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Alternative LIFO method for car dealers.

Car dealers may choose to use the dollar-value LIFO method to value their ending inventory of new cars and new light-duty trucks. This method uses "pools," the composition of which has, until recently, caused much confusion. Rev. Proc. 92-79, 1992-39 IRB 13 reduces this confusion by introducing an "alternative LIFO method" that simplifies the pooling process. This article, through a common fact pattern and two examples, explains the significance of the revenue procedure.

Common Fact Pattern

Consider a car dealer who sells one make of car. The 1992 models have regular brakes. The 1993 models, however, have either disc brakes or anti-lock brakes. The 1992s and 1993s are alike in most respects except for the brake systems. These facts emphasize the point that, from year to year, most cars remain fundamentally the same (e.g., wheel base, frame). But because of technological advances, new cars have different "whistles and bells" that change their cosmetics and other features.

Mechanics of Dollar-Value LIFO

The dollar-value LIFO method ignores individual inventory items because it groups these items into one or more pools. The pools contain product categories so, for example, new cars could form one pool and new trucks could form another pool. At year end, the current cost of each pool is computed. This value is then reduced to base-year cost. The base-year cost is the initial cost of the inventory in the pool at the beginning of the year in which LIFO is adopted.

The current year's ending inventory at base-year cost will probably be larger than the original LIFO inventory at base-year cost. If so, the current ending inventory is assumed to consist of two layers: the original layer at base-year cost plus the incremental layer at current cost.

Issues and Rev. Proc. 92-79

How many pools should exist when a dealer has cars with regular brakes, disc brakes and anti-lock brakes? Until recently, IRS agents said three pools and dealers said one pool. As the examples will illustrate, there are tax advantages to having fewer, larger pools.

As a general rule, merchandise pools are established by major lines, types or classes of goods, according to customary business classifications. In the past, IRS strictly interpreted this rule to mean that various goods had to conform exactly before they could share the same pool.

In Rev. Proc. 92-79, IRS relaxed its position and adopted definite, objective guidelines for organizing pools. These guidelines consist of "manufacturer's base model codes." The codes are so broad and general that they allow one pool to encompass cars with regular brakes, disc brakes and anti-lock brakes.

There is a secondary issue. Assume cars with regular brakes comprise one pool. Will these cars, undergoing continual technological advances, evolve into a different product requiring a new pool? According to Rev. Proc. 92-79, the manufacturer's base model codes have a life of five to seven years. That is, it takes five to seven years of accumulating "whistles and bells" before a car evolves into a product requiring a new pool.

Example 1: One Pool

Assume a dealer's beginning inventory on January 1, 1992, consists of 50 new cars (1992s with regular brakes), for which he paid $10,000 apiece. His base-year cost is $500,000: 50 x $10,000.

In October 1992, the 1993 models are unveiled. Some 1993 models have disc brakes while other models have anti-lock brakes. The dealer buys 400 of the 1993 models at an average price of $12,000 apiece. Assume the dealer has 62 cars on hand at December 31, 1992, and he needs to value this ending inventory.

Under the LIFO method, the last cars purchased are the first cars sold. Thus, ending inventory consists of the costs of the first cars purchased. So the 62 cars in ending inventory consist of the original 50 1992s (costing $10,000 each) + the 12 1993s (averaging $12,000 each). The dealer's ending inventory at base-year cost is $620,000: (50 + 12) x $10,000. His ending inventory at current cost is $744,000: (50 + 12) x $12,000. In the dollar-value LIFO calculation appearing in Table 1, EI and BI represent ending inventory and beginning inventory, respectively.

Thus, under the dollar-value LIFO method using one pool, ending inventory is valued at $644,000. If it were valued under a current cost approach, such as FIFO or specific identification, it would be valued at $744,000 (62 x $12,000).

Notice the tax savings produced by LIFO. Because ending inventory is lower by $100,000 ($644,000 v. $744,000) under LIFO, cost of goods sold is higher by $100,000. As a result, the dealer's taxable income is lower by $100,000. If his effective tax rate is 34%, he saves taxes of $34,000 ($100,000 x 34%).

Example 2: Two Pools

Assume the same facts in Example 1, except ending inventory includes two 1993 cars with anti-lock brakes, costing $14,000 apiece. Assume these two cars go into pool #2. Thus the 62 cars in ending inventory are allotted as follows:

Pool #1

Fifty 1992s (reg. brakes) Ten 1993s (disc brakes)

60 cars

Pool #2

Two 1993s (anti-lock brakes)

2 cars

When the two 1993s with anti-lock brakes are split off into a second pool, their current cost (2 x $14,000 or $28,000) is isolated and affects the value of ending inventory. As the calculations in Table 2 reveal, the creation of a second pool increases ending inventory by $4,000 ($644,000 to $648,000).

The one-pool and two-pool examples produce ending inventory of $644,000 and $648,000 respectively. The $4,000 increase produced in the two-pool example will increase the dealer's taxable income by $4,000. If the dealer's effective tax rate is 34%, he pays extra taxes of $1,360 ($4,000 x 34%). This illustrates the general proposition that it is better to have fewer, larger pools than to have many, smaller pools.


Dealers wishing to adopt the "alternative LIFO method" must file an election statement on Form 970. Proper completion of the form requires dealers to specifically (1) refer to Rev. Proc. 92-79, and (2) state they are electing the new method.


The new alternative LIFO method of Rev. Proc. 92-79 allows dealers to adopt more natural business pools for new cars and light-duty trucks. The revenue procedure enables dealers to establish fewer, larger pools by using manufacturer's base model codes. The codes provide objective guidelines that will reduce conflicts between the IRS and dealers.


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Title Annotation:Debits and Credits; last-in first-out
Author:Lynch, Michael; Witner, Larry
Publication:The National Public Accountant
Date:Mar 1, 1993
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