Rev. Proc. 84-57

SECTION 1. PURPOSE

The purpose of this revenue procedure is to provide guidance to taxpayers that elect to use the dollar-value last-in, first-out (LIFO) inventory method and the inventory price index computation method described in section 1.472-8(e)(3) of the Income Tax Regulations.

SEC. 2. BACKGROUND

.01 Section 1.472-8 of the regulations provides that taxpayers may elect to determine the cost of their LIFO inventories under the dollar-value LIFO method, provided such method is used consistently and clearly reflects the taxpayer's income.

.02 Section 1.472-8(e) of the regulations describes the methods available for computing the LIFO value of a dollar-value pool: (1) the double-extension method, (2) an index method, (3) the link-chain method, and (4) the inventory price index computation method.

.03 The inventory price index computation method is acceptable for tax years beginning after December 31, 1981 as an appropriate method of computing an index. Any taxpayer that adopts the inventory price index computation method must use the method in determining the value of all goods for which the taxpayer has elected to use the LIFO method.

.04 The inventory price index computation method is not available to taxpayers eligible to use the retail price indexes prepared by the Bureau of Labor Statistics and published in the Department Store Inventory Price Indexes.

.05 Section 1.472-8(e)(3) of the regulations provides that, under the inventory price index computation method, inventory price indexes are computed with reference to consumer or producer price indexes. The inventory items in each pool are classified according to the detailed listings in the appropriate tables of the CPI Detailed Report or in Producer Prices and Price Indexes. The inventory items are assigned to various index categories, and index categories are assigned to a pool or pools. Published indexes and weights are used to compute the appropriate index for an index category, and then an index is computed for the pool.

SEC. 3. APPLICATION

.01 Determine the appropriate index category for inventory items.

1 Inventory items have to be categorized into index categories chosen from the CPI Detailed Report; or the Producer Prices and Price Index. The most detailed index category is required only when 10 percent or more of the total inventory value falls within such an index category. If 10 percent or more of the total inventory value (defined in section 3.01 2) does not fall within an index category, the next less detailed index category that does include 10 percent or more of the total inventory value will be used. In the case of the CPI Detailed Report, an index category may be selected only from Table 3 (Consumer Price Index for All Urban Consumers: Food expenditure categories, U.S. city average) and Table 5 (Consumer Price Index for all Urban Consumers: Nonfood expenditure categories, U.S. city average). In the case of the Producer Prices and Price Indexes, an index category may be selected only from Table 6 (Producer prices and price indexes for commodity groupings and individual items), unless it can be demonstrated that the selection of an index from another Producer Prices and Price Indexes table would be more appropriate. Both the CPI Detailed Report and the Producer Prices and Price Indexes are published monthly by the Bureau of Labor Statistics. They can be obtained, for a fee, from the Superintendent of Documents, U.S. Government Printing Office, Washington, D.C. 20212.

(a) Manufacturers, processors, wholesalers, jobbers, and distributors may select an index category from only Producer Prices and Price Indexes as of the month or months most appropriate to the method of determining the current-year cost in section 3.01 2, or make a one-time binding election of an appropriate representative month during the tax year.

(b) Retailers may select an index category from either the CPI Detailed Report or Producer Prices and Price Indexes, but if equally appropriate index categories could be selected from either publication, a retailer using the retail inventory method must select index categories from the CPI Detailed Report and a retailer not using the retail inventory method must select the index from the Producer Prices and Price Indexes. The selected index categories for retailers using the retail method must be from indexes as of the last month of their tax year. Retailers not using the retail method may select index categories from indexes of the month or months most appropriate to the month of determining the current-year cost in section 3.01 2, or make a one-time binding election of an appropriate representative month during the tax year.

2 Total inventory value. Retailers using the retail method, authorized by sections 1.471-8 and 1.472-1(k) of the regulations, must determine total inventory value at retail selling prices of the goods on hand at the end of the tax year. Taxpayers that do not use the retail method must determine total inventory at current-year costs in ending inventory; that is,

(a) By reference to the actual cost of the goods most recently purchased or produced;

(b) By reference to the actual cost of the goods purchased or produced during the taxable year in the order of acquisition;

(c) By application of an average unit cost equal to the aggregate cost of all the goods purchased or produced throughout the tax year divided by the total number of units purchased or produced.

3 The assignment of inventory items to index categories is accomplished by a process of elimination described in section 1.472-8(e)(3)(iii)(B)(1), (2) and (3) of the regulations.

.02 Selecting and computing the appropriate index for an index category.

1 Whenever an index category is selected pursuant to section 1.472-8(e)(3)(iii)(B)(1) of the regulations, the appropriate index must be the published index for that index category.

2 Whenever an index category is selected pursuant to section 1.472-8(e)(3)(iii)(B)(2) or (3) of the regulations, the appropriate index must be a weighted average of the published indexes of the index category items actually present in the inventory.

(a) When index categories and the corresponding indexes are selected from the CPI Detailed Report, Table 3 (Consumer Price Index for all Urban Consumer: Food expenditure categories, U.S. city average) or Table 5 (Consumer Price Index for All Urban Consumer: Nonfood expenditure categories, U.S. city average), the proper BLS weights are those found in the Relative Importance of Components in the Consumer Price Indexes, Table 1 (Relative importance of components in the Consumer Price Indexes: U.S. city average, All Urban Consumers).

(b) When a taxpayer selects index categories and the corresponding indexes from the Producer Prices and Price Indexes, Table 6 (Producer prices and price indexes for commodity groupings and individual items), the proper BLS weights are those found in the Supplement to Producer Prices and Price Indexes, Table 14 (Relative importance of commodities included in the Producer Price index, all levels).

(c) The BLS weights are revised annually and released by BLS in January each year. The indexes and weights can be obtained, for a fee, from the Superintendent of Documents, U.S. Government Printing Office, Washington, D.C. 20212.

(d) For tax years ending on or after December 31, 1982, but before July 1, 1983, taxpayers are to use the December 1981 BLS weights. For tax years ending after June 30, 1983, the December BLS weights for a given calendar year are to be used for all tax years ending during the 12 calendar-month period beginning on July 1 of the following calendar year. The following examples illustrate the provisions of this paragraph.

Example (1). Taxpayer's tax year ends July 3, 1983. The proper BLS weights to use for computing a weighted category index is the December 1982 BLS weights.

Example (2). Taxpayer's tax year ends December 31, 1984. The proper BLS weights to use for computing a weighted category index is the December 1983 BLS weights.

.03 Cost and retail price indexes

1 If a retailer not using the retail inventory method selects an index from the CPI Detailed Report, the selected index must be converted into a cost price index because the CPI Detailed Report measures changes in retail prices, not changes in wholesale or cost prices. Cost price indexes may be derived from indexes selected from the CPI Detailed Report by reference to the changes in the cost complements of the gross profit margins of an individual index category.

The difference between the movements of wholesale (or cost) and retail prices for any given year must be reflected in a change in the markon percentage, since cost and retail prices would necessarily change by the same relative amount if the markon were uniform. The change in the net markon percentage, or its complement, the cost percentage, may, therefore, be used to derive a cost index from a retail price index for a given department. Nevertheless, a retailer not using the retail method does not ordinarily compute the net markon percentages for its respective departments, for this is a tool of the retail inventory method. It does, however, compute its gross profit percentages for its respective departments using essentially the same quantity. The only material difference between the two is that the former is computed on the year's purchases and the latter on the year's sales, and this difference will average out over a few years. It is, therefore, appropriate to derive a cost index by reference to the ratio between cost percentages derived by taking the complements of the gross profit ratios for a department. A simplified method of computing is available, particularly for use when the base date for the retail price index is prior to the year of adoption of the elective inventory method by the taxpayer. This may be illustrated as follows:

                                         Dec. 31    Dec. 31    Dec. 31

.04 Inventory pools. The inventory categories set up in section 3.01 must be grouped into a pool or pools. The pool or pools selected must be used for the year of adoption and for all subsequent tax years unless a change is required by the Commissioner in order to clearly reflect income, or unless permission to change is requested and granted by the Commissioner as provided in section 446(e) of the Code. The rules relating to the establishment of pools are as follows.

1(a) A retailer, wholesaler, jobber, or distributor may establish an inventory pool or pools for any group of goods included within one of 11 categories of consumer goods described in the CPI Detailed Report. The 11 categories are:

(1) Food and beverages,

(2) Housing maintenance and repair commodities,

(3) Fuels (other than gasoline),

(4) House furnishings and housekeeping,

(5) Apparel commodities,

(6) Private transportation (including gasoline),

(7) Medical care commodities,

(8) Entertainment commodities,

(9) Tobacco products,

(10) Toilet goods and personal care applications, and

(11) School books and supplies.

(b) An inventory pool or pools may be established for any group of goods included within one of the 15 general categories of producer goods described in Table 6 of the Producer Prices and Price Indexes. The 15 categories are:

(1) Farm products,

(2) Processed food and feeds,

(3) Textile products and apparel,

(4) Hides, skin, leather, and related products,

(5) Fuels and related products and power,

(6) Chemicals and allied products,

(7) Rubber and plastic products,

(8) Lumber and wood products,

(9) Pulp, paper, and allied products,

(10) Metals and metal products,

(11) Machinery and equipment,

(12) Furniture and household durables,

(13) Nonmetallic mineral products,

(14) Transportation equipment, and

(15) Miscellaneous products.

(c) Inventory pools that comprise less than 5 percent of total inventory value may be combined to form a single miscellaneous inventory pool. If the resulting miscellaneous inventory pool itself comprises less than 5 percent of inventory value, such pool may be combined only with the largest inventory pool.

2 Manufacturers and processors may establish natural business unit pools. A natural business unit pool consists of all items entering into the entire inventory investment for a natural business unit of a business enterprise. The principles for establishing natural business unit pools are enumerated in section 1.472-8(b)(1) and (2) of the regulations.

3 Inventory categories may be grouped into multiple pools consisting of inventory categories that are substantially similar. The formulation of detailed rules for selection of pools is not feasible. Important considerations to be taken into consideration when establishing multiple pools are enumerated in section 1.472-8(b)(3) of the regulations.

4 A single pool may be used by an eligible small business. A taxpayer is an eligible small business for any tax year if the average annual gross receipts of the taxpayer do not exceed $2,000,000 for the 3-tax-year period ending with the tax year. Section 474(b) of the Code.

.04 Pool index.

1 If it is necessary to select more than one inventory category for an inventory pool, then the pool index is the weighted average of the indexes for the index categories in the pool. The weighted average is computed with reference to the relative amounts of costs in the inventory pool for each index category of goods. The costs to be used in computing the weighted average must be the costs in ending inventory. In computing the index for a pool, the taxpayer must weigh the appropriate indexes for the separate inventory categories comprising the pool according to the taxpayer's actual inventory weights for such separate inventory category.

2 A pool index must be modified by a stated percentage.

(a) The stated percentage for an eligible small business is 100 percent. See section 3.34.

(b) The stated percentage for all other taxpayers is 80 percent.

Example (3)

The taxpayer, a retailer of women's shoes and an eligible small business under section 474 of the Code, has elected the dollar-value LIFO method and the inventory price index computation method for the tax year ended August 31, 1983. The total inventory value at current-year costs are determined by reference to the actual cost of the goods most recently purchased. The current year index is computed as follows:

                 (1)    (2)   (3)     (4)      (5)     (6)        (7)

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention: CC:C:C:2, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.