index components, creates a cumulative index which discounts present dollar values back to the equivalent dollar values of the base year (the "link-chain" method).

Instead of using actual inventory prices, a taxpayer may use tables of price changes published by the Bureau of Labor Statistics as part of the "Producers Price Index" and "Consumer Price Index" publications to construct the index necessary to determine equivalent dollar values. Use of these tables requires an index specific to the taxpayer to be constructed by taking a weighted average of price changes for specific categories of inventory. A taxpayer with average annual gross receipts for its most recent three years of no more than $2 million may use 100% of the constructed index. Taxpayers with greater average annual gross receipts are limited to an index equal to 80% of the constructed index.

Reasons for Change

The LIFO method generally is considered to be an advantageous method of accounting for inventories, particularly when costs are rising. The LIFO method matches the costs of the most recent additions to inventories against sales. When costs are rising, a higher measure of costs of goods sold results and, consequently, a lower measure of taxable income.

The Congress believed, however, that the complexity and greater costs of compliance associated with the LIFO method, including the dollar-value LIFO method, discouraged some smaller taxpayers from using the LIFO method in accounting for their inventories. The Congress believed that the LIFO method should be simplified for smaller taxpayers so that the use of the method will be practical for all taxpayers.

In general

Explanation of Provision

The Act provides an election to certain small businesses to use a simplified dollar-value LIFO method in accounting for their inventories. The simplified dollar-value LIFO method requires inventories to be grouped into pools in accordance with the major categories of the "Producer Prices Indexes" or the "CPI Detailed Report. The change in inventory costs for the pool for the taxable year is determined by the change in the published index for the general category to which the pool relates. The computation of the ending LIFO value of the pool is then made using the dollar-value LIFŌ method. The indices necessary to compute the equivalent dollar values of prior years are to be developed using the link-chain method.

Eligible businesses

A taxpayer is eligible to use the simplified dollar-value LIFO method if its average annual gross receipts for its three preceding taxable years (or for such part of the previous three years that the taxpayer has been actively engaged in a trade or business) do not exceed $5 million. In the case of a taxpayer who is a member of a controlled group, all persons who are members of the controlled

group are to be treated as a single taxpayer for the purpose of determining average annual gross receipts. A controlled group consists of all persons who would be treated as a single employer under sections 52 (a) or (b).

The provision of the Act is a replacement for the prior law rule allowing taxpayers with average annual gross receipts of $2 million or less to elect to use a single inventory pool in accounting for its inventories using the LIFO method (sec. 474 of prior law). Any taxpayer who has in effect a valid election to use the single pool method of section 474 of prior law may continue to account for its inventories using that election, so long as the taxpayer continues to meet the requirements for that election. A taxpayer accounting for its inventories using the single pool election of section 474 of prior law is not eligible to elect to use the simplified dollar-value LIFO method of the Act for any year in which the election under prior law is effective. Under the Act, the election to use the single pool method of section 474 of prior law may be revoked without the consent of the Secretary of the Treasury.

Making the election

A taxpayer may elect to use the simplified dollar-value LIFO method without the consent of the Secretary of the Treasury. The election is to be made at such time and in such manner as the Secretary of the Treasury may prescribe. An election to use the method applies to the year of election and to all succeeding taxable years, unless permission to change to another method is obtained from the Secretary of the Treasury, or the taxpayer becomes ineligible to use the simplified dollar-value LIFO method as a result of having exceeded $5 million of average annual gross receipts.

If the taxpayer previously has used a method of accounting for its inventories which allows the value of the inventories to be written down below cost, any amount of such writedown must be restored to income in accordance with section 472(d).

If the taxpayer makes an election to use the simplified dollarvalue LIFO method, the method must be used for all the inventories of the taxpayer that are accounted for using a LIFO method. Computation of simplified dollar-value LIFO inventories

In general.-The computation of inventory values using the simplified dollar-value LIFO method generally follows the rules provided for the computation of inventories using the dollar-value LIFO method in present Treas. Regs. sec. 1.472-8. The simplified dollarvalue LIFO method differs from these current rules, however, with regard to the manner in which inventory items are to be pooled, the use of published indices to determine an annual index component for each pool, and the technique to be used in computing the cumulative index for a pool for any given year.

The simplified dollar-value LIFO method requires the use of multiple pools in order to avoid the construction of a weighted index specific to the taxpayer. Rather than construct such an index, the annual change in costs for the pool as a whole is measured by the change in the published index for the general category. The percentage change for the year in the published index for the general category determines the annual index for the pool.

The simplified dollar-value LIFO method uses the link-chain approach, rather than the double-extension approach, to compute a cumulative index for the purpose of determining equivalent dollar values in prior years.

Establishment of inventory pools.-The simplified dollar-value LIFO method requires inventory pools to be established based on either the 15 general (2 digit) categories of the "Producers Prices and Price Indexes for Commodity Groupings and Individual Items" (currently "Table 6. Producer prices and price indexes for commodity groupings and individual items, Producers Price Indexes" published monthly by the Bureau of Labor Statistics) or the 11 general categories of the "Consumer Price Index for All Urban Consumers" (currently "Table 3. Consumer Price Index for All Urban Consumers: Food expenditure categories, U.S. city average, CPI Detailer Report" and "Table 5. Consumer Price Index for All Urban Consumers: Nonfood expenditures categories, U.S. city average, CPI Detailed Report" published monthly by the Bureau of Labor Statistics) as set forth in Treas. Regs. sec. 1.472-8(e)(3)(iv).5 Retailers using the retail method are to use the CPI categories and all other taxpayers must use the Producers Price Index categories.

Selection of index.-The taxpayer must establish a month within its taxable year and use it to measure the annual change in the index for all pools. Once the choice of month is established, another month may not be used unless advance permission to do so is granted by the Secretary of the Treasury. The annual change is measured from the established month in one calendar year to the same month in the next calendar year. Comparison of different months to measure change is not allowed. If the published index figure which the taxpayer has used to measure annual change in costs for an inventory pool is restated by the Bureau of Labor Statistics after the taxpayer has filed its return for the taxable year in question, the return may not be filed again or amended in order to reflect the restatement. Instead, the change in costs for the pool for the next taxable year will be measured with regard to the index figure which was used to measure the change in costs for the prior taxable year as the return was filed, and not the restated value. Rules applicable to year of change.-The first year for which the simplified dollar-value LIFO method is used will represent a new base year for the purpose of the dollar-value LIFO computation. The base year dollar value of each pool will be the portion of the beginning inventory value for such first year which is attributable to the inventory items represented by such pool.

The computations necessary to convert a taxpayer's inventories to the simplified dollar-value LIFO method will depend upon the method that was used to account for the inventories prior to the

5 The 11 categories in the Consumer Price Index are food and beverages; housing, mainte nance and repair commodities; fuels (other than gasoline); house furnishings and housekeeping supplies; apparel commodities; private transportation (including gasoline); medical care commodities; entertainment commodities; tobacco products; toilet goods and personal care appliances; and school books and supplies. The 15 categories in the Producers Price Index are farm prod ucts; processed food and feeds; textile products and apparel; hides, skin, leather, and related products; fuels and related products and power; chemicals and allied products; rubber and plas tic products; lumber and wood products; pulp, paper, and allied products; metals and metal prod ucts; machinery and equipment; furniture and household durables; nonmetalic mineral products; transportation equipment; and miscellaneous products.

year of election. A taxpayer that has been using the FIFO method to value its inventories must establish base year dollar values for each of its pools by assigning the inventory items to their respective pools and combining their values. The combined values of inventory items assigned to a pool constitute the base year layer of the pool for future dollar-value LIFO computations.

A taxpayer changing to the simplified dollar-value method from a method that allows inventories to be stated at less than cost (such as the FIFO method) must restore to income any amounts by which the previous inventories were written down below cost, as required by section 472(d). The base year dollar value of the pools established for dollar-value computations will include any amounts required to be recognized as income by section 472(d).

A taxpayer that has been using a LIFO method must establish values for each of its pools expressed in base year dollars in generally the same manner as does a taxpayer that has been using the FIFO method. In order to preserve pre-existing LIFO layers, however, the entire value of the inventory is not considered as attributable to the base year as is the case for taxpayers that have been using the FIFO method. Instead, the taxpayer is required to restate the prior years" layers in values expressed in base year dollars by comparing the prices at which such goods were added to inventories and determining an index for the layer with reference to the present value of the same inventory item.

Example.-The following example shows the computations required by a taxpayer in the first year in which it uses the simplified dollar-value LIFO method. The example assumes that the taxpayer used the FIFO method to calculate inventories in prior years. The taxpayer's inventories consist of a chemical, classified in the "Chemicals and Allied Products" general category, and a high school chemistry text book, classified in the "Pulp, Paper and Allied Products" general category. The index numbers for the "Chemicals and Allied Products" general category are 200 for the prior year (the "base year") and 220 for the current year (the "first LIFO year"). The index numbers for the "Pulp, Paper and Allied Products" general category are 142 for the prior year and 150 for the current year. In the prior year, the present dollar value of the taxpayer's ending inventory was $30,000 for the chemical and $30,000 for the textbooks. In the current year, the present dollar value of the taxpayer's ending inventory is $35,000 for the chemical and $30,000 for the textbooks.

As the two types of inventory items are classified in different general categories, the taxpayer must set up a separate dollarvalue LIFO pool for each. The annual index for each pool is determined by taking one plus the percentage change in the index for the general category, as shown in the following table.

For years after the first year in which the method is used, the annual index would be multiplied by the cumulative index for the prior year to determine the current cumulative index. For the first year in which the simplified dollar-value LIFO method is used, the annual index and the cumulative index are the same.

The present dollar value of the ending inventory for the current year is divided by the cumulative index to restate the ending inventory in its equivalent value in base year dollars. This amount is assigned to the appropriate LIFO inventory layers and multiplied by the cumulative index for the year to which the layer relates in order to find an indexed dollar value for that layer. The sum of the indexed dollar values for the layers is the ending LIFO inventory value for the pool. These computations, for the taxpayer's first year using the simplified dollar-value LIFO method, are shown below.

The provision is effective for taxable years beginning after De

cember 31, 1986.