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

as one item, there would probably never be a new item in the car pool.
The technique probably used most often is to develop an index for comparable items and then
use that index to determine the base-year cost (beginning of the year cost for a link-chain
taxpayer) for new items. Whether or not this reconstruction technique is reasonable has been
the subject of two recent private letter rulings.
Chief Counsel recently commented on retail automobile dealerships with essentially the same
facts and arguments. Each dealership had reconstructed the beginning-of-the-year costs of
new vehicles in ending inventory utilizing an index derived only from comparable vehicles.
The dealers argued they had used a reasonable method of reconstruction because the cost
increases for comparable vehicles should be used as a guide for the new vehicles. They stated
that it would be reasonable to assume that non-comparables (new vehicles) would have
increased in price at the same rate as other vehicles produced by that same manufacturer. The
same administrative staff, raw material suppliers, union contracts, and depreciation schedules,
etc., would influence the price of both comparables and non-comparables. One dealer argued
that new vehicles as a percentage of the total inventory was not material and therefore, it had
double-extended a representative portion of its inventory. The facts showed that comparable
vehicles represented anywhere from 73 to 100 percent of the value of the vehicles in the
various pools and years.
The National Office defines "comparables" as items that exist in both beginning and ending
inventory. Non-comparables are items that only exist in the ending inventory.
The National Office concluded that the reconstruction methods used by these dealers were not
reasonable and provided the following reasons:
a. Comparable and non-comparable vehicles may vary in their characteristics and costs.
b. This method is not supported by the regulations. It is inappropriate to apply an index
derived from one subset of items in a pool to another subset of items. An index computed
that excludes new models does not clearly reflect income.
c. The method has the potential to produce distortions in the dollar-value computations.
These inaccuracies would then cause distortions in computations in subsequent years due
to the use of the link-chain method.
d. Even if a dealer could substantiate its claim that the effect of inflation on comparable
vehicles is reflective of the effect on non-comparable vehicles, there is no reasonable
assurance that this relationship would continue in the future.
e. A price index for a dollar-value LIFO pool must be computed based on all the items in
ending inventory for that pool.
The National Office stated "Whether a taxpayer’s particular method is reasonable is a
determination that should be left to the district director because such a determination requires
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