Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board
Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board
different taxable years because of differences in make, year, model, body style, standard equipment, options, and other factors, appropriate adjustments should be made to the cost of the vehicles on hand at the end of the prior taxable year to account for as many of these factors as possible. The prices of all factory-installed options are readily available to distributors and dealers. For body style, standard equipment, options and other features that are available at one point and not another, the adjustment should be based on the stated or implied price when available and factored in as a percentage of the base vehicle cost. Under full comparability LIFO when a vehicle cannot be compared to a similarly equipped vehicle in the prior year, beginning and ending cost are the same, resulting in an index of 1.00. Reconstruction is a fundamental issue for all three methods. The base year cost of an item will be the current year cost of the item unless the taxpayer is able to reconstruct or otherwise establish a different cost to the satisfaction of the representative of the District Director, the agent. If the taxpayer originally elects on their Form 970 the double extension method, but applies the link chain method without requesting permission, the taxpayer has an unauthorized change in accounting method. The taxpayer should recalculate their LIFO by applying the double extension method as originally filed. If the taxpayer wishes to change their method, then a Form 3115 should be filed under the provisions of Rev. Proc. 97-27, 1997-1 C.B 680 (May 8, 1997). 5. How many ways are there to compute a dollar value index? There are two general classes of indices, the internal and the external. The internal method generates indexes from information derived and maintained by the dealership. The external method indices are taken from the Consumer Price Index (CPI) or the Producer Price Index (PPI). These classes of indices should not be confused with different LIFO methods previously discussed. Remember, an index is a subpart of an overall LIFO method tracking the inflation or deflation of a particular item (pool) in ending inventory at a certain yearend. The external indices are used with the Inventory Price Index (IPI) Method and are seldom used for two reasons. The Government generated indices are generally lower than those produced internally by the dealers. Second, a dealership or group with gross receipts over $5,000,000 does not qualify, under IRC section 474, and under the IPI method can only take 80 percent of the annual change in IPI Method CPI or PPI for the index. 6. What methods can be used to determine the current-year costs that can be used in the index calculations to price units in the yearend inventory? 8-8
The current-year costs that can be used in the index calculations are: a. Cost based on the most recent purchases. b. Cost based on the average cost of purchases during the year. c. Cost based on the earliest acquisitions during the year. Remember, each item in the inventory pool at yearend is priced at current-year cost. See Treas. Reg. section 1.472-(2)(i). In addition to these three methods, the regulations authorize the use of any other proper method which, in the opinion of the Commissioner clearly reflects income. Whatever method is adopted, it must be adhered to in all subsequent years. See Treas. Reg. section 1.472-8(e). We will focus our concentration on the Earliest Acquisitions Method and the Latest Acquisitions Method (most recent purchases) because these are the most prevalent in the auto dealership industry. The true theory of LIFO entails use of the earliest acquisitions method. This method encompasses pricing the inventory items on hand at the yearend with the actual cost of goods purchased during the taxable year in the order of acquisition. This theoretical position assumes that pricing is being done in chronological order to the actual purchases. Note, in dollar-value LIFO, the indices are used to ascertain the amount of the LIFO reserve. However, in using the earliest acquisitions method, not only is the index creating the reserve, in addition there is an amount created called a "Hidden Reserve." If we compare the result of the pricing of yearend inventory using the earliest acquisitions method to the general ledger amount of the inventory at yearend, the difference is this additional amount of "reserve." This difference is not obtained in using the most recent purchases method. An example of these comparisons follows: Example 1 There are 40 units of X in ending inventory that are to be valued at their earliest acquisition cost. Purchases of X during the year were as follows: Date Quantity Amount 1/21 10 @ $2.00 2/15 10 @ 2.10 3/25 15 @ 2.15 4/08 30 @ 2.25 5/10 100 @ 2.30 10/11 150 @ 2.50 12/10 200 @ 2.45 8-9
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The current-year costs that can be used in the index calculations are:<br />
a. Cost based on the most recent purchases.<br />
b. Cost based on the average cost of purchases during the year.<br />
c. Cost based on the earliest acquisitions during the year.<br />
Remember, each item in the inventory pool at yearend is priced at current-year cost. See<br />
Treas. Reg. section 1.472-(2)(i).<br />
In addition to these three methods, the regulations authorize the use of any other proper<br />
method which, in the opinion of the Commissioner clearly reflects income. Whatever method<br />
is adopted, it must be adhered to in all subsequent years. See Treas. Reg. section 1.472-8(e).<br />
We will focus our concentration on the Earliest Acquisitions Method and the Latest<br />
Acquisitions Method (most recent purchases) because these are the most prevalent in the auto<br />
dealership industry.<br />
The true theory of LIFO entails use of the earliest acquisitions method. This method<br />
encompasses pricing the inventory items on hand at the yearend with the actual cost of goods<br />
purchased during the taxable year in the order of acquisition. This theoretical position<br />
assumes that pricing is being done in chronological order to the actual purchases.<br />
Note, in dollar-value LIFO, the indices are used to ascertain the amount of the LIFO reserve.<br />
However, in using the earliest acquisitions method, not only is the index creating the reserve,<br />
in addition there is an amount created called a "Hidden Reserve." If we compare the result of<br />
the pricing of yearend inventory using the earliest acquisitions method to the general ledger<br />
amount of the inventory at yearend, the difference is this additional amount of "reserve." This<br />
difference is not obtained in using the most recent purchases method. An example of these<br />
comparisons follows:<br />
Example 1<br />
There are 40 units of X in ending inventory that are to be valued at their earliest<br />
acquisition cost. Purchases of X during the year were as follows:<br />
Date Quantity Amount<br />
1/21 10 @ $2.00<br />
2/15 10 @ 2.10<br />
3/25 15 @ 2.15<br />
4/08 30 @ 2.25<br />
5/10 100 @ 2.30<br />
10/11 150 @ 2.50<br />
12/10 200 @ 2.45<br />
8-9
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