Choice of accounting method for manufacturers.

• Author: Lerman, Jerry L.

The choice of accounting method is an important decision that is sometimes made inadvertently. In general, a taxpayer is permitted to adopt any accounting method, as long as it clearly reflects income (Sec. 446). Available methods include the cashreceipts-and-disbursements method, the accrual method and the long-term contract method. A taxpayer can adopt a method simply by filing two consecutive returns based on the selected method.

Specific accounting methods are statutorily prescribed for certain taxpayers. For example, taxpayers required to use inventories must use the accrual method when reporting sales and purchases (Regs. Sec. 1.446-1(c)(2)(i)). Taxpayers with longterm contracts generally must use the percentage-of-completion method under Sec. 460. Interestingly, even a taxpayer that manufactures personal property may be required to use the long-term contract method, rather than an overall accrual method.

Sec. 460(f) defines a long-term contract as a contract for the manufacture, building, installation or construction of property if it is not completed within the tax year started. Sec. 460(f)(2) contains additional requirements for long-term contract treatment for manufacturing contracts. Specifically, a manufacturing contract not completed in the contracting year is considered a long-term contract and subject to the percentage-of-completion accounting method if manufactured personal property is:

* A unique item not normally carried in finished goods; or

* An item that normally requires more than 12 calendar months to complete.

Prop. Regs. Sec. 1.460-2(b), issued May 5, 1999, further clarifies the definition of a long-term manufacturing contract by addressing the definition of a unique item. A "unique item" is something designed for a specific customer. The factors used to evaluate whether an item is unique include the level of research, development, design and engineering the taxpayer must perform to complete the contract. Also to be considered is whether the same item could be sold to other customers.

Prop. Regs...