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GLOSSARY OF LIFO TERMS LIFO METHOD ALTERNATIVES COMMON LIFO MISCONCEPTIONS IPIC LIFO METHOD ADVANTAGES LIFO PROJECTIONS SEC. 263A COSTS FOR LIFO TAXPAYERS LIFO DOCUMENTATION CHECKLIST LIFO DOCUMENTATION EXAMPLES

GOOD CANDIDATES TO USE LIFO-PRO SOFTWARE GOOD LIFO CANDIDATES BY INDUSTRY

SUPERMARKET LIFO:

The use of the LIFO method in this industry is probably more common than for almost any other industry. We estimate the LIFO method usage rate at over 90% because of the consistency of inflation for supermarket merchandise over many years together with significant inventory balances (single store cost inventory balances ranging from $300,000 to $2,000,000).

Supermarket chain LIFO calculations are more complicated than those for most other industries. This has been one of our primary practice areas since our LIFO expertise and automated software is more useful to companies whose LIFO calculations are complicated. Complicated LIFO situations along with complicated IRS LIFO Regs. are much more likely to result in IRS Regs. noncompliance because of improper method and submethod elections and application of improper computational methodology. They are also more prone to computational errors when spreadsheet assisted manual calculations are used for numerous steps.

The reasons LIFO calculations for supermarket chains are more complicated than those for most industries include:

• Large number of inventory items - Most supermarket chains stock approximately 30,000+ SKUs representing approximately 100 different CPI most detailed commodity codes and 200 different PPI most detailed commodity codes and the turnover of SKUs is relatively high.
• Use of 10% method – Most supermarket chains use the optional IPIC 10% method to reduce the number of required CPI or PPI category breakdowns to approximately 30 to 50 less detailed categories (if you use fewer categories than this, you are not in compliance with the IRS Regs.). The use of spreadsheet assisted manual calculation for the required 10% method computations for numerous CPI or PPI categories always results in errors.
• Retail inventory method (RIM) complications – The widespread use of the RIM in this industry and lack of item cost inventory accounting necessitates the use of physical inventory counts to obtain the necessary store inventory breakdowns by CPI or PPI categories for most companies. Our experience with this type of inventory accounting and the fact that the standardized list of supermarket chain 10% method CPI and PPI categories we created has been used as the industry standard for the past ten years has resulted in more widespread usage of the IPIC LIFO method for supermarkets and has considerably reduced the amount of time required for proper LIFO calculations.
• Retail LIFO method complications – The Retail LIFO method is different than the RIM. Retail LIFO is used only for LIFO pools for which the RIM is used but the Cost LIFO method can also be used for LIFO pools for which the RIM is used. Refer to our Glossary web page for the definitions of these methods. Retail LIFO is more complicated than Cost LIFO because the inventory at base is calculated using retail inventory balances and LIFO indexes that measure retail price inflation and cost complements (of the gross profit margin percentages) must be multiplied times the layers at retail to calculate LIFO layers at cost.
• Warehouse and store inventories for larger chains – Different inventory accounting methods are used for warehouse v. store inventories and the methods of obtaining CPI or PPI category breakdowns are different. Item cost methods are used for warehouse inventories and a mixture of RIM and cost is used for store inventories.
• Use of either CPI or PPI indexes - The IRS Regs. allow retailers to use either CPI or PPI indexes. Until several years ago, most supermarkets used CPI indexes but the use of PPI indexes has become much more common recently because PPI inflation for supermarkets has consistently exceeded CPI inflation in the past several years. Our LIFO-PRO software supports both CPI and PPI indexes and we have helped many companies make the switch from CPI to PPI indexes. The computations required for supermarket PPI LIFO calculations are more complicated because additional breakdowns are required and the PPI categories published changes every six months (approximately 30 new categories are added every six months and a like number are discontinued). Keeping up with these changes takes a lot of time but this process is automated in our software so that when discontinued categories are entered and read by our software, it automatically reassigns the inventory balances to the proper PPI replacement category.
• Use of internal indexes for GAAP for large companies – Most publicly traded and many other large supermarket chains use internal indexes to calculate LIFO inflation for GAAP and use the IPIC method for tax purposes and the use of two different methods increases the chances of errors. Calculation of accurate internal indexes is a challenge for some of the same reasons proper IPIC method calculations are a challenge.
• Selective LIFO elections - Historically many supermarkets have excluded certain departments from their LIFO election scope. The most commonly excluded departments are fresh meat, produce, deli, bakery, floral and pharmacy. Since virtually all goods stocked by supermarkets experience inflation over time, our normal recommendation is that all goods should be on LIFO to maximize tax savings.

The Food Marketing Institute (FMI) provided a great deal of guidance regarding the use of the IPIC LIFO method by supermarkets in earlier years. The FMI and FMI members actually wrote the IPIC method IRS Regulations in 1982 in collaboration with the IRS as a result of FMI’s desire to develop a simpler LIFO methodology that would allow more widespread usage of the method by smaller supermarket chains. The FMI went a step further and produced a booklet in January 1983 entitled Handbook for LIFO Tax Valuations-Inventory Price Index Computation Method (IPIC) that was a practical how-to guide that was used extensively by supermarkets until 1998. This handbook included a list of the 21 different 10% method CPI categories that was the minimum number required for compliance with IRS Regs. before 1998. The FMI prior to 1998 also made service bureau LIFO calculations for a number of small companies using specialized LIFO software developed by a FMI member company because the calculations required were prone to error when made by in-house accountants without extensive LIFO experience.

The FMI is no longer a LIFO resource for its members and has not been since sometime in the 1990s and the specialized LIFO software referred to above is no longer used. The Handbook the FMI published in 1983 is also now obsolete because of the 1998 changes in the makeup of the CPI categories by the BLS and because of the mandatory method changes incorporated in the new IPIC LIFO Regs. issued in 2002.

We have succeeded the FMI in their role of providing guidance to implement and use the IPIC LIFO method for supermarkets. In 2003, we published our Guide for Planning & Implementation of the IPIC LIFO Method for Supermarket Chains which not only supersedes the 1983 FMI Handbook but provides much more comprehensive guidance. This guide includes a list of the 33 different 10% method CPI categories and 55 different 10% method PPI categories that has been the minimum number required for compliance with the revised IRS IPIC LIFO Regs. published in 2002.

We serve clients in all industries except auto dealers but we made our name serving retailers using the IPIC method. Our LIFO-PRO software is used for the tax LIFO calculations for over 60% (by dollar volume) of supermarkets in the U.S. and most of these companies use our LIFO consulting services. We sell licenses to use our LIFO-PRO software to companies or their CPAs and also provide LIFO service bureau calculations to companies or their CPAs. Our LIFO-PRO software is the only comprehensive, commercially available non-auto dealer LIFO program sold. There have been numerous spreadsheet templates created to use for IPIC LIFO calculations but these are very much prone to error because it is not possible to fully automate many aspects of the LIFO computations in a spreadsheet and even if you could, it is very difficult to secure a spreadsheet to prevent changes.

Recent developments affecting supermarket LIFO:

FIN 48 & IRS preparer penalty implications – Many LIFO computation shortcuts have been used in all industries including supermarkets. The most common supermarket LIFO shortcuts are: 1) not using the appropriate 10% method CPI or PPI categories (using too few categories or only a single category for each pool) and 2) incorrect 10% method math. Most non-large case IRS audit supermarkets faced little IRS scrutiny in the past because of the lack of LIFO experience possessed by most IRS field agents and this resulted in relatively few IRS LIFO audit adjustments. These companies and their CPAs have played “IRS audit roulette” because of the low level of LIFO IRS scrutiny.

The LIFO IRS Regs. compliance standard has been drastically raised by these new pronouncements. The numerous LIFO shortcuts (to the IRS Regs. requirements) used are all “undisclosed positions taken” that clearly are not “more likely than not” to be sustained on their merits and therefore practitioners may not sign tax returns for these taxpayers. The likelihood of IRS audit or audit adjustment are not factors to be considered in the application of this rule; only whether the CPA has knowledge of IRS Regs. noncompliance is pertinent. FIN 48 requires valuation reserves to be established for IRS Regs. noncompliance in some cases.

PPI index usage – More and more supermarket chains are using PPI indexes instead of CPI indexes for their tax LIFO calculations because the PPI inflation for supermarkets has been consistently higher for nonfood goods the past several years.

LIFO adoptions by small supermarket companies – We are seeing more small companies including single store supermarket companies adopt LIFO because of the higher CPI and PPI inflation the past few years. The average inflation for the 12 months ended September 2007 for supermarkets has been between 3% to 5% which is higher than the historical 20 year average for CPI and PPI inflation of about 2%. The LIFO related reduction in taxable income for each 1% of inflation for each $1 million of inventory at cost is $10,000 per year.