A change in accounting method from cash to accrual: new revenue procedures use incentives to encourage voluntary compliance.

New Revenue Procedures Use Incentives to Encourage Voluntary Compliance

One of the oldest axioms in the business world is "obtain the highest possible financial income while reporting the lowest legal taxable income." It cannot be denied that a strong financial statement builds equity, promotes expansion and eases credit requirements. On the other hand, high income generally means higher taxes. Nobody likes to pay taxes. Thus, it has been the goal of entrepreneurs, and their advisers, to devise methods that would accomplish this objective.

Reporting financial income on the accrual basis, while filing tax returns on the cash basis, is a popular technique. This tactic permits the entity to recognize financial income and expenses according to the matching principle promulgated by generally accepted accounting principles (GAAP). Meanwhile, the recognition of taxable income can be deferred until actually received (often years). A successful enterprise can often defer or reduce its tax liability from the maximum 34% to the minimum 15% rate.

Congress has recognized this disparity in reporting taxable income, and initiated legislation to require, coerce and encourage cash-basis taxpayers to convert to the accrual method. The Tax Reform Act of 1986 (TRA) directly addressed this issue by adding Sec. 448, "Limitation on Use of Cash Method of Accounting," to the Code.(1)

This article will contrast tax law with accounting principles; clarify the appropriate accounting method; identify those circumstances requiring the accrual method; examine the advantages and disadvantages of elective versus required change and the planning strategies available; and analyze compliance requirements and the incentives for change offered under three new revenue procedures.

Tax Code vs. GAAP

The Code and regulations do not define the terms "accounting" or "accounting method." Yet, the law is very specific in stipulating when and how items of income are to be reported. Therefore, an entity's "tax accounting" method would imply the procedures, processes and practices that are followed in determining taxable income. The term "accounting method" includes not only the overall method of accounting used by the taxpayer, but also the accounting treatment of any item.(2) Consequently, it is important to understand that a change in accounting method also includes any change in a material item used in an overall plan. Materiality of an item is defined in the regulations as any item that involves the proper time for inclusion in income or the taking of a deduction.(3)

Frequently, tax law does not agree with GAAP (used for financial statements) because social, economic and government funding requirements have been built into the Code.

The Financial Accounting Standards Board (FASB) has identified several objectives of financial reporting. The general objective is to provide useful information for present and potential investors, creditors and other external users in making rational investment, credit and similar decisions.(4) Since GAAP and "tax accounting" have different objectives, taxpayers have been able to justify maintaining different methods of accounting. In Patchen,(5) the court concluded that reconciliation schedules between the general books of account and a cash method tax return were to be included as part of the "books." Therefore, compliance with Sec. 446 had been met.

Planning opportunity: A taxpayer may keep its records of account on the accrual method and still file its tax return on the cash method. Schedules maintained by the taxpayer reconciling income to the tax return are required.(6) This may be used by new small corporations that are not otherwise required to use the accrual method. Later, an "expeditious procedure" permitted for an accounting change of cash to accrual can facilitate a possible six-year spread of the adjustment to income.

Appropriate Method Under GAAP

GAAP recognizes the concept of matching under the accrual method. The intention is to determine revenue first and then match appropriate costs against revenue. If a financial statement is prepared on another basis of accounting, a statement must be made that the presentation is not in conformity with GAAP. Many small businesses have chosen this method. By preparing their financial statements on an income tax basis, many of the complexities, such as calculating deferred taxes, are avoided. Thus, the cash method of accounting can be used when preparing a compilation or review financial statement.

Permissible Methods Under the Code

Both the cash receipts and disbursements method (cash) and the accrual method are permissible under the law. A taxable entity must follow the general rule that "taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books."(7) Although the law specifically permits the use of both cash and accrual methods, Sec. 448 places limitations on the use of the cash method. C corporations and partnerships including C corporations as partners and tax shelters are not permitted to use the cash method.(8) Thus, new businesses of these types are required to use the accrual method of accounting when filing their first tax return. However, there are three exceptions to this rule.

* Exceptions to the use of the accrual method

For C corporations and partnerships including C corporations, if the entity qualifies under one of three exceptions, the cash method is permitted. 1. A farming business, as defined in Sec. 263A: If the taxpayer is engaged in a separate business that requires the use of the accrual method, this will not preclude the taxpayer from using the cash method for the farming business.(9) 2. A "qualified personal service corporation": According to Sec. 448(d)(2), this exception applies only if two tests are met.

* The function test requires that at least 95% of the corporation's activity involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting.(10)

* The ownership test requires that at least 95% of the corporation's stock be held directly, or indirectly, by active or retired employees who perform, or performed, services as qualified under the function test. The estate of an employee would also qualify.(11)

A personal service corporation that fails to meet either of these tests must change to the accrual method. 3. A small business: This exception requires the application of a gross receipts test of $5 million using an average of three tax years.(12) A change to the accrual method is required in the year following a failure under this test.

Example 1: XYZ Corp. had gross receipts as follows:
         1989                      3,000,000
         1990                      5,000,000
         1991                     10,000,000
         Total 3-year receipts   $18,000,000

Since this is an average of $6,000,000 ($18,000,000/3), the corporation would be required to use the accrual method of accounting in 1992.

* Inventory factor - accrual method required

The accrual method is required for taxpayers that use inventory in computing income results.(13) If the IRS can establish that inventories are a material income-producing factor, taxpayers have no argument to support use of the cash method.

Two exceptions may exist when dealing with inventory.

* Incidental materials and supplies used in a service business have been deemed permissible with the use of the cash method.(14)

* Small inventories that "did not effect any substantial distortion of income"(15) have also been permitted with the use of the cash method.

The question arises, "Why would a taxpayer change from the cash to accrual method?" Answers to this vary a great deal and depend on different situations. The following circumstances may cause a taxpayer to change methods.

* Acquisition of inventory has occurred for the first time.

* Annual gross receipts exceed $5 million and are expected to remain at that level.

* An S corporation with annual gross receipts in excess of $5 million wishes to break the election and become a C corporation.

* The taxpayer may require audited financial statements. The cost of maintaining two sets of books may be excessive.

* A partnership interest is acquired by a C corporation.

* The "books" are being maintained on the accrual method.

* The current method does not clearly reflect income.

* The taxpayer is using the cash method erroneously and wishes to correct the error before being contacted by the IRS.

Advantages and Disadvantages of Elective

vs. Required Change

The advantages of changing methods as an elective measure (before the IRS initiates or requires the change) are tremendous. The old adage "being in the right place at the right time" certainly can apply here: timing is everything. An adjustment to income resulting from voluntary compliance may be included in income over a period of up to six years. A change begun by the IRS may be limited to as little as a one-year period.

Planning opportunities also exist for cash flow needs to cover additional taxes created by the change. The danger of penalties being imposed (both on the taxpayer and the preparer) exists. A thorough review of accounting records is required to insure that proper tax practices are being followed.

Changing from the cash to the accrual method may involve considerable time and expense. However, proper planning can eliminate much of this burden. Most taxpayers would rather pay taxes based on a planned approach. The additional unexpected burden of a large assessment, penalties and interest on audit is less palatable.

The disadvantages appear obvious. A change in accounting method will normally result in additional cost to the taxpayer in the form of accounting fees and tax.

Planning strategies: Small corporations with sales approaching $5 million might consider a voluntary change from the cash to the accrual method. The opportunity for savings in tax dollars may be available due to the current recession. This economic downturn may have caused the business to suffer lower sales and profits. Therefore, the adjustment to taxable income, required under Sec. 481(a), would be less significant. Additionally, by voluntarily changing, six years would be permitted as opposed to a four-year adjustment period.

S corporations and partnerships without C corporation partners are not automatically required to use the accrual method. A possible planning technique would be an S election or a partnership as opposed to a C corporation form of entity.

If a taxpayer foresees the acquisition of inventory, a voluntary election to change from the cash to the accrual method would be appropriate. Changing methods before acquiring inventory will permit a longer spread of the income adjustment.

Compliance Requirements

IRS approval of a change from the cash to the accrual method is required. This requirement must be met under all circumstances (e.g., the cash method is being used erroneously). However, as with most tax law, an exception exists. Those taxpayers forced to change methods to comply with Sec. 448 generally have the implied consent of the Service. Furthermore, they must determine the adjustment and include it in income over a period of four years.

When changing from the cash to the accrual method, three revenue procedures may apply. A decision as to which procedure is proper hinges on the circumstances involved. Rev. Proc. 92-20[16] is effective for applications filed after Mar. 23, 1992. It is to be followed when expeditious procedures do not apply. This revenue procedure both modifies and supersedes the previous central procedural guide for accounting changes, Rev. Proc. 84-74.(17)

* Expeditious procedures

Rev. Procs. 92-74(18) and 92-75(19) are the new expeditious procedures effective as of Sept. 21, 1992. These procedures modify, supersede and significantly change Rev. Procs. 85-36(20) and 85-37,(21) respectively.

The new expeditious procedures were issued for three basic reasons: (1) To further encourage voluntary change to the accrual method; (2) to create consistency between the central procedural guide, Rev. Proc. 92-20, and the expeditious rules; and (3) to alleviate the burden of letter rulings at the IRS National Office.

The IRS's consent to change from the cash to accrual method is presumed when filing under an expeditious procedure. However, Form 3115, Application for Change in Accounting Method, must be completed in duplicate, signed and filed no later than the due date for filing the original Federal income tax return (with extensions). The original form is filed with the tax return and a copy must be sent to the IRS National Office. This separate filing will not be acknowledged. The normal user's fee of $500 is not required.(2) It is important to note that taxpayers will not qualify under expeditious procedures if they are "under examination" (which includes having been contacted for the purpose of scheduling an audit). Taxpayers under examination may, however, be able to change accounting methods using Rev. Proc. 92-20. Compliance under this procedure requires the user's fee and a filing date no later than 180 days from the beginning of the year.

The new expeditious procedures permit a change to an overall accrual method by taxpayers that are using a hybrid method. Also, taxpayers may change to an accrual method in conjunction with a special method. These are revisions in the new documents.

A de minimis rule was added to the expeditious procedures, which permits an election of a one-year period in lieu of a longer time for inclusion of the Sec. 481(a) adjustment. A request for this election is made by a statement attached to the Form 3115.[23]

Voluntary change to an accrual method by using the new revenue procedures will protect prior years. The same method of accounting cannot be challenged by an agent examining a prior year. This protection offers the taxpayer another incentive for considering a voluntary change to the overall accrual method.(24)

The expeditious revenue procedures may not be used if a prior request has been made within the last six years without a change actually being made. This would include a request under their predecessors, Rev. Procs. 85-36 and 85-37.(25)

* Special method change

Changing to the accrual method, and also changing to a special method, requires separate filings of Form 3115. The special method change requires a user's fee and must be filed within the first 180 days of the year of change. IRS approval is required and not automatically granted.

Approval of a specific change would require the net Sec. 481(a) adjustment to be taken into income in accordance with the IRS's consent. Disapproval of a special change will not, however, preclude the use of an expeditious procedure when changing to an overall accrual method.(26)

* Rev. Proc. 92-74: change when using inventory

Expeditious consent for a change from the cash to the accrual method will be given to taxpayers that are required to use inventories in order to clearly determine income. This consent is now available to manufacturers required to use the full absorption method for costing inventory. However, any change required by Sec. 263A and the related Sec. 481(a) adjustment must be made before the change in accounting method.(27)

All accounting method changes require the same first step of calculating the required Sec. 481(a) adjustment. If inventory is required to clearly reflect income, the adjustment period for any positive calculation is three tax years. A negative adjustment must be included in income in the year of change. The adjustment calculation would take into account inventories, accounts receivable, accounts payable and other items necessary to prevent duplication of income and expenses. A recurring item exception is now permitted in the calculation as specified in Sec. 461(h)(3).

Example 2: In 1992, a calendar-year taxpayer changes from the
overall cash method to the accrual method. In previous years,
inventory was deducted as paid. The following items must be
considered for the calculation of the "net adjustment."
  Income, determined by a
    current listing of A/R 12/31/91   $200,000
  Inventory previously deducted
    at 12/31/91                        150,000
  Expenses, determined by a current
    listing of A/P 12/31/91             80,000
  Sec. 481(a) "net adjustment" computation:
  Income not previously recorded      $200,000
  Inventory previously deducted
    (expensed under cash method)       150,000
  Total positive adjustment            350,000
  Less expenses not previously
    recorded                           (80,000)
  Net Sec. 48 1 (a) adjustment        $270,000

This adjustment would be added to income at $90,000 per year ($270,000/3 years) for 1992, 1993 and 1994. Note: The beginning of the tax year of change is used to compute the adjustment to income.

A decrease in inventory of more than 33 1/3% that remains reduced for a period of one tax year would require any remaining portion of the adjustment, attributable to inventory, to be included in income the succeeding year.(28)

Caution: It is important to remember that the use of this expeditious procedure, and the spreading of the adjustment over three years, is permitted only if the taxpayer is not under examination at the time of the request.

* Rev. Proc. 92-75: change without inventories

The second expeditious consent procedure applies to an overall change from the cash to the accrual method when no inventories are involved. This procedure assumes that the cash method was properly applied. Methods considered permissible under the law are included in the "Category B" methods. The Sec. 481(a) net adjustment under these rules may be spread over six years (whether positive or negative).(29)

Under Rev. Proc. 92-75, the 67% rule (a requirement that most of the adjustment be accounted for within the first three years) has been eliminated. This change is an incentive to encourage voluntary adoption of the accrual method.

* Exceptions to the adjustment period spread

The exceptions listed in Exhibit A, on page 109, apply to Rev. Proc. 92-20 and the two new expeditious procedures. However, there are two exceptions not contained in Rev. Proc. 92-20 that must be considered, both of which involve accounts receivable.

A 33 1/3% reduction in accounts receivable, compared to the balance at the beginning of the year of change, triggers an exception. The remaining Sec. 481(a) adjustment must be included in the tax year after this reduction. (These rules are similar to those in Rev. Proc. 92-20 that apply when inventory is reduced by 33 1/3%.) Temporary fluctuations of less than one tax year will not require this inclusion in income. It should be further noted that, at the discretion of the IRS, this exception may be waived. The waiver is designed to offer relief when the reduction in receivables is due to unusual circumstances.(30)

The accounts receivable reduction exception exists to discourage taxpayers from manipulating income. Without this exception, there would be no deterrent to selling the accounts receivable for cash.

If any portion of net Sec. 481(a) accounts receivable becomes worthless during the adjustment period, the net adjustment must be recomputed.(31) This is necessary for the proper matching of income and expense.

Example 3: Taxpayer W has determined a net positive Sec.
481(a) adjustment of $120,000. W has no inventory and therefore
qualifies for a six-year spread adjustment period in changing
to the overall accrual method. The year of change is 1993.
In 1995, $42,000 of the accounts receivable included in the
original Sec. 481(a) adjustment are determined worthless.
This requires the following reallocation of the adjustment.(31)
Net Sec. 481(a) adjustment
would be included in
income as follows:
  1993                                      $ 20,000
  1994                                        20,000
  1995: Worthless A/R
    ($42,000 - $14,000)         $28,000(*)
    Add: 1/4 remaining
      Sec. 481(a) adjustment
      (($80,000 - $28,000)/4)    13,000
  Total 1995 adjustment                       41,000
  1996                                        13,000
  1997                                        13,000
  1998                                        13,000
                                            $120,000
(*) This amount has been reduced by the portion included in 1993 and
1994 prior to the worthless determination (($42,000/6) x 2 =
$14,000).

Rev. Proc. 92-20: Encouraging a Voluntary

Change in Method

Any taxpayer excluded from the use of an expeditious procedure must make a request for a change in accounting method using Rev. Proc. 92-20. Exhibit B, on page 110, lists those taxpayers specifically excluded.

Rev. Proc. 92-20 is an attempt by the IRS to encourage voluntary changes in accounting methods. The new rules will offer the taxpayer who voluntarily initiates a change terms and conditions that are more favorable than those offered to taxpayers who wait until they are contacted for audit. Overall, the procedure is designed "to encourage prompt compliance with proper tax accounting principles, and to discourage taxpayers from delaying the filing of applications for permission to change an impermissible accounting method."(33) A system of gradation in incentives is used to promote these voluntary changes.

Prior practice permitted a taxpayer to voluntarily change methods while under examination. This would avoid the change being made by the auditor. Consequently, the change could be spread over a maximum of six years. As a result, taxpayers delayed a required change until specifically questioned on audit. There was no incentive stimulating voluntary compliance for change to a proper accounting method.

Although the IRS boasts of simplifying and eliminating many of the complex rules and requirements of Rev. Proc. 84-74, the new procedure contains transition rules, technical complexities and voluminous alternatives, based on different window periods.

An understanding of terms used in the new procedure is necessary. As in previous procedures, "Category A," "Category B" and "Designated B" methods are used in applying the rules. A Category A method (see Exhibit C, on page 111) is a method of accounting specifically not permitted under the Code, the regulations or a decision of the Supreme Court.(34) Category B methods are all methods other than Category A methods, including both permissible and impermissible methods. Therefore, as an example, the cash method would be a Category A method if inventories were involved. Alternatively, the cash method would be a Category B method if inventories were not a material income-producing factor (assuming there is no other applicable limitation on the use of the cash method, such as Sec. 448).

Designated B methods, on the other hand, are methods that the IRS will designate by revenue rulings or revenue procedures. These are methods that are considered erroneous but are not expressly prohibited by the Code, regulations or the Supreme Court. If a method has been a Designated B method for more than two years, any change will be treated as a change from a Category A method.(35) An abridged list of Designated B methods appears in Exhibit D, above.

Rev. Proc. 92-20 created a new method classification, "Designated A." Designated A methods are Category A methods that have been designated Designated A methods in documents published in the Internal Revenue Bulletin.(36)

Caveat: At the writing of this article, there are no Designated A methods. However, the prerogative is available to the IRS. A document declaring a current Category A method as a Designated A method can be issued at any time. If this occurs, the taxpayer will include any positive Sec. 481(a) adjustment in taxable income for the year of change. No spread period will be allowed. On the other hand, a negative Sec. 481(a) adjustment will be spread over the subsequent three tax years.(37) This appears to be a clear warning. Currently, an impermissible method may be changed. The taxpayer may (if granted permission) spread the adjustment over a three-year period. On the creation of Designated A methods, this option will disappear.

In addition, the new rules affect taxpayers who wait until contact for audit to consider a change in accounting method. They will receive fewer favorable terms than a taxpayer who voluntarily complies. Among others, a 90-day window exists, beginning with the date a taxpayer is contacted for examination, which will permit more favorable terms than those permitted on completion of the audit.(38) Exhibit E, above, summarizes the new adjustment periods.

Accordingly, the first consideration under the new rules is whether or not a taxpayer is currently under examination. If the taxpayer is under exam, the appropriate window period must be applied.

* 90-day window

Using this window permits a taxpayer to spread the adjustment over a maximum of three years if the method being changed is a Category A method. The 90-day period begins the day after the beginning of the examination (which begins on the date a taxpayer is notified by the IRS that an examination has been scheduled). An exception exists if an impermissible (Category A) method was adopted in the year being examined; then the taxpayer is not permitted to change methods under Rev. Proc. 92-20.(39)

Example 4: X began business in 1989. Merchandise is an income-producing factor; therefore, inventories are required. However, X uses the cash method. On contact for audit of the tax year 1991, X could apply for a change on Form 3115, using Rev. Proc. 92-20. If the request is filed within 90 days, X would be allowed to spread the Sec. 481(a) adjustment over a three-year period. However, if the year being audited is 1989, no spread would be permitted.

Generally, the 90-day window permits a taxpayer to treat a Category A method change as if it were not under examination. Category B methods, however, are not afforded the same courtesy. Without the specific consent of the district director, a Category B method change, within the 90-day window period, will result in a positive adjustment being made in one tax year. No spread is allowed. A negative adjustment, however, must be spread over six years.(40) Thus, any taxpayer wishing to change from one permissible method to another should seek the consent of the district director. This action may allow a six-year spread of a positive adjustment.(41)

Example 5: D keeps his books and records on the cash basis. Tax returns are filed accordingly. D has no inventories. He is not prohibited from the use of the cash method, but now desires to change to the accrual method. If D is contacted for an examination, he should seek the consent of the district director before applying for a change in accounting methods. Without this consent, a positive Sec. 481(a) adjustment would have to be included in one tax year.

* 30-day window

There is also a 30-day window period under Rev. Proc. 92-20 referring to the first 30 days of a tax year in which a taxpayer wishes to change accounting methods. Presuming the time constraints can be met, an application to change methods may be made on compliance with two conditions: 1. The taxpayer has been under examination for at least 18 consecutive months prior to the 30-day window, and 2. The taxpayer has not received written notification from the examiner citing the method (or submethod) to be changed as an issue under consideration.(42)

Compliance with these constraints and conditions will permit the taxpayer to change methods using Rev. Proc. 92-20.

* 120-day window

If the taxpayer is under examination for any tax year other than the year of change, the 90-day window is not applicable. However, a taxpayer may request a change using Rev. Proc. 92-20 during the 120-day period following the completion of an audit, even though another examination has begun. Permission to change will not be available if - the method of accounting is included as an item of adjustment in a prior examination. - the method of accounting is an issue placed in suspense by the Service; or - the taxpayer has received notice that the method is an issue under consideration for subsequent exams.(43)

* Additional considerations

Transition rules cover taxpayers that applied for a change between Mar. 23, 1992 and Sept. 19, 1992. Basically, taxpayers wishing changes during this transition period will be accorded no less favorable conditions than those applying for changes under Rev. Proc. 84-74.(44)

This discussion of Rev. Proc. 92-20 has considered the rules and procedures applying to a change from the cash method of accounting to the accrual method. But Rev. Proc. 92-20 is comprehensive and complex, and this discussion is not intended to be all-inclusive. For example, taxpayers using the LIFO method of inventory who wish to change methods must follow specific rules. Therefore, a thorough review of Rev. Proc. 92-20 would be required before any attempt is made to file Form 3115.

Conclusion

In keeping with the trend established by the Tax Reform Act of 1986, the accrual method of accounting for taxes is becoming the rule rather than the exception. The issuance of Rev. Proc. 92-20 and subsequent expeditious procedures is another step in this legislative trend. It would behoove all prudent taxpayers and preparers to recognize the handwriting on the wall. They should review their status, determine whether a voluntary change is to their benefit, and make any necessary adjustments before the results get even worse.

Exhibit A: Exception to Sec. 481(a) Adjustment Period

Under Rev. Proc. 92-20

1. De minimis rule - if the adjustment is less than $25,000, an election

may be made to use a one-year period. (Section 8.01 (1).) 2. Preceding year test - if 90% or more of the adjustment is attributable

to the preceding year, the entire amount must be included in the year

of change. (Section 8.01(2).) 3. Number of tax years - the adjustment period cannot exceed the number

of years the method was actually used. (Section 8.01(3).) 4. Acceleration of the adjustment may occur under the following conditions: * 33 1/3% reduction in inventory rule applies. (Section 8.03(1).) * Taxpayer ceases to engage in the trade or business. (Section 8.03(2).)

Exhibit B: Taxpayers Excluded From Using Expeditious

Procedures When Changing From Cash to Accrual Method(*)

1. Financial institutions. 2. Farmers. 3. Cooperatives. 4. Individuals - except for activities conducted as sole proprietorships. 5. Taxpayers specifically excluded from the use of the cash

method of accounting:

* C corporations (gross receipts over $5 million).

* Partnerships with a C corporation partner.

* Tax shelters. 6. Taxpayers under examination by the IRS or who have been

contacted in any manner for the purpose of scheduling an

audit. 7. Taxpayers who, at the time of filing Form 3115, are

- before an appeals office of the IRS with respect to an

examination;

- before any Federal court with respect to an income tax issue. 8. Taxpayers who are the subject of a criminal investigation concerning

Federal tax liability. 9. Taxpayers required to use the percentage of completion method

for long-term contracts. 10. Taxpayers that are not in compliance with the uniform capitalization 

rules. 11. Taxpayers changing from a Category A method see Exhibit C, on

page 111). 12. Corporations engaged in certain corporate acquisitions.

(*) Adapted from Rev. Procs. 92-74 and 92-75, Section 4.

Exhibit C: Examples of Category A Methods(*)

1. Methods of inventory valuation not in accord with those listed in

Regs. Sec. 1.471-2(f)(1) through (7). 2. Write-down of goods in inventory that does not comply with Regs.

Sec. 1.471-2(c) or Regs. Sec. 1.471-4(b). 3. Write-down of "excess inventory" to a net realizable value, when

such inventory has not been scrapped, sold or offered for sale at

reduced prices. See Thor Power Tool Co., 439 US 522 (1979)(43

AFTR2d 79-362, 79-1 USTC [para] 139). 4. The use of the cash method for sales and purchases of merchandise

when such merchandise is an income-producing factor and inventory

is required. Regs. Sec. 1.446-1(c)(2)(i). 5. The use of the cash method when prohibited by Secs. 447 and 448. 6. The use of the LIFO method of accounting for inventories when there

has been a termination event that occurred during a year not barred

by the statute of limitations as of the date of filing a Form 3115 to

request a change from the LIFO method. (Rev. Proc. 79-23, 1979-1 CB

564.)

(*) See Rev. Proc. 92-20, Section 3.06.

Exhibit D: Designated Category B Accounting Methods(*)
                      Code
                     section
   Authority        reference           Description
Rev. Rul. 81-173,    Sec. 461   Accrual method public utilities
 1981-1 CB 314                  may not deduct as a state
                                franchise
                                tax amounts attributable to
                                unbilled sales that are neither
                                actually, nor required to be,
                                included in gross sales for
                                state
                                franchise purposes.
Rev. Rul. 81-176,    Sec. 461   Accrual method nursing homes
 1981-2 CB 112                  must report those readily
                                calculable,
                                year-end income adjustments
                                with respect to income
                                earned from Medicaid patients
                                in
                                the year in which the services
                                are
                                performed.
Rev. Rul. 83-106,    Sec. 451   Accrual method gambling casino
 1983-2 CB 77                   must include gambling revenue
                                derived from customers who
                                gamble
                                on credit in the tax year the
                                obligations arise and the
                                gambling
                                occurs.
Rev. Rul. 84-31,     Sec. 451   The deficiency taking amount in
 1984-1 CB 127                  a
                                "take or pay" gas purchase
                                contract
                                must be included in income
                                when the amount of the
                                deficiency
                                taking becomes fixed and
                                determinable.
Rev. Rul. 86-35,     Sec. 446   Accrual method financial
 1986-1 CB 218                  institution
                                must also report interest
                                income from commercial and
                                mortgage loans on accrual
                                method.
Rev. Rul. 88-60,     Sec. 61    Cash method farmers cannot use
 1988-2 CB 30                   an inventory method to
                                determine
                                the cost of purchased
                                livestock.
(*) An abridged version adapted from Holman, Diamond and Oshinsky, 303-4th
T.M., Accounting Methods - Adoption and Changes.

(1) TRA Section 801(a). (2) Sec. 446(a); Regs. Sec. 1.446-1(a)(1). (3) Regs. Sec. 1.446-1(3)(2)(ii)(a). Conversely, a change that does not affect timing would not be considered a change in method. Regs. Sec. 1.446-1(e)(2)(ii)(b). (4) Statement of Financial Accounting Concepts No. 1: "Objectives of Financial Reporting by Business Enterprises" (Stamford, Conn.: FASB, Nov. 1978), 28. (5) See Josef C. Patchen, 258 F2d 544 (5th Cir. 1958)(2 AFTR2d 5433, 58-2 USTC [para]9733), rev'g in part and aff'g in part 27 TC 592 (1956). (6) Rev. Rul. 58-601, 1958-2 CB 81. (7) Sec. 446(a); Regs. Sec. 1.446-1(a)(1). (8) Sec. 448(a); Temp. Regs. Sec. 1.448-1T(a)(2). (9) Temp. Regs. Sec. 1.448-1T(d)(1). A farming business is also subject to Sec. 447(a), which requires the use of the accrual method for certain corporations and partnerships. (10) Temp. Regs. Sec. 1.448-1T(e)(4). (11) Temp. Regs. Sec. 1.448-1T(e)(5). (12) Temp. Regs. Sec. 1.448-1T(f). (13) Temp. Regs. Sec. 1.446-1(c)(2)(i). (14) See Est. of Howard T. Roe, 36 TC 939, 952 (1961). (15) See Michael Drazen, 34 TC 1070, 1079 (1960). (16) Rev. Proc. 92-20, IRB 1992-12, 10, as modified by Rev. Proc. 92-85, IRB 1992-42, 62. (17) Rev. Proc. 84074, 1984-2 CB 736, as modified by Rev. Proc. 88-15, 1988-1 CB 683. (18) Rev. Proc. 92-74, IRB 1992-38, 16. (19) Rev. Proc. 92-75, IRB 1992-38, 22. (20) Rev. Proc. 85-36, 1985-2 CB 434. (21) Rev. Proc. 85-37, 1985-2 CB 438. (22) Rev. Procs. 92-74 and 92-75, Sections 7.01 and 7.02. (23) Id., Sections 3.05 and 5.04. (24) Rev. Proc.92-74, Sections 5.10 and 5.11; Rev. Proc. 92-75, Sections 5.10 and 5.09. (25) Rev. Procs. 92-74 and 92-75, Section 4.02(13). (26) Id., Section 8.01. (27) Rev. Proc. 92-74, Section 5.06(3)(b). (28) Id. Section 5.06(1). This example was adapted from Rev. Proc. 92-74, Section 5.01, Example 1. (29) Rev. Proc. 92-75, Section 5.03(1)(b). (30) Id., Section 5.05(3) and (4). (31) Id., Section 5.05(2). (32) This example was adapted from Rev. Proc. 92-75, Section 5.05(2), Example 3. (33) Rev. Proc. 92-20, Section 1. (34) Id., Section 3.06. (35) Id., Section 3.09. (36) Id., Section 3.07. (37) Id., Section 7.03(3)(b). (38) Id., Section 1. (39) Id., Section 4.01. (40) Id., Section 6.02(3)(b). (41) Id., Section 6.06. (42) Id., Section 6.04. (43) Id., Section 6.03(1). (44) Id., Section 14.01.

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Sally A. Wahrmann, MST, CPA Assistant Professor of Accounting and Taxation School of Professor Accountancy C.W. Post/Long Island University Brookville, N.Y.