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New Vehicle Dealership Audit Technique Guide - 2004 - Chapter 6 - Alternative LIFO for Auto Dealers (12-2004)

NOTE: This guide is current through the publication date.  Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.

Each chapter in this Audit Techniques Guide (ATG) can be printed individually. Please follow the links at the beginning or end of this chapter to return to either the previous chapter or the Table of Contents or to proceed to the next chapter.

Chapter 5 | Table of Contents | Chapter 7

Chapter 6 - Table of Contents

Introduction
LIFO Pooling
Used Vehicle Alternative LIFO Method

As demonstrated in the chapter regarding the LIFO Method of Inventory Valuation, LIFO computations are complex. To simplify the dollar-value computation for auto dealerships, Rev. Proc. 92-79, 1992-2 C.B. 457, Alternative LIFO Method, was published, superseded by Rev. Proc. 97-36, I.R.B. 1997-33, 14 (July 31, 1997). This Revenue Procedure applies to new cars and light duty truck. On January 19, 2001 Revenue Procedure 2001-23, Used Vehicle Alternative LIFO Method was published. This Revenue Procedure applies to used automobiles and used light-duty trucks. Automatic change procedures are covered in Rev. Proc. 2002-9. The first part of this chapter discusses the Alternative LIFO Method for new vehicles while the second part discusses the Used Vehicle Alternative LIFO Method.

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Alternative LIFO Method, New Cars and Light-duty Trucks
In general, the Alternative LIFO Method is a comprehensive dollar-value, link-chain LIFO method of accounting that encompasses several LIFO sub-methods and may only be used by an automobile dealer engaged in the trade or business of retail sales of new automobiles or new light-duty trucks to value its inventory of new automobiles and new light-duty trucks.

The Alternative LIFO Method is designed to simplify the dollar value computations of automobile dealers. It does this by not requiring comparability adjustments from one year to the next. Under the authority of Treas. Reg. section 1.446-1(c)(2)(ii), the Commissioner will waive strict adherence of Treas. Reg. section 1.472-8 comparability requirement in applying the Alternative LIFO Method provided that a taxpayer complies with the requirements stated in the revenue procedure.

Summary of Rules
The Alternative LIFO Method is available to any automobile dealer engaged in the business of retail sales of new automobiles or new light-duty trucks for its LIFO inventories of new automobiles and new light-duty trucks. Light-duty trucks are trucks with a gross vehicle weight of 14,000 pounds or less, which are also referred to as class 1, 2, or 3 trucks. Discussion of pertinent areas of this revenue procedure is summarized in the following paragraphs.

LIFO Pools
The revenue procedure was not intended to change the pooling rules and all rules in effect prior to Rev. Proc. 92-79 remain in effect. All new automobiles and demonstrators (regardless of manufacturer) must be included in one LIFO pool and all new light trucks and demonstrators (regardless of manufacturer) must be included in another separate LIFO pool. Section 4.02(1) states that pools must be established for each "separate trade or business." There is little guidance on just what constitutes a separate trade or business. However, certain factors such as the location of multiple franchises, whether there is separate management, personnel and recordkeeping functions at each location can be used to determine whether each franchise is a separate trade or business.

Specific Identification Increment Method
The current-year cost of the items making up a pool must be determined by reference to the actual cost of the specific new automobiles or new light-duty trucks in ending inventory. Therefore, the actual cost of the specific vehicles on hand at year-end will be the current-year cost of such vehicles.

Item of Inventory
Rev. Proc. 97-36 focuses on model codes with the intent that the model code will apply to a specific vehicle with a specific base vehicle cost. 

Section 4.02(3) of Rev. Proc. 97-36 requires that an item of inventory (inventory category) be "* * * determined using the entire manufacturer's base model code number that represents the most detailed description of the base vehicles" characteristics, such as model line, body style, trim level, etc." (Emphasis added). Many manufacturers identify the "most detailed description" by a combination of alphanumeric characters, commonly called model codes or model code numbers. However, some manufacturers use the same characters to identify base vehicles with different detailed descriptions. Other manufacturers have no model codes at all. The term "shared code" describes this situation.

The reference to "model code number" was intended only to provide a label for the "most detailed description" of the base vehicle. Taxpayers who focus only on the "model code number" may not be in compliance with the clear and specific requirements of the revenue procedure. Some manufacturers change their model code by one digit or letter to reflect only a year change, not a model change. This would not be a new item. By using only the alphanumeric vehicle identifier, (i.e. the model code number) vehicles with different base costs could be treated as the same item category. For example: the 1995 Ford Explorer, model code number U34, is available in four versions, with four different base prices.

Model 

Code Description 

1995Base Price 
U34 XL Utility 4DR $19,948
U34 XLT Utility DR $22,320
U34 Eddie Bauer Utility 4Dr $26,293
U34 Limited Utility 4DR

$30,183

 

 

 

 

 

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Use of the model code number U34 would allow four distinctly different vehicles with a base cost difference of over $10,000 to be treated as the same item category. This was not the intent of the revenue procedure. Because the intent is to measure inflation, an interpretation that focuses merely on the model code and ignores the most detailed description is improper and a misapplication of the revenue procedure. Such an interpretation could result in deflation where there is inflation or inflation where there is actually deflation. Additionally, the rate of inflation or deflation may be different. The Ford Explorer again provides an example:

Model Code Description 1995 Base Price  1994 Base Price  Price Diff.  Index
U34 XL Utility 4DR 19,948 18,169 1,779 1.0979
U34 XLT Utility 4DR 22,320 20,324 1,996 1.0982
U34 Eddie Bauer Utility 4DR 26,293 22,503 3,790 1.1684
U34 Limited Utility 4DR 30,183 25,455 4,728 1.1857
              98,744 86,451

          

1.1421

The above example illustrates the variance in the inflation rate for vehicles with the same model code. The index can also vary significantly based on changes in the taxpayer's product mix.

The following examples illustrate changes in product mix. (Assume no quantity change. EOY = End of Year; BOY = Beginning of Year)

Example 1
   Description Quantity  Base Price   Total Cost 
EOY Limited Utility 4DR  4 30,183 120,732
BOY XL Utility 4DR 4 18,169 72,676
Index - .6612

 

 

 

 

 

Changing the product mix from low cost vehicles to high cost vehicles results in an abnormally high index.

Example 2               
   Description  Quantity  Base Price  Total Cost 
EOY  XL Utility 4DR  19,948 79,792
BOY  Limited Utility 4DR  25,455  101,820
Index - .7836    

 

 

 

 

Changing the product mix from high cost vehicles to low cost vehicles results in an abnormally low index.

Inflation is more accurately reflected in clearly defined item categories and both of the above examples produce distorted indices.

To properly determine an item category, a taxpayer must, as specifically stated in the revenue procedure, use the "* * * most detailed description of the base vehicle's characteristics * * *." Some taxpayers interpret "model code number" to mean only the alphanumeric character. This is incorrect. Had this been the intention of the Service, any reference to the "most detailed description" would have been unnecessary. The intention of the Service was that an item must be determined using "* * * the most detailed description of the base vehicle's characteristics * * *." which may be identified by a unique model code. If no unique code is present, the item must be identified by its detailed description. 

The revenue procedure's language is clear and specific that an item must be identified, not merely by its model code number, but by the most detailed description of the base vehicle. While the term "shared code" is not found in the revenue procedure, it does describe model codes that apply to more than one base vehicle and must be treated as separate items.

Cost of the Vehicle Used for Purposes of Computing the Pool Index
The actual base vehicle cost of each specific vehicle in ending inventory is used to compute the LIFO index. The pool index computed from only the base vehicle cost is applied to the total vehicle cost of all vehicles in the pool at the end of the taxable year.

Definition of a New Item
Section 4.02(5) of the Revenue Procedure provides three situations when a new item category is created:

  1. "Any new or reassigned manufacturer's model code * * * that is caused by a change in an existing vehicle, or

  2. [A] manufacturer's model code, * * * created or reassigned because the classified vehicle did not previously exist.

  3. Additionally, if there is no change in a manufacturer's model code but there has been a change to the platform * * * that results in a change in the track width or wheel base, whether or not the same model name was previously used by the manufacturer, a new item category is created."

Generally, if there has been a change to the most detailed description corresponding to the base cost of the vehicle, either in the number or description, which is caused by a change in an existing vehicle, a new item category is created.

The Motor Vehicle Technical Adviser Program analyzes all vehicles each year to determine whether a new item category is created under the situations specified above. Contact that office to receive a list of new item categories. 

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Treatment of a New Item Not in Existence in the Prior Year
The automobile dealer must use the current-year base vehicle cost of the new item category as the prior-year-base vehicle cost of that item category. 

Item in Existence in the Prior Year, but Not Stocked
If the automobile dealer did not stock an item in ending inventory at the end of the prior year, the automobile dealer must determine the prior-year-base vehicle cost by using a manufacturer's price list in effect as of the beginning of the last month of the prior taxable year.

Computations
The computational methodology is illustrated in the following example for ABC Lexus who elected Alternative LIFO for its taxable year ending December 31, 1992.

Ending Inventory Schedule
(This example is limited to a new car pool.)

Stock Number Model Invoice Number Description Amount
45810 9100A LS400 4-DR Sedan $33,065.00
45820 9010A ES250 4-DR Sedan   19,079.00
45822 9100A LS400 4-DR Sedan 35,633.00
45853 9100A LS400 4-DR Sedan 33,777.00
45854 9010A ES250 4-DR Sedan 18,941.50
               $140,495.50

Step # 1
Obtain the actual invoice for each vehicle in the ending inventory.

Step # 2
Group all of the invoices from Step 1 by item category. In this example, we have two (2) item categories as follows:

Model #     Description
9100A       LS400 4-DR Sedan
9010A       ES250 4-DR Sedan

Step # 3
For each item category, add together the base vehicle costs.

Item Category - Model 9100A, LS400, 4DR Sedan     
Stock #  Base Vehicle Cost 
45810  $30,400
45822 30,400
45853 30,400
Total Base Vehicle Cost  $91,200

 

 

 

 

 

Item Category - Model 9010A, ES250, 4DR Sedan
Stock #  Base Vehicle Cost 
45820  $17,466
45854 18,081
Total Base Vehicle Cost  $35,547
                             
                                            
                                              
                                             

 

Step # 4
Compute an average base vehicle cost for each item category.

    Item Category - Model 9100A, LS400, 4DR Sedan
        $91,200 divided by 3 vehicles = $30,400

    Item Category - Model 9010A, ES250, 4DR Sedan
        $35,547 divided by 2 vehicles = $17,773.50

Step # 5
Compute the total current year base vehicle cost.

Item  Category  Total 
9100A  LS400 4DR Sedan  $ 91,200
9010A  ES250 4DR Sedan  35,547
Total Current-Year Base Vehicle Cost of the Pool    $126,747

 

 

 

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Step # 6
Compute the total base vehicle cost of the ending inventory at the prior year's base vehicle cost.

By performing the same steps, number 1, 2, 3, and 4 above for the preceding year's ending inventory, you would obtain the preceding year's average base vehicle cost. In this example, we will assume that the average base vehicle cost for model 9100A was $29,756 and for model 9010A was $16,810.

Item Category # of Vehicles in Current Year's Ending Inventory Preceding Year's Average Base Vehicle Cost Total Average Base Vehicle Cost
9100A, LS400 3 $29,756 $ 89,268
9010A, ES250 2 16,810 33,620

Based vehicle cost of ending inventory
at prior year based vehicle cost

   

    

$122,888

Step # 7
Compute the current year index.
        $126,747 divided by $122,888 = 1.0314

Step # 8
Compute the cumulative index. The cumulative index at the beginning of the year of change was 1.0000 due to restatement. Restatement is discussed later in this section.
        1.0000 x 1.0314 = 1.0314

Step # 9
Compute the total current year total vehicle cost by adding together the total invoice costs. (NOTE: not base cost only)

Stock Number Model Number Description Amount
45810 9100A LS400 4-DR Sedan $ 33,065.00
45820 9010A ES250 4-DR Sedan    19,079.00
45822 9100A LS400 4-DR Sedan 35,633.00
45853 9100A LS400 4-DR Sedan 33,777.00
45854 9010A ES250 4-DR Sedan 18,941.50
             $140,495.50

 

Step # 10
Compute the total cost of the current year's ending inventory at base year cost.
        $140,495.50 divided by 1.0314 = $136,218

Step # 11
Determine if there is an increment for the current year by comparing the total cost of the pool's current year ending inventory at base year cost with the prior year.

In this example we will assume that the total cost of preceding year's ending inventory at base year cost was $116,774.

        $136,218 - 116,774 = $19,444

Since the current year's inventory at base year cost is greater, there is an increment.

Step # 12
Value the current year's increment at current-year cost.
        $19,444 x 1.0314 = $20,055.

Step # 13
Since there was an increment, step # 13 is not applicable. However, if there is no increment for a pool (rather, a decrement), reduce the LIFO layers in reverse chronological order until the decrement is fully absorbed.

Step # 14
Compute the total LIFO value for the pool. In this example we will assume that the LIFO Value as of December 31, 1991, was $117,327.

Year Amount
01/01/90 (Base Year)  $105,798
12/31/90   9,424
12/31/91   2,105
Total LIFO Value for the Pool (12/31/91)   117,327
12/31/92   20,055
Total LIFO Value for the Pool (12/31/92)   $137,382

 

 

 

 

 

Other Considerations
Discussion of other areas of pertinence regarding Alternative LIFO are summarized as follows:

  1. Audit Protection
    If an automobile dealer timely files a Form 3115, Application for Change in Accounting Method, under the procedures provided in this revenue procedure and effects the change to the Alternative LIFO Method in accordance with all of the requirements and conditions of this revenue procedure, an examining agent may not propose that the automobile dealer change the same method of accounting for a year prior to a year of change required under this revenue procedure.

  2. Conformity
    Automobile dealers who elect the LIFO method of inventory valuation are required to meet certain conformity requirements. Financial statements and reports issued by the automobile dealer must be issued on a LIFO basis. Alternative LIFO does not provide audit protection for conformity violations.

  3. Item Category Without Consideration of Model Year
    New models are generally introduced in the fall of each year. An automobile dealer may have 2 model years of a single vehicle with the same model code. The revenue procedure does not distinguish an item category by model year.  Therefore, if an automobile dealer's inventory contains 2 model years of a single vehicle they will be included in one item category to arrive at an average cost for this item category.

  4. IPI Computation Method Changes
    An automobile dealer that uses the IPI computation method must also change from the IPI computation method to another acceptable method for its goods other than new automobiles and new light duty trucks. For parts and accessories, the automobile dealer must change to the dollar value, index method. For used vehicles, the automobile dealer must change to the dollar value, link chain method.

  5. Restating the Base Year
    Section 9.02(8) of Rev. Proc. 92-79 and section 5.03(8) of Rev. Proc. 97-36 require that the year of change become the new base year and that the cumulative index at the beginning of the year of change must be restated to 1.0000. Prior years' layer valuation indices are converted to less than 1.0000, assuming a period of rising prices. The mechanics of restating the base year are illustrated in the following example. In this example, 1992, is the year of change.

1991 Inventory Value at Current Year and Base Year Cost
Year Base Year Cost  Current Year Cost [1]  Index 
12/31/91 $116,774 $128,451 1.1000 
[1] Taken from the general ledger    

 

 

 

 

LIFO Inventory Layers Before the Year of Change   
Year  Base Year Cost  Index  LIFO Value 
01/01/90  $105,798  1.0000  $105,798
12/31/90 9,062 1.0400 9,424
12/31/91 1,914 1.1000 2,105
$116,774 $117,327
Restating the Existing LIFO Layers as of January 1, 1992    

 

 

 

 

 

Year Value Old Base Year Cost New Base Year Cost Ratio  LIFO 
01/01/90 $105,798 $116,378 .9091 $105,798
12/31/90 9,062 9,968 .9454 9,424
12/31/91  1,914 2,105 1.0000       2,105
   $128,451  $116,774    $117,327

                          
                                                      
.


 

 

To determine the new base year cost, multiply the existing base year cost of each layer by the cumulative index preceding the year of change. In this example, the cumulative index preceding the year of change is 1.1000. The LIFO layer values remain the same. After the new base year cost is determined, the restated indices are computed by dividing the LIFO value of each layer by its new base year cost. In this example, the ratio for 1990 is .9454 ($9,424 divided by 9,968).

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Used Vehicle Alternative LIFO Method
On January 19, 2001, the Internal Revenue Service published the Used Vehicle Alternative LIFO Method; Revenue Procedure 2001-23. This new method incorporates a computational methodology similar, although with some significant differences, to the method used in Rev. Proc. 97-36, Alternative LIFO for New Vehicles.

Overview of the Method
The Used Vehicle Alternative LIFO Method applies to taxpayers that sell used automobiles or used light-duty trucks and is effective for tax years ending on or after December 31, 2000. For purposes of the revenue procedure, used automobiles and used light-duty trucks are defined as previously titled vehicles and do not include demonstrator vehicles typically used in new car dealerships.

The new method is an elective, comprehensive link-chain method that includes several special rules and required sub-methods. In the opinion of the Commissioner, provided that dealers properly implement and apply the method described in Revenue Procedure 2001-23, income from the sale of used vehicles will be clearly reflected and the method will be accepted as an accurate, reliable, and suitable method of computing a LIFO inventory index. However, all computations under the Used Vehicle Alternative LIFO Method remain subject to verification upon examination of the dealer's tax return.

General Rules and Definitions
In general, dealers that elect the Used Vehicle Alternative method will compute the LIFO index by reference to average base vehicles that correspond to the vehicles in the dealership's ending inventory. The LIFO index computed using the base costs and the methodology in the revenue procedure is applied to the current-year cost of the dealership's ending inventory.

Section 4.02(1) of the revenue procedure defines base vehicle as "…the most relevant combination of (a) a detailed base model description, consisting of model line, body style, and trim level…and (b) an associated manufacturer's base model code number…” When computing the LIFO index, dealers must determine base vehicle prices by reference to an official used vehicle guide.

The revenue procedure provides a specific definition of current-year cost for purchased vehicles and for trade-in vehicles (§4.02(4)(a) and (b)). The current-year cost of trade-in and purchased vehicles includes the vehicle's purchase price plus reconditioning costs, delivery charges, and any other costs properly allocated to the vehicle, i.e. §263A costs. "Cost" for a vehicle acquired by purchase is easily identified by reference to the sales documents. However, the "cost' of a trade-in vehicle is not as clear. §4.02(4)(b) specifically defines the "cost" of a trade-in vehicle by reference to Revenue Ruling 67-107, i.e. the wholesale price of a comparable vehicle reflecting the actual vehicle's actual mileage, condition, options and accessories.

As a simplifying measure, the revenue procedure provides for the use of an "official used vehicle guide" in the computation of the LIFO index. "Official used vehicle guide" is defined as a guide that is "…widely recognized and utilized in the used vehicle dealer industry." The selected guide must be used consistently and must be the appropriate guide for the dealers region. 

When determining current-year cost of trade-in vehicles, the guide must cover the day of acquisition of each specific vehicle. When computing the LIFO index, current-year cost must be determined using the guide in effect on the last day of the dealer's current taxable year. Prior-year cost must be determined by reference to the guide covering the last day of the dealer's preceding taxable year.

It is important to note that any change in the particular used vehicle guide or any change in the precise manner in which the guide is used represents a change in method of accounting. Accounting method changes generally require the Commissioner's consent. (§4.02(2)) Revenue procedure §4.02(3) requires dealerships to establish two used vehicle pools for each separate trade or business. The pools consist of a pool for all used light-duty trucks, regardless of manufacturer and a pool for used automobiles, regardless of manufacturer.

The revenue procedure also provides some of the first guidance on where to pool the new generation of hybrid vehicles. Section §4.02(3) provides that "used sport utility vehicles and used hybrid vehicles…may be included initially in either the used automobile or the used light-duty truck…pool." The original selection is a method of accounting and any deviation requires the consent of the Commissioner.

General Index Guidelines
To compute the annual LIFO index for each pool, the dealership must compare the current and prior year base costs for each vehicle in ending inventory. The properly determined current-year base vehicle price (as defined in §4.02) is matched to a comparable base vehicle of the same age and in average condition in the prior year. When no comparable prior-year base vehicle exists, the current-year base vehicle cost is also used as the prior-year base vehicle cost, i.e. that vehicle receives an index of 1.000. The current-year cost and prior-year cost are also identical if there is a change in the vehicle's wheel base or track width, regardless of whether the base vehicle code and description has changed.

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Changing to the Used Vehicle Alternative LIFO Method
Dealerships must follow the automatic change provisions of Revenue Procedure 99-49, with some modifications, to change to the Used Vehicle Alternative LIFO Method. With one exception, if the change is made for the first or second taxable year ending on or after 12-31-00, the taxpayer may change to the new method automatically even if the dealership is under examination. Caution: If the dealership is under examination and used car LIFO is a pending issue, the automatic change provisions do not apply. An issue is pending if the Service has provided written notification indicating that an adjustment is being made or will be made regarding a method of accounting. The exact amount of the adjustment may not yet have been determined. The definition of pending issue can be found in §6.01(6) of Revenue Procedure 2000-38.

Changes to the Used Vehicle Alternative LIFO Method are made on a cut-off basis that requires that the value of the used vehicle inventory at the beginning of the year of change must be the same as the inventory value at the end of the prior year. Note: The revenue procedure contains special rules if the dealer has previously improperly accounted for a bulk bargain purchase or uses the IPIC method. For further information see Section 5.02(2) and §5.03(2). 

Conditions of Change
Dealerships must also comply with several conditions in order to use the Used Vehicle Alternative LIFO Method including compliance with the conformity requirements of Treasury Regulation 1.472-2(e).

Electing dealerships must maintain complete books and records of the computations under the method. Records must include the used vehicle guides used in the index computation. LIFO inventory cost increments and the values of the increments must be retained. The year of change to the new method becomes the new base year {§5.01(3)}.

The dealership's LIFO election must be reviewed to determine whether the initial election included used vehicles. If not, the dealership must file a Form 970 electing LIFO for used vehicles. Prior to adopting the new method, dealerships should also insure that vehicles are properly pooled and if necessary combine or separate pools to comply with the revenue procedure's requirements.

Information to request when examining the Alternative LIFO Methods
An pro-forma Information Document Request relating to these Revenue procedures should incorporate the following request:

  1. Copy of Form 3115, Application for Change in Accounting Method, and all attachments.

  2. Computation of current index workpapers by pool including:

    1. Current year's ending inventory schedules,

    2. Invoices for all items in current year's ending inventory,

    3. Prior year's ending inventory schedules,

    4. Invoices for all items in prior year's ending inventory,

    5. Applicable price lists for items in existence in the prior year but not stocked in current year's ending inventory; and

    6. All schedules that group model lines and compute average base cost at beginning of the year and at the end of the year,

  3. Computation of LIFO inventory value workpapers by pool.

  4. Rebasing computations by pool.

  5. If you changed from the IPI method for parts and accessories to the dollar value, index method, provide workpapers to support computations.

  6. If you changed from the IPI method for used vehicles to the dollar value, link chain method, provide workpapers to support computations.

  7. Financial Statements.

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Page Last Reviewed or Updated: 26-Nov-2013