LIFO dual index method.

• Author: Garrett, Rich
• Position: Last-in, first-out inventory accounting

The IRS Industry Specialization Program has just released a position paper that holds that taxpayers using a dual index method should not estimate earliest acquisitions cost under the last-in, first-out (LIFO) inventory method. The following discussion shows how to identify a dual index method, and determine whether the method is subject to IRS attack.

The dual index method is designed to help a taxpayer simplify a LIFO inventory calculation. Example 1 on pages 200-201 of a LIFO calculation shows how a dual index method works.

The IRS position paper holds that taxpayers using a dual index method should not estimate earliest acquisitions cost in steps 6 and 7 of the dual index method calculation. For example, the Service would object to the use of the prior year's cumulative deflator index as the current year's cumulative inflator index, since this assumes there was no inflation at the beginning of 1996. In addition, the IRS objects to a method that computes the current year inflator index based on inventory turns.

Example 2: The inventory turnover of Company A, from Example 1, is four times a year. In this case, the Service feels that A should not compute its current year inflator index as follows:

Current year deflator index

- 1.00

Total current year inflation

[divided by] Inventory turns

...