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
The current year cost of X computed according to the earliest acquisition cost method would be $84.50: 10 x $2.00 = $20.00 10 x 2.10 = 21.00 15 x 2.15 = 32.25 05 x 2.25 = 11.25 40 $84.50 FIFO amount (cost) = 40 x 2.45 = $98.00 The difference between the current-year cost pricing of the inventory being $84.50 and the FIFO amount of $98 results in a difference of $13.50, which is the "Hidden Reserve" obtained in earliest acquisition without considering the indices. This is an example of the hidden reserve referred to earlier. If we want to use the most recent purchases (latest acquisition), the current year pricing will equal the FIFO amount. Therefore, the hidden reserve is not present under this method. Forty units at $2.25 equals $98 which is equal to the FIFO amount. If an inventory contains a large number of different items, such as with auto dealerships, the pricing procedure just described could involve quite a few calculations and most, if not all, taxpayers do not price all items in their inventory using the earliest acquisition method. For this reason, the theoretical method of pricing ending inventory quantities under LIFO is not used and the taxpayers who elect this method use a shortcut method to determine the earliest acquisition cost. The IRS has not approved any short cut method. See coordinated issue "Segment of Inventory Excluded from the Computation of the LIFO Index." In practice, using example 1 above, some taxpayers apply the earliest acquisition method of pricing quantities by using the $2 purchase price on January 21 to price all 40 units of X in ending inventory. Current-year costs of X would, therefore, be $80 (40 x $2). Even under this shortcut method a hidden reserve would result in the amount of $18. In periods of inflation, the earliest acquisition cost generally produces the lowest LIFO inventory value. Use of the latest acquisition cost usually results in the highest LIFO inventory value. Pooling Introduction One of the central points of LIFO valuation is the requirement to compare only like kind items. A unique aspect of the dollar value method is pooling, allowing the dealer to combine like kind items into a group where inflation is computed on these like kind items. If non-comparable items were pooled together there would be a fundamental problem with the indices causing a material distortion of income. 8-10
Assuming the dealership elects LIFO for its inventory. Under the full comparability LIFO method, a dealer may have a pool for: • New cars • New trucks • Parts • Used cars • Used trucks • Other items such as recreational vehicles Proper pooling must be determined for each trade or business. Some of the factors Chief Counsel has relied upon are based upon the particular facts and circumstances of the dealership include the following: 1. The dealership is engaged in the same type of activities (i.e., those related to new and used vehicle sales and service). 2. Employees including upper-level management, accounting personnel and administrative personnel can work at other locations, for example, the same employee is the general manager of multiple locations that sell automobiles and the used car manager manages all used vehicle sales for all locations and purchases all used vehicles that are not acquired through trade-in sales. 3. The dealership only has one checking account out of which all payrolls and other expenses are paid. The dealership has one line of credit that is secured by all inventories, regardless of location or manufacturer. Importance of Pooling The first and probably the most important problem involved in the dollar-value method is determining the character of the inventory items which may be grouped into a pool. The reason this question is so important is that the goods grouped in one pool are treated as fungible under the dollar-value method. Hence, inventory decreases in one item may be offset by increases in another item contained in the same pool. Under the specific goods method, if you have a quantity increase in an item of inventory, that increase is valued at the cost prevailing for that item in the year of the increase, absolutely separate from any other item in the inventory. Each item retains its own unique history of cost. Under the dollar-value method, quantity increases or decreases are determined looking at the pool as a whole with the unit of measure the dollar. Treas. Reg. section 1.472-8(a) states in part "* * * new items which properly fall within the pool may be added, and old items may disappear from the pool, all without necessarily effecting a change in the dollar value of the pool as a whole." If there is a quantity increase, in terms of dollars, that increase is valued at the cost prevailing for the year of the increase considering all of the items in the pool. Under this concept, historical cost for items decreasing or disappearing can be substituted for the cost of items increasing in quantity or new items entering the pool. This is the major difference between the dollar-value method and the 8-11
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The current year cost of X computed according to the earliest acquisition cost method<br />
would be $84.50:<br />
10 x $2.00 = $20.00<br />
10 x 2.10 = 21.00<br />
15 x 2.15 = 32.25<br />
05 x 2.25 = 11.25<br />
40 $84.50<br />
FIFO amount (cost) = 40 x 2.45 = $98.00<br />
The difference between the current-year cost pricing of the inventory being $84.50 and the<br />
FIFO amount of $98 results in a difference of $13.50, which is the "Hidden Reserve" obtained<br />
in earliest acquisition without considering the indices. This is an example of the hidden<br />
reserve referred to earlier.<br />
If we want to use the most recent purchases (latest acquisition), the current year pricing will<br />
equal the FIFO amount. Therefore, the hidden reserve is not present under this method.<br />
Forty units at $2.25 equals $98 which is equal to the FIFO amount.<br />
If an inventory contains a large number of different items, such as with auto dealerships, the<br />
pricing procedure just described could involve quite a few calculations and most, if not all,<br />
taxpayers do not price all items in their inventory using the earliest acquisition method. For<br />
this reason, the theoretical method of pricing ending inventory quantities under LIFO is not<br />
used and the taxpayers who elect this method use a shortcut method to determine the earliest<br />
acquisition cost. The IRS has not approved any short cut method. See coordinated issue<br />
"Segment of Inventory Excluded from the Computation of the LIFO Index."<br />
In practice, using example 1 above, some taxpayers apply the earliest acquisition method of<br />
pricing quantities by using the $2 purchase price on January 21 to price all 40 units of X in<br />
ending inventory. Current-year costs of X would, therefore, be $80 (40 x $2). Even under<br />
this shortcut method a hidden reserve would result in the amount of $18.<br />
In periods of inflation, the earliest acquisition cost generally produces the lowest LIFO<br />
inventory value. Use of the latest acquisition cost usually results in the highest LIFO<br />
inventory value.<br />
Pooling<br />
Introduction<br />
One of the central points of LIFO valuation is the requirement to compare only like kind items. A<br />
unique aspect of the dollar value method is pooling, allowing the dealer to combine like kind items<br />
into a group where inflation is computed on these like kind items. If non-comparable items were<br />
pooled together there would be a fundamental problem with the indices causing a material<br />
distortion of income.<br />
8-10
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