IPIC LIFO Guide

The Inventory Price Index Computation (IPIC) method allows taxpayers to use published external indexes to calculate inflation for the purpose of valuing LIFO inventories. The IPIC method was first authorized by the IRS in 1982 in order to provide an approved method that would simplify LIFO calculations & make LIFO more accessible to smaller taxpayers.

A taxpayer using the IPIC method must assign appropriate Bureau of Labor Statistics (BLS) Consumer Price Index (CPI) or Producer Price Index (PPI) categories to inventory items in order to measure the amount of inflation used for LIFO calculations. Manufacturers & wholesalers are required to use PPI while retailers are allowed to use either CPI or PPI. These indexes are used to calculate category inflation indexes. Category inflation indexes are then weighted by inventory dollars (taxpayers using the optional 10% Method must also use BLS weights) to compute a current year inflation index for each pool. Taxpayers using the IPIC method can use the IPIC pooling method for which pools are created using broad CPI or PPI major groups (and not the individual categories). Use of the IPIC pooling method is not mandatory & other authorized pooing methods may be used. The pool cumulative indexes are used to deflate the inventory current-year cost (FIFO or average cost) to base period prices, which is then compared to the prior year’s inventory valued at base period prices. If the current year’s inventory at base is greater than the previous year’s inventory at base, the increment is multiplied by the pool cumulative inflation index to price the LIFO layer. If the current year’s inventory at base is less than the previous year’s inventory at base, the decrement erodes a previous layer (or multiple layers) & is priced using the index(es) originally used to price the layer(s).

On May 19, 2000 the IRS published proposed changes to the IPIC LIFO Regulations under Treasury Regulations Section 1.472-8(e)(3) & solicited comments regarding the proposed regulations. A public hearing was held in Washington, D.C. on September 15, 2000 on the proposed regulations.

On January 8, 2002 the IRS issued final Regulations § 1.472-8(e)(3) in Treasury Decision 8976. The following is a synopsis of most important changes encompassed in the new Regs:

• 100% inflation – All taxpayers may now use 100% of inflation calculated using IPIC for tax purposes. The elimination of the”20% haircut” should encourage more widespread use of IPIC.
• Use of 10% categories & BLS Weights – The use of this method was mandatory under the old Regulations but is now optional. Taxpayers now have the option of using only their actual FIFO inventory balances to calculate weighted average pool indexes. Having this option provides for simplification of pool index calculations for companies that can sort their inventories into the Most Detailed CPI or PPI categories the new Regulations require & taxpayers for whom assigning BLS categories to their inventory in greater detail would be burdensome or impossible can still use the IPIC method.
• Elimination of requirement to use cost complements – The requirement to make stage of production index conversions using gross margin percentages, (i.e., convert the CPI retail selling price indexes to a cost basis for companies not using Retail LIFO) was well intentioned by the IRS but created numerous problems in practical application. This change is greatly welcomed by any company to whom this applied under the old Regulations.
• Use of CPI categories by retailers – Many retailers using CPI categories who do not use the Retail Inventory Method would have been forced to use PPI categories under the proposed Regulations. Under the final new Regulations, these companies can still use CPI categories & can do so without making cost complement adjustments that the old Regulations required. The use of PPI categories for these retailers would have been burdensome because the CPI categories correlate much better with their inventory mix than the PPI categories.
• Use of Weighted Harmonic mean – Since the great majority of taxpayers have used the Weighted Arithmetic Mean in the past, this will require a change for most taxpayers. The new method always produces less inflation or greater deflation than using the Weighted Arithmetic Mean method. The decrease in LIFO benefits this produces is relatively small for most taxpayers (much less compared to using 100% vs. 80% of inflation), though this difference will be significant for some. A likely source of confusion will be the requirement that the Weighted Harmonic Mean is to be used only for pool index FIFO dollars weighting calculations & not for the Category Index BLS weighting calculations required for calculations using the 10 percent categories & BLS Weights method.
• Change in definition of 10% categories – Most taxpayers who continue to use the 10 percent categories & BLS Weights method under the new Regulations will need to sort their inventories in greater detail. This is because the new Regulations definition of the 10% categories threshold is the sum of each pool’s FIFO inventory values. The old Regulations specified that the denominator for the 10% categories was “total inventory value” which almost all taxpayers interpreted to mean either the sum of their FIFO inventory values, the sum of their FIFO inventory values on LIFO, or the sum of their FIFO inventory values for which the IPIC method was used. A small minority of taxpayers used the sum of each pool’s FIFO inventory values as the 10% categories threshold. Not only does the new definition of 10% categories require more detailed BLS category assignment, it makes this process more complicated because instead of there being one threshold amount for all inventories, there will now be as many different 10% thresholds as there are pools.

1. BLS Category Assignment – all items on LIFO are required to be assigned a Consumer or Producer Price Index category. Some companies assign these categories by product hierarchy (category, class, departments, groups, lines etc.) to preclude doing so on an item-by-item basis.
2. Inflation Index Calculation – front-end exercise to compute the following input variables required to complete the back end of the LIFO calculation:
   1. Current-year cost balance (CYC) – total average-cost or FIFO on LIFO balance.
   2. Current year inflation index – involves comparing current vs. prior period BLS price indexes. The detailed IPIC LIFO inflation index steps are described later in this guide.

LIFO Reserve Calculation – computation of increments/decrements, LIFO inventory, reserve & expense (income) values (detailed steps shown in LIFO Inventory Training Basics & Audit Guide

Use of the IPIC pooling method is not mandatory for companies using the IPIC method. The following are alternative pooling methods provided by the IRS:

• By line, type, or class of goods – Wholesalers & retailers can use separate pools for each major line, type, or class of goods. Customary business practices for a trade or industry determine what constitutes a major line, type, or class of goods. Authorized by Regs. § 1.472-8(c).
• Natural business unit pooling – A pooling method authorized by Regs. § 1.472-8(b)(1) for manufacturers & processors. A Natural Business Unit (NBU) includes all inventory items related to a product line or related product lines, including raw materials, work in process, & finished goods. Distinct business units require separate pools. A natural business unit may be defined based on divisions established by internal management, separate production facilities or processes, or separate financial records. Manufacturers that also purchase goods for resale are required by the IRS in Rev. Rul. 79-290, Rev. Rul. 82-192 & PLR 8842061 to use separate pools for manufactured goods & goods purchased for resale.
• Multiple pools – Companies may group together similar items in a pool even if they are not all within the same natural business unit. Grouping goods together to form a pool may be based on such factors as the similarity or interchangeability of raw materials, the similarity of the production processes, the similarity of the use of the products, standard practices within the trade or industry, & whether the goods are treated similarly by a company’s management. Authorized by Regs. § 1.472-8(b)(3)(i).
• Raw materials content – Goods with similar raw materials, including the raw material content of work-in-process & finished goods may be grouped together to form a pool for manufacturers or processors. Raw materials that are not similar in nature may not be grouped together in the same pool even if they are processed or manufactured into the same finished product. Authorized by Regs. § 1.472-8(b)(3)(ii).

To maximize tax savings, companies should use as few pools as possible because this will reduce the likelihood of decrements because decreases in inventory values will be offset by increases in others for groupings of inventory items included in the same pool. Decrements result in lower-cost goods being included in cost of goods sold which increases taxable income.

Unlike for the PPI, the BLS does not introduce new CPI categories & discontinue old ones every three months. The BLS restructured the entire CPI series beginning in January 1998, though & similar restructurings may occur in the future.

The 2002 New Regs specified that LIFO taxpayers using Consumer Price Indexes & the IPIC Pooling Method should use the CPI major expenditure categories (i.e., major groups) as their IPIC pools. These Major Groups are not defined in the Regs. but appear to be these:

10 Percent Method vs. Most-Detailed Categories Method

The IRS Regs. describe an optional method that taxpayers may use for assigning inventory items to BLS categories & for determining category inflation indexes called the 10 Percent method. The 10 Percent method is intended to simplify the use of the IPIC method by allowing taxpayers to sort their inventories into fewer, less-detailed categories than are required for the alternative Most-Detailed Categories method. While the 10 Percent method makes the task of assigning inventory to BLS categories less burdensome, there is a trade-off involved because the math required to calculate category inflation indexes is more complex. The Regs. require taxpayers electing to use the 10 Percent method to first weight inflation indexes with BLS weights, then with inventory dollars. Taxpayers using the Most-Detailed Categories method only use inventory dollars to weight inflation indexes.

Taxpayers are allowed to select either the 10 Percent method or the Most-Detailed Categories method for assigning BLS categories to their inventory dollars & calculating pool indexes. Many retailers still use the retail inventory method & do not have inventory systems that allow them to track the actual costs of specific goods at their stores. Requiring taxpayers to sort inventory into most-detailed categories, therefore, would have been a formidable burden for most retailers. The real value of the 10 Percent method is that it allows taxpayers carrying many different inventory items to reduce the burden of assigning all of their IPIC LIFO inventories to BLS categories.

LIFO-PRO, Inc. has performed numerous pro-forma calculations comparing the results of the two methods & over time there is little difference. As a practical matter, taxpayers should consider the following when deciding which index calculation method to use:

1. Time & cost associated with assigning less (10% method categories) or more-detailed categories
2. Whether they have software that automates the 10 Percent method pool index calculations

Most-Detailed Categories Method

Regs. § 1.472-8(e)(3)(iii)(C)(1) states that taxpayers using the Most-Detailed Categories method “must assign each item in a dollar-value pool to the most-detailed BLS category of the selected BLS table that contains that item.” This simply means that all inventory items must be assigned to each most-detailed category of the BLS table selected by the taxpayer (CPI or PPI) for items that are present in inventory. To think of it more simplify, BLS category assignment under this method must be performed on an item by item basis.

BLS Category Assignment Considerations

• Companies that sort their inventory balances using 10% categories are required to use the 10 Percent method
• Companies that sort their inventory by most-detailed CPI or PPI categories may also use BLS Weights & 10% rollups in performing their pool index calculations
• Taxpayers may switch from one IPIC pool index calculation method to the other after the initial adoption of the IPIC Method, but this requires filing a Form 3115
• Once this change in this method is made, the taxpayer cannot change to the alternative method for a five year period

10 Percent Method BLS Category Assignment

IPIC Regs. § 1.472-8(e)(3)(iii)(C)(2) describe a three-step process to assign inventory items to BLS categories when using the 10 Percent method:

1. First, when the current-year inventory value of a specific item is 10% or more of the pool total, that item must be assigned to the most-detailed category that includes that item.
2. Second, for items not assigned to BLS categories in the first step, the taxpayer must examine successively less-detailed categories to determine whether the combined value of the categories included within them is 10% or greater, a process known as “rolling up,” or performing “10% roll-ups.” This step must be repeated until all items in the pool have been rolled up to a less-detailed category level where the 10% threshold is met. The highest level that items can be rolled up to is the General Category level.
3. Third, items not assigned after the previous two steps (i.e., due to the hierarchical structure of BLS categories) must be identified & segregated.

In addition, Regs. § 1.472-8(e)(3)(iii)(D)(5) defines a less-detailed category (in the context of determining a category inflation index) as a BLS category that:

A) subsumes (i.e., includes, or incorporates in a more comprehensive category) two or more BLS categories;

B) does not have a single assigned item whose current-year cost is 10% or more of the current-year cost of all items in the dollar-value pool;

C) has at least one item in at least one of the subsumed BLS categories; and

D) has at least one subsumed BLS category that either does not have any assigned items or is a separate 10% BLS category.

Based on these Regs. sections, three types of index categories may be identified:

• Most-Detailed 10% Categories – Any most-detailed category with a FIFO balance greater than 10% of the pool sum of FIFO balances is an index category by itself. BLS weights will not be applied to these categories when performing index calculations; only actual inventory dollar weighting will be used. Also, these categories are excluded from the roll-ups used to create Other 10% Categories. Most-Detailed 10% Categories are those that are assigned inventory dollars in Step 1 of Regs. § 1.472-8(e)(3)(iii)(C)(2).
• Other 10% Categories – These categories, which are always less-detailed categories, are those with aggregated FIFO balances (for the categories they include) that exceed 10% of the pool sum of FIFO balances. BLS weighting is used for Other 10% Categories in category index calculations. Other 10% Categories are those that are assigned inventory dollars in Step 2 of Regs. § 1.472-8(e)(3)(iii)(C)(2).
• Remaining Categories Grouping – This is the aggregation of all categories which remain after the procedures described above. Due to the hierarchical structure of the BLS categories it is possible that some categories may not be rolled up so that they are included in an Other 10% Category. There might not be any Remaining categories for a given pool. BLS weighting is used for remaining categories in category index calculations. Remaining categories are those that are identified & segregated in Step 3 of Regs. § 1.472-8(e)(3)(iii)(C)(2).

Category Representation

A taxpayer that uses the 10 Percent method does not need to break down their inventory dollars to the level of greatest detail but it is necessary to account for whether the most-detailed categories actually have items present in inventory. The reason for this is that only the indexes & BLS weights of categories actually present are used for pool index calculations. If category representation is not performed, the BLS weights for items present within a company’s product mix may not be included in the LIFO calculation. Similarly, failing to perform category representation may cause BLS the BLS weights for items not present within a company’s product mix to be included in the LIFO calculation. For this reason alone, it’s highly recommended to use software when using the 10 Percent method.

10 Percent Categories Determination

Assigning inventory dollars to BLS categories is a data-gathering process that precedes pool index calculations. The mechanics of the 10 Percent method pool index calculations determines the appropriate BLS category assignments when using the 10% method. This means that changes in the inventory mix or pooling may require assigning different BLS categories if using the 10% method.

Examples

Example 1 – CPI: This company uses CPI & does not have fuels on LIFO. The following CPI Major Groups each include at least 5% of the total FIFO inventory balances:

BLS IPIC CPI Pools:

*The sum of the other six Major Groups’ FIFO inventory balances is greater than 5% of total inventory, so they will be combined in a third All other goods pool.

Pool 1 Food & Beverages BLS CPI 10% Categories

Pool 2 Other Goods & Services BLS 10% Categories

Pool 3 All Other Goods 10% Categories:

Example 2 – PPI

This company uses PPI & has fuels on LIFO. The following PPI 2-digit codes each include at least 5% of the total FIFO inventory balances:

BLS IPIC Pools:

The sum of the other 11 PPI 2-digit codes inventory balances is less than 5% of total inventory balances so they will be included with the largest pool.

Pool 1 Processed Foods & Feeds (02) & All Other 10% Categories

025503 Candy & nuts, 02620609 Noncarbonated soft drinks, 026207 Bottled carbonated soft drinks, & 02890172 Chips (potato, corn, etc.) will each probably include at least 10% of Pool 1’s inventory balances. 0261 Alcoholic beverages includes canned & bottled beer & other malt beverages, wine, & distilled spirits. If any of those categories of alcoholic beverages is likely to include 10% of the pool total, then more detailed categories should be used for BLS category assignment to inventory items. 02 Processed foods & feeds can be used for BLS category assignment to inventory items that are all other food & beverage categories because the pool’s 10% threshold is not likely to be met by aggregating (“rolling up”) inventory balances at any four-digit or three-digit level included in the 02 PPI 2-digit code. Similarly, all other inventory in Pool 1 can be sorted at the 2-digit level because no other PPI 2-digit code will likely include 10% or more of the pool total. In fact, some of these PPI 2-digit codes will probably not have any inventory balances—10 Metal & metal products & 13 Nonmetallic mineral products, for example.

Pool 2 Fuels & Related Products & Power (05) 10% Categories

Each of these are likely to include 10% of the pool total.

Pool 3 Chemicals & Allied Products (06) 10% Categories

It may be necessary to use one or more 8-digit category included in 0638 for BLS category assignment to inventory items. For example, if 063802 Central nervous system, 063805 Respiratory system, & 063807 Vitamins, nutrients & hematinic preparations were each more than 10% of the pool total then those would be used as BLS categories & all other pharmaceutical preparations would be assigned into 0638.

Pool 4 Miscellaneous Products (15) 10% Categories

152101 Cigarettes & 15250101 Other tobacco products are most detailed categories that are likely to include 10% of the pool total. All other goods in this pool can be can be assigned 2-digit BLS PPI codes.

Double-Extension v. Link-Chain Index Method

The double-extension method is the term used to describe calculation of cumulative indexes by dividing current year prices by base year prices for individual inventory items. The link-chain method is the term used to describe calculation of current year indexes by dividing current year prices by prior year prices, which is then multiplied by the prior year cumulative index to calculate the current year cumulative index. The prior year link-chain cumulative indexes would have been determined in a similar fashion. Either the double-extension or link-chain methods may be used by IPIC taxpayers. Use of the double-extension method by non-IPIC method retailers is very rare because this method is not practical for companies with rapid turnover of inventory items. In our opinion, the double-extension method should never be elected for IPIC taxpayers because discontinuation of CPI or PPI categories will require complicated index calculations that are avoided if the link-chain method is used. Use of the double-extension method can also cause greatly distorted inflation or deflation rates when there are substantial inventory mix changes from one year to the next solely as a result of the change in mix.

IPIC Index Month Options

The Regs. provide options to certain taxpayers regarding the selection of CPI or PPI months. Determination of appropriate index months for both IPIC & non-IPIC method taxpayers can be somewhat confusing because past IRS Regs. & other guidance in this area have been neither clear nor consistent. One item of confusion has been the definition of “current-year costs”. This could mean the valuation method (FIFO or average cost) used to determine general ledger inventory balances(gross of the LIFO reserve) or the method used to value LIFO increments. Many taxpayers & CPAs in the past have assumed current-year costs was only the method of valuing LIFO increments because of the pre-December 2005 Form 970 line 6a caption which reads “Method used to figure the cost of goods in the closing inventory over those in the opening inventory”. Such thinking led to the use of “dual indexes” whereby separate indexes were used to: 1) convert year end inventory balances to base year costs (deflator index), & 2) value the current year increment (inflator index). While it is still not clear what the intent of the IRS terminology & rules in this area really were in the past, the new Regs. published in 2002, the new Form 970(as of December 2005) & the Dual Index Methods Proposed Coordinated Issue Paper issued in April 2003 by the IRS Inventory Technical Advisor make it clear that:

1. Dual indexes methods are no longer permitted.
2. The term “current-year costs”, at least as it pertains to LIFO taxpayers, refers only to the three time periods during the year (end of year, beginning of year or middle of the year) from which the appropriate index month for the single LIFO index may be selected. IRS LIFO Regs. § 1.472-8(e)(2)(ii) provides these current-year cost method options:

• • The actual cost of goods most recently purchased or produced (latest acquisitions).
  • The actual cost of the goods purchased or produced during the taxable year in the order of acquisition (earliest acquisitions).
  • The average unit cost of all of the goods purchased or produced throughout the taxable year divided by the total number of units purchased or produced (12 month moving average).
  • Any other method that clearly reflects income (this option is not applicable for IPIC taxpayers because use of one of the three other options will be more practical).

Since there are PPI & CPI inflation indexes compiled & published for each month, IPIC taxpayers must decide which month’s indexes are to be used for pool index calculations. These are referred to as the “appropriate month” in the Regs.

Appropriate Month Selection Options

The Regs. provide options to taxpayers regarding the selection of CPI or PPI months depending on their current year cost method & their history of inventory production or purchases throughout the year. These index months are referred to as the appropriate month in the Regs. The Regs. allow retailers using the retail method to only use the month of their year end as their appropriate month. The IRS definition of “retail method” is LIFO calculations for which retail inventory balances are converted to base year retail indexes using retail selling price inflation indexes. This definition differs from the commonly used retail industry term Retail Inventory Method (RIM) which is the method commonly used to reduce retail inventory balances to a cost balance using departmental purchase & price change data. Other taxpayers (other than retailers using the retail method) have the option of electing one of the following two appropriate month selection options:

1. Annual selection – Annually determining an appropriate month for each pool. The appropriate month is the month most consistent with the taxpayer’s current-year cost method & the taxpayer’s history of inventory production or purchases throughout the year. The appropriate month can change from year to year.
2. Representative appropriate month – Making an election to use the same representative appropriate month for every year. This representative month must also be a month consistent with the taxpayer’s current-year cost method & the taxpayer’s history of inventory production or purchases throughout the year.

If the latest acquisitions current-year cost method is selected, the appropriate month will either be the year end month or a month or two earlier than the year end month. If the earliest acquisitions current-year cost method is selected, the appropriate month will be one of the first months of the year.

Reg. § 1.472-8(e)(3)(iii)(B)(3) provides examples of months deemed to be appropriate months for various current-year cost & taxpayer’s history of inventory production or purchases throughout the year combinations.

Although various CPAs have touted the ability to use different appropriate months for different pools & different months for different years as an improvement in the New Regs., doing so almost always creates additional complications in the annual index calculations without any compensating tax savings benefit. This is because the cumulative amount of inflation will be the same over time once the IPIC method is adopted & changing the appropriate month from year to year or using different appropriate months for different pools only complicates the calculations by requiring index calculations using either more than or less than 12 months’ inflation.

Most companies have historically used the most recent purchases current-year cost method. A fairly common practice for these IPIC taxpayers not required to use the last month of the year as the appropriate month (by virtue of being a retailer using the retail method), is to use an appropriate month earlier than the last month of the year to facilitate quicker LIFO calculations. Before the advent of the BLS Web site which makes PPI & CPI available within about 15 days after month end, this was a useful technique but is not really necessary now. Another planning idea was to elect the earliest acquisitions current-year cost method so that the first month of the year can be used as the appropriate month. This is an option no longer available based on the IRS’s clarification of the definition of current-year cost in their 2000 Dual Index Issues Paper.

 Producer Price Index Timeframe Options

The BLS publishes Preliminary indexes around the 15th of the following month (e.g., Preliminary August indexes are made available around September 15). All indexes are subject to revision four months after their original publication—these are Final indexes. Taxpayers may choose to use either Preliminary or Final indexes, but they must be consistent in their use (i.e., both Current Year indexes & Previous Year indexes must be Preliminary, or both must be Final). As a practical matter, taxpayers should use Preliminary indexes in order to perform IPIC calculations in a timely manner.

Companies using PPI must be aware of the issue of missing indexes. The PPI categories in Table 9 are not a static list because new categories are added & others discontinued on a regular basis. In July & January of each year the BLS publishes an Appendix in the PPI Detailed Report identifying which new categories have been added & which categories have been discontinued. It is not uncommon for the BLS to stop publishing indexes for some categories months before they are officially discontinued. Also, there are categories for which the BLS publishes indexes only sporadically, such as for seasonal produce (e.g., 01110203 Cherries).

Cost or Retail LIFO Method for Retailers

Retailers adopting LIFO for the first time will need to decide whether to use retail or cost LIFO. Historically, those companies with warehouse inventories used cost LIFO because of the difficultly of converting warehouse cost inventory balances to retail values. Companies without warehouse inventories using the IPIC method typically used retail LIFO because this did not require conversion of retail basis CPI to a cost basis using cost complements as required by the old (pre-2002) IPIC LIFO Regs. We believe most retailers would be better off using cost LIFO regardless of whether they have warehouse inventories. The reason for this is that the annual LIFO expense using retail LIFO is affected by margin changes from the prior year (this is not the case for cost LIFO) & this makes the planning for the amount of LIFO expense less predictable.

 Stores Inventory BLS Category Assignment Options

Most retailers use the 10 Percent method because this allows them to reduce time spent assigning BLS categories to their inventory items & use fewer less detailed CPI or PPI codes. Supermarkets using CPI, for example, must make BLS category assignments to their inventories by 33 less-detailed CPI categories rather than about 100 most-detailed categories as required by use of the Most-Detailed Categories method. Supermarkets using PPI that use the 10 Percent method must sort their inventories by about 55 less-detailed PPI categories rather than about 200 most-detailed categories as required by use of the Most-Detailed Categories method

The 10 Percent method entails more complicated pool index calculations but this is not an issue if the LIFO-PRO software is used because the necessary BLS weighting & dollar weighting is completely automated.

Most retailers that maintain warehouse inventories have warehouse inventory accounting systems that produce sufficient detail to allow breakdown of these balances by the required CPI or PPI categories. This is because these systems typically keep track of cost per item. Some companies’ store inventory accounting systems also include sufficient cost per item data to allow breakdown of these balances by the required CPI or PPI categories but at this point, the majority of retailers don’t have this luxury. For store inventories, the traditional inventory accounting method for at least some departments has been some variation of the Retail Inventory Method for which retail balances are known by department & cost by department balances are calculated by use of standard gross profit margins for these departments.

While any means of breaking store inventories down by CPI or PPI categories may be considered, the most common way to do this has been to get these breakdowns from physical inventory counts. When this procedure is used, the physical inventory counts planning need to incorporate these aspects:

Inventory Count Instructions

The inventory service should be provided the list of CPI or PPI categories required for IPIC method calculations. These are referred to as “LIFO counts”. While a few of the CPI or PPI categories may correspond to the regular physical count breakdowns, this will be a special LIFO count listing. The inventory service may or may not be instructed to make the normal count breakdowns in addition to the LIFO counts. An inventory service should be able to provide both the normal & LIFO breakdowns from the same physical count. This is accomplished by making different store layout maps (what shelf space belongs in the various breakout categories). Making LIFO counts in addition to normal counts often entails an additional fee from the inventory service & a 40% premium to do this is not unusual.

Sample size – For companies having only a few stores, they may well make LIFO counts for all stores. For companies with numerous stores, LIFO counts are made for a sample of stores & the sample stores’ CPI or PPI category distribution is used for the total of all stores’ inventory balances. The IRS provides no guidelines for this type of sampling. The IPIC LIFO Regs. make no mention of whether sampling is an appropriate means of obtaining the CPI or PPI category breakdowns, but this type of sampling has been used by retail grocers for 20 years without substantial IRS challenge of this practice. The sampling plan should take into account different store size, formats & location or other factors that could cause one store to have a significantly different inventory mix than another store. It is not uncommon for the same LIFO count stores for one year to be LIFO count stores in succeeding years because this eliminates the need for the inventory service to make LIFO count layouts for more stores.

Once the physical counts have been taken & the LIFO count sheets are available, there are several things that need to be taken into consideration including:

• Most count categories will have retail selling price totals but some may be cost totals
• Some departments may not be counted & back room goods are usually not counted
• There will usually be departments, such as pharmacy, for which the non-LIFO physical counts are broken down that correspond exactly to CPI or PPI categories. If physical counts are made for all stores at or near year end, a company may decide that the stores’ total for pharmacy per all counts (LIFO or not) is more accurate than extrapolating the LIFO count breakdown percentages to the entire inventory.
• Once the stores total balances by CPI or PPI categories have been accumulated, the warehouse balances, if applicable, should be added to these totals.
• Cost-only or cost & retail balances required—Only cost balances by CPI or PPI category are required for cost LIFO taxpayers but both cost & retail balances by CPI or PPI category is required for retail LIFO taxpayers.

 Missing PPI Treatment Options
The IRS IPIC LIFO Regulations issued in January, 2002 specify that what we call the “Substitute Index Method” be used for categories for which indexes are missing (for either the current or prior year for the applicable index month) but for which the categories have not been discontinued (what we refer to as “sporadic index categories”). We believe the use of the Substitute Index Method is also the most practical way to handle missing indexes for categories discontinued for which a replacement category is not added by the BLS until the same month.

Regulations § 1.472-8(e)(3)(iii)(D)(4) states that “…If the BLS has revised the applicable BLS table for a taxable year, a taxpayer must compute the category inflation index for each BLS category for which the taxpayer cannot compute a category inflation index in accordance with paragraph (e)(3)(iii)(D)(3) of this section (affected BLS category) using a reasonable method, provided the method is used consistently for all affected BLS categories within a particular taxable year.” This Reg. paragraph goes on to say “The compound category inflation index described in paragraph (e)(3)(iii)(D)(4)(ii) of this section is a reasonable method of computing the category inflation index for an affected BLS category.”

The Compound Inflation method entails the multiplication of partial year inflation rates for both the discontinued & replacement categories. We believe this method is not as practical as the Substitute Index Method & the use of the Substitute Index Method will generally produce indexes not significantly different from those calculated using the Compound Category Inflation Index method.

It is important to use a current list of PPI categories in order to minimize the problems associated with missing indexes. LIFO-PRO, Inc. performs extensive research on an ongoing basis to identify discontinued categories & their likely replacements.

Eligibility to Use the IPIC Method & IRS Filing Requirements

With the issuance of the New IPIC LIFO Regs. in 2002, all taxpayers are eligible to use the IPIC method. A Form 3115 Application for Change in Accounting Method is required to be filed to change from a non-IPIC LIFO method to the IPIC method. This type of change is normally an automatic approval change for which the Form 3115 due date is the same as for the Form 1120 including extension. A Form 970 Application to Use LIFO Inventory Method is required to be filed for changes to the IPIC method even for companies already using a non-IPIC LIFO method. No Form 3115 filing fee is required for automatic approval accounting method changes. Taxpayers not already using the LIFO method need only to file a Form 970 to adopt LIFO (IPIC or otherwise) & the Form 970 due date is the same as for the Form 1120 including extension.

IPIC Method IRS Automatic Approval Changes

The IRS allows a number of automatic approval changes to and within the IPIC method, for these automatic changes, the following applies:

• Change is made on a cut-off basis, meaning that no prior-period adjustments (i.e. §481(a) adjustments) are required & the change is made of as of the year that the IRS Form 3115 Change in Accounting Method is filed; if a company were to switch to the IPIC method for their 12/31/2018 year end, the IPIC method change would be effective as of 01/01/2018 if the IRS Form 3115 is filed with their 2018 year end 1120(s)
• No IRS users fee required to adopt the change
• Form may be filed after the year end, meaning a company can decide to make the change between their tax year end and 1120(s) filing deadline

LIFO Election Scope Expansions

A fairly common practice among retail grocers historically has been to exclude certain departments from LIFO. Perhaps 40% or so of these companies have excluded fresh meats & produce. Many also excluded bakery, deli, floral & pharmacy departments. One of the reasons these departments were not on LIFO was that meat & produce are commodity goods whose prices & inflation indexes can fluctuate greatly which results in unpredictable LIFO expense amounts. Another reason for these departments’ exclusion from LIFO is that internal indexes are difficult to calculate for commodity items. Using the IPIC LIFO method precludes the need to calculate internal inflation indexes using a company’s actual costs.

Our recommendation with respect to the LIFO election scope for grocery retailers is that all food & beverage goods be on LIFO because over time all food & beverage categories prices have risen. Meats & produce are typically not a large enough portion of total inventories that their volatile price indexes will greatly affect the total LIFO expense. Use of the IPIC method makes calculation of indexes for commodity items simple, so this reason for excluding departments from LIFO is not applicable for LIFO taxpayers.

 Repooling

If the makeup of pools changes as a result of switching to the IPIC method, reconfiguration of pools, or “repooling” is required. To do this, inventory must be sorted by the categories required (using either the Most-Detailed Categories method or the 10 Percent method) by the new pooling configuration as well as those categories required by the old pooling scheme. The result of this is that portions of individual old pools are allocated to different new pools. A repooling matrix illustrates this below:

Old pools B & C are each split into three pieces as shown above, pools G & H are each split into four pieces & the other pools are each split into five pieces. The seven pieces coming from the old pools that now belong in new pool 1 are combined. The same combination procedure is then applied to the other pools. Pool splitting & combination procedures are described in Regs. §1.472-8. The measurement date for the allocation is the year end before the new pooling method is implemented. The repooling matrix percentages are calculated using the FIFO balances as of the year end of the pooling method change despite the fact that the LIFO layer histories being repooled are as of the year end prior to the method change.

Pooling for Separate Corporations

The IRS Regs. require separate sets of LIFO pools to be maintained for each separate corporation regardless of whether consolidated federal tax returns are filed. Qualified Subchapter S subsidiary corporations (Q-Subs) & certain other legal entities may be “disregarded entities” in the eyes of the IRS & separate LIFO pools need not be maintained for disregarded entities for tax purposes.

No such separate set of LIFO pools for different corporations requirement exists for GAAP & book LIFO calculations for a “consolidated” set of pools are not uncommon.

 Changing Corporate Status

Companies that change from “C” corporations to Subchapter S corporations are required by the IRS Regs. to recapture their LIFO reserve. This is required for tax purposed only because there is no corresponding GAAP requirement.