Rev. Rul. 76-531

Advice has been requested whether, under the circumstances described below, the allocation of production cost variances to inventory, for Federal income tax purposes, pursuant to section 1.471-11(d)(3)(ii)(a) of the Income Tax Regulations, and the deduction of such variances for financial reporting purposes is a violation of sections 472(c) and (e) of the Internal Revenue Code of 1954.

The taxpayer is a corporation engaged in the manufacture and sale of electric appliances. The taxpayer uses the accrual method of accounting and files its returns on a calendar year basis. The taxpayer values its inventory at cost and employs the last-in, first-out (LIFO) inventory method.

For taxable years ended before 1975, the taxpayer did not employ the full absorption method of inventory costing within the meaning of 1.471-11 of the regulations. The taxpayer used a standard cost system to allocate production costs to inventory. Before 1975, all variances from standard cost were reflected in the cost of goods sold for both tax and financial reporting purposes resulting in current deductions.

The taxpayer elected, pursuant to section 1.471-11(e)(1)(ii) of the regulations, to change to the full absorption method of inventory costing, for its 1975 calendar year. Under the full absorption method, the taxpayer was required to allocate to ending inventory a pro rata portion of the variances from standard costs that were reflected in cost of goods sold because such variances were significant in amount. However, the taxpayer continued to reflect the variances in cost of goods sold for financial reporting purposes.

Section 1.471-11(d)(3)(ii)(a) of the regulations provides, in part, that the proper use of the standard cost method requires that a taxpayer must allocate to the goods in ending inventory a pro rata portion of any net negative or net positive overhead variances and net negative or net positive direct production variances. If such variances are not significant in amount in relation to the taxpayer's total actual indirect production costs for the year, then such variances need not be allocated to the taxpayer's goods in ending inventory unless such allocation is made in the taxpayer's financial reports.

In describing the LIFO inventory method, section 472(b) of the Code prescribes the procedure that must be followed by a taxpayer in inventorying goods.

Sections 472(c) and (e) of the Code and sections 1.472-2(e) and (g) of the regulations require that a taxpayer adopting the LIFO inventory method must not have used any other inventory method in ascertaining income, profit, or loss for the taxable year in which LIFO method was first adopted or in any subsequent taxable year for credit purposes or for the purpose of reports to shareholders, partners, or other proprietors, or the Commissioner may require the taxpayer to change to another method of accounting for Federal income tax purposes if it has used any other method of reporting its income for these purposes.

In the instant case, the taxpayer's treatment of the above costs in the manner described, does not result in the use of an inventory method other than the LIFO inventory method, as described in section 472(b) of the Code, because the difference in the treatment of variances from standard costs does not result in the taxpayer's use of "any other inventory method" as such phrase is used in section 472(c). See Rev. Rul. 76-379, page 138, this Bulletin.

Accordingly, in the instant case, the required allocation by the taxpayer to inventories, for Federal income tax purposes, of significant production cost variances pursuant to section 1.471-11(d)(3)(ii) of the regulations and the deduction of such variances for financial reporting purposes does not result in a violation by the taxpayer of the conformity requirements of sections 472(c) and (e) of the Code.