LIFO recordkeeping and compliance.

• Author: Miller, Louis J.
• Position: Last-in-first-out inventory accounting

The main advantage of using the LIFO method of accounting for inventory costs is to eliminate "inventory profits" in periods of rising costs. LIFO allocates the most current inventory costs to cost of sales, allowing taxpayers to more clearly match current costs with current sales. In periods of rising prices (and increasing inventory quantities), the taxpayer can lock in lower prices in inventory. Other benefits of using LIFO may be lower personal property taxes or decreased expenses directly related to income, such as bonuses or profit-sharing payments.

Taxpayers elect to use the LIFO inventory method (and the resulting increased recordkeeping required to maintain this method) to reap these benefits. These same taxpayers should be aware, however, of the necessary recordkeeping requirements, as failure to comply could result in LIFO termination. Regs. Sec. 1.472-2(h) provides that supplemental and detailed inventory records shall be maintained to enable the district director to readily verify a taxpayer's inventory computations, as well as its compliance with the LIFO requirements. In addition, on examination, the propriety of all computations incidental to the use of LIFO are subject to the IRS's discretion in deciding whether the taxpayer may continue to stay on LIFO (Regs. Sec. 1.472-3(d)).

In Field Service Advice (FSA) 9920002, the taxpayer elected LIFO in fiscal year 1, then later filed an election for the use of multiple pools. The taxpayer requested a change in accounting method in fiscal year 2, and was granted permission to use a single pool as well as the double extension method of accounting for its LIFO inventory. The taxpayer, a retail jeweler, included in its single pool primarily finished goods inventory; also included in the pool were diamonds and semi-precious stones, classified by weight. This method continued until fiscal year 4, at which time the taxpayer began a different accounting for its items. The number of items within the pool increased tenfold, and the cost was accounted for using three component parts--the amount of gold in the merchandise, the type of stone in the merchandise and the difference of the first two over the total costs of the merchandise.

The taxpayer manually prepared accounting records when it elected LIFO; it maintained inventory records by item, including the cost and date purchased. The taxpayer then switched to a computerized accounting system that tracked inventory in the same manner. On...