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

The unit method is rarely used by the auto dealership industry.
The dollar value method measures inventory changes in terms of dollars instead of in
terms of changes in quantity of items. This method is properly used when measuring an
inventory that contains similar specific items such as vehicles. This method groups items
into separate pools. See Treas. Reg. section 1.472-8. Most auto dealerships use the
dollar value method.
3. What are the Dollar Value methods of pricing a LIFO inventory?
Treas. Reg. section 1.472-8(e)(1) states there are four:
a. Double Extension Method
b. Link Chain Method
c. Index Method
d. Retail Method (not discussed at this time)
Whatever method is used must consistently and clearly reflect the income of the taxpayer.
See IRC section 446(b). The dollar value method of valuing LIFO inventories is a method
of determining cost by using "base year" cost expressed in terms of total dollars rather
than quantity and price of specific goods as a unit of measurement. See Treas. Reg.
section 1.472-8.
This Guide will primarily focus on the Link Chain Method and touch upon the Double
Extension Method because these methods are more commonly elected by auto dealers to
value their inventories. The index method has not been encountered in an auto dealership
setting, but is mentioned because it is an acceptable method that may be used. The retail
method is technically an acceptable method to use, but it would be unlikely to be
encountered because it uses external indexes that may produce indices significantly lower
than those the auto dealer can generate internally.
a. Double Extension Method
Under the double extension method, the quantity of each item in the inventory pool at the
close of the taxable year is extended (priced) at both base year unit cost and current year
unit cost. (Pools are discussed below.) The respective extensions (pricing) of the two
costs are then each totaled. The first total gives the amount of such inventory in terms of
current year costs. (See below, for a discussion of determining current year costs.)
Under the double extension method, a base year cost must be ascertained for each item
entering a pool for the first time subsequent to the beginning of the base year. In such a
case, the base year unit cost of the entering item shall be the current year cost of that item,
unless the taxpayer is able to reconstruct or otherwise establish a different cost.
8-2