SERVICE ANNOUNCES THREE ADDITIONAL POOLS FOR DEPARTMENT STORE INVENTORY PRICE INDEXING

Rev. Proc. 86-46

SECTION 1. PURPOSE

The purpose of this revenue procedure is to modify and supersede Rev. Proc. 72-21, 1972-1 C.B. 745, which sets forth the groups or pools used by the United States Bureau of Labor Statistics (BLS) in preparing price indexes for use by department stores that have elected to use the last-in, first-out (LIFO) inventory identification method in conjunction with the retail method of valuing inventories.

SEC. 2. BACKGROUND

01. Section 1.472-1(k) of the Income Tax Regulations provides that if a taxpayer using the retail method of pricing inventories, authorized by section 1.471-8, elects to use in connection therewith the LIFO method authorized by section 472 of the Internal Revenue code, the apparent cost of the goods on hand at the end of the year, determined pursuant to section 1.471-8, shall be adjusted to the extent of price changes therein taking place after the close of the preceding tax year. The amount of any apparent inventory increase or decrease to be eliminated in this adjustment shall be determined by reference to acceptable price indexes established to the satisfaction of the Commissioner.

02. Price indexes prepared by BLS that are applicable to the goods in question are acceptable to the Commissioner under section 1.472-1(k) of the regulations. Monthly indexes are published by BLS and are subsequently published in the Internal Revenue Bulletin. The use of the BLS indexes is not mandatory. Indexes may be prepared by a taxpayer based upon its own data on prices and inventory quantities, subject to the provisions of section 1.472-1(k) of the regulations. Price indexes that are based upon inadequate records, or that are not subject to complete and detailed audit within the Internal Revenue Service, will not be approved.

03. Section 1.472-8(a) of the regulations provides that under the dollar-value LIFO method of valuing inventories, the goods contained in the inventory are grouped into a pool or pools. Section 1.472-8(g) provides that any method of pooling used in computing the taxpayer's LIFO inventories shall be treated as a method of accounting. Any method of pooling shall 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 granted by the Commissioner as provided in section 1.446-1(e). A taxpayer must secure the consent of the Commissioner under section 1.446-1(e)(2)(i) before it changes its method of accounting for federal income tax purposes.

04. Rev. Proc. 72-21 provides instructions and illustrations for the use of BLS indexes by a taxpayer who has elected to use the retail method of valuing inventories that are computed under the LIFO method. The last determination of the merchandise groups or pools for department stores was made by BLS in 1953, when 10 groups were added to the then existing 10 groups to reach the total of 20 groups set forth in Rev. Proc. 72-21.

05. The lines of merchandise typically carried by full-line retail department stores have expanded since the 20 major groups were last revised in 1953. For this reason, BLS will now publish monthly indexes for three new groups and a monthly index for the aggregate of these groups. These new groups are listed in section 4.01 of this revenue procedure.

06. Because the new indexes were introduced by BLS in February 1986, January 1987 will be the first month for which there will be a percent change based on a 12-month period. The January 1986 indexes for the new groups or pools are all 100.

07. Rev. Proc. 86-47, page 8, this Bulletin, sets forth the procedures required of taxpayers to change their method of accounting from that of using the 20 groups or pools set forth in Rev. Proc. 72- 21 to the method of using the 23 groups or pools set forth in this revenue procedure. Section 3.02 of Rev. Proc. 86-47 provides that its procedures, except as otherwise noted in section 3.03, apply to retail department stores (as described in section 3.01) for their first tax year ending on (or with referenct to) a date that is on or after January 31, 1987. Section 3.03 of Rev. Proc. 86-47 provides that if retail department stores (as described in section 3.01) do not have the records necessary to (1) calculate the cost complement for each new expanded pool, or (2) separate its miscellaneous pool or pools into the new expanded pools, its procedures apply to affected retail department stores for their first tax year beginning on (or with reference to) a date that is after January 31, 1987.

SEC. 3. SCOPE

This revenue procedure applies to retail department stores that (1) have elected to use the LIFO inventory identification method in conjunction with the retail method of valuing inventories, and (2) have elected to use the BLS department store price indexes published monthly by the Service.

SEC. 4. THE 23 GROUPS PROVIDED BY BLS

01. The following groups or combinations of groups are used by BLS as the basis for the preparation of indexes for use by department stores:

            1. Piece Goods

01. As illustrated in sections 5 and 6 of this revenue procedure, in using the group indexes, a department store taxpayer must apply to the inventory data for each of its departments separately the index for the group in which the department logically belongs. A given group index may be applicable to a number of departments in a department store.

02. When one or more departments of a department store do not fit into any one of the 23 major groups or into either of the special combinations listed in section 4.01 of this revenue procedure, an index shall be employed that represents an average for the whole of the remainder of the store. This index may be the store total, as shown by BLS, or the total for those of the 23 major groups (or combination of groups) that most closely represents the coverage of the inventory carried in the department or departments that require an index. For example, in a particular department that carries apparel, piece goods, and notions, the index may be the total of groups 1, 3, 4, 7, 8, 9, 10, 11, 12, and 14, or whichever combination most closely represents the coverage of the inventory stock carried by the store.

SEC. 6. ILLUSTRATION OF FIRST YEAR PRICE ADJUSTMENT

01. The method of making the first year price adjustments to the closing inventory values under the retail method, combined with the LIFO method, is illustrated for three hypothetical departments. In the first two departments there was an increase in the physical quantity of inventory during the year in question, as shown by the comparison of the adjusted retail value at the end of the year and the retail value at the beginning of the year. In the third department there was a decline in the physical quantity of inventory. In all three departments prices rose during the year, as shown by the index.

METHOD OF COMPUTING LIFO, RETAIL INVENTORY, THREE DEPARTMENTS, FIRST YEAR

                                                Department No.

(a) The mark-ons in steps 2 and 4 must be computed taking account of mark-downs as well as mark-ups.

(b) In succeeding years the data to be used in steps 1, 2, and 3, to the extent applicable, must be taken from the taxpayer's books as of the beginning of the first year of the use of the LIFO method, and must be identical to those shown in the first year's computations.

(c) Steps 6 and 7 are shown to allow comparison of LIFO and FIFO inventories.

(d) The index in step 8 is the index of retail prices applicable to the goods in each department, showing the level of prices at the end of the year (104.4% in department 1) relative to the beginning of the year (100.0%).

SEC. 7. ILLUSTRATION OF SECOND AND THIRD YEAR ADJUSTMENTS

01. To illustrate further the principles involved in making adjustments for additional years the data for Department 1 are shown below, the first year being repeated to show the continuity. The physical quantity of inventory increased in the first two years, but decreased in the third year, as indicated by the adjusted retail values (Line 9). Note that the decrease in the third year eliminated all of the second year's increase and part of the first year's increase, in that order, retaining in the closing inventory the merchandise appearing in the opening inventory "in the order of acquisition" (Line 10). Thus, it is necessary under the LIFO method to retain the identity of each annual increment to the inventory of each department. The price changes are measured by reference to the fixed prices at the beginning of the first LIFO year and the retail inventory value on each inventory date is adjusted to the price level on that date.

02. These illustrations are intended to show the main principles involved in the LIFO adjustments to retail inventories, and are not intended to cover all accounting details of computations which may be required, particularly in later years, under the LIFO method.

               METHOD OF COMPUTING LIFO, RETAIL INVENTORY

Rev. Proc. 72-21 is modified and as modified is superseded.

SEC. 9. EFFECTIVE DATE

For taxpayers described in section 3.01 of Rev. Proc. 86-47, but not described in section 3.03 of Rev. Proc. 86-47, this revenue procedure is effective for tax years ending on (or with reference to) a date that is on or after January 31, 1987. For taxpayers described in sections 3.01 and 3.03 of Rev. Proc. 86-47, this revenue procedure is effective for tax years beginning on (or with reference to) a date that is after January 31, 1987.

Rev. Proc. 72-21 shall continue to be effective for tax years ending on (or with reference to) a date that is prior to January 31, 1987. For taxpayers described in sections 3.01 and 3.03 of Rev. Proc. 86-47, Rev. Proc. 72-21 shall continue to be effective for tax years beginning on (or with reference to) a date that is prior to January 31, 1987.