Inventory price index computation method for LIFO inventories.

• Author: Hajduch, Mark A.
• Position: Brief Article

The inventory price index computation (IPIC) method described in Regs. Sec. 1.4728(e)(3) is designed to simplify the computation of a taxpayer's LIFO inventories. Although adopted with smaller taxpayers in mind, the IPIC method is often a more favorable LIFO computation method for larger taxpayers Because the IPIC method is mechanical in nature and relies on published price indexes to compute inflation (versus a taxpayer's actual inflation experience), its use can result in inflation (and a potential tax benefit) when none might otherwise exist.

Use of the method can be advantageous in a number of situations. For example, the method might be considered when a taxpayer's costs are being reduced as a result of manufacturing efficiencies (e.g., from reengineering) or outsourcing (e.g., buying parts or materials from less expensive sources).

Under the IPIC method, a taxpayer's inventory items are assigned to categories in the producer (PPI) or consumer (CPI) price index. PPI tables must be used by manufacturers and wholesalers; CPI tables may be used by retailers. As with other LIFO methods, taxpayers must establish inventory pools. However, retailers and wholesalers may establish inventory pools for any group of inventory items included in one of the 11 general CPI categories. Also, manufacturers may use one or more natural business unit pools.

Except for eligible small businesses (as defined in Sec. 474(b)), Regs. Sec. 1.472-8(e)(3)(u) provides that in computing the annual LIFO index, taxpayers must use only 80% of the percentage change in the applicable selected price indexes; eligible small businesses may use 100%. As shown beIow, the use of the IPIC method may still be favorable, even with the 80% limit.

Example 1: T manufactures widgets. Due to reengineering and outsourcing, the cost to manufacture widgets has decreased from $100 per widget to $90 per widget. The categorization rules under the IPIC method result in nominal inflation being computed for the year; for this purpose, assume that the allowable inflation is 2% (i.e., 80% of the inflation rate computed). T has 15 widgets on hand at the end of the year; it had 10 on hand at the beginning of the year.

The first-year LIFO computation would be as follows:

LIFO FIFO Year-end inventory at FIFO...