finance commission.
Obligations of purchasers for deferred payments on installment sales are discounted or
sold by them [dealers] to finance companies, which pay the dealers most of the amounts in
cash, but credit to each dealer in a "reserve account" a small percentage thereof, which is
retained by the finance company to secure performance of the dealer’s obligations under
his guarantees or endorsements. The amounts thus credited to the dealers in "reserve
accounts" on the books of the finance companies must be reported as income accrued
during the tax years in which they are credited to such reserve accounts.
Inventory includes items that are used to produce income and are not period expenses, such
as:
a. New vehicles
b. Used vehicles
c. Parts and Accessories
d. IRC section 263A
e. LIFO reserve
f. Demonstrators
g. Body shop materials
h. Sublet repairs
i. Labor-in-process
Taken on an individual basis, these sectors of the inventory account can be analyzed by
looking at the LIFO calculations, the accountant’s workpapers on the 263A allocation, and the
used vehicle valuation sheets.
a. New Vehicles
Many dealerships use LIFO to value new car and truck inventories. LIFO was previously
discussed in a separate section due to its complexity.
b. Used Vehicles
The auditor should verify that any used vehicle valuations are not arbitrary or incorrectly
computed. Used vehicles are usually kept separate from new vehicles, both physically and
in the books. They are most commonly accounted for using Lower of Cost or Market
(LCM).
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