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

The double extension index formula is as follows:
Current year quantity (CYQ) x Current year costs (CYC)
Index = ----------------------------------------------------------------------
Current year quantity (CYQ) x Base year costs (BYC)
b. Link Chain Method
The link chain method is a cumulative index which considers all annual indices dating back
to the year of election. It is used to restate current year inventory to base year costs. This
cumulative index is also used to value increments of base year cost when they occur.
This cumulative index is called the link chain method because it is derived by a
multiplication process that involves the "linking" of annual indices back to base year. For
example, if the year of the LIFO election is 1991, and the current year is 1993, the 1993
link chain index is computed as follows:
1991 index times 1992 index times 1993 index = 1993 cumulative link chain index.
c. Index Method
Under the index method, indices are developed by double extending a representative
portion of inventory in a LIFO pool or by using other sound and consistent statistical
methods. The formula for calculating the sample index is identical to the one used in the
double extension method.
In order to determine total base year costs, total current year cost is divided by a weighted
average index derived for the sample. This calculation technique is necessary because the
index method does not double extend the entire current year inventory. This index is also
used to value increments.
The dollar value indices determined under the double extension and index methods
measure inflation from "day 1" of the LIFO election, through the current year.
The annual inflation index is determined according to this formula:
End of year quantity (EQ) x End of year costs (EC)
Index = ----------------------------------------------------------------------
End of year quantity (EQ) x Beginning of year cost (BC)
4. How does reconstruction of base year costs affect Dollar Value pricing?
The double extension method is the "preferred method" to compute base year costs as stated
in Treas. Reg. section 1.472-8(e)(1). However, in the auto dealership context, using the
double extension method to reconstruct base year costs is raises concerns and hence is more
susceptible to error than other known methods.
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