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l^te clax ^Aspect Why should there be a continuing interest in the techniques of valuing inventories? The simple answer is that "inventory" is one of the most important factors in the existence of any business. It accounts for a large part of the company's investment in assets, and it is usually the largest single cost on the income statement. It is important, therefore, to know what is an "acceptable" inventory for tax purposes; what the Internal Revenue Service is doing in this area to insist that taxpayers follow accepted rules; and what the courts have said about the subject. "Inventories" is a subject that is too often taken for granted, insofar as income taxes are concerned. That is, "good" accounting dictates what to do and we naturally follow along for tax return purposes, accepting the bcok inventory as correct for tax purposes with no further thought given to this item. But how many people, and especially those responsible for tax planning and tax returns, have become involved in the technical tax ru!es? These rules are discussed in the following paragraphs, and their implications analyzed. THE TAX LAW- SECTION 471: Perhaps the natural starting point is a glance at the law on this subject, since in the final analysis this will dictate the acceptability of an inventory for tax purposes, and will also enable an appreciation of the "problems" involved. This very brief "law" is Section 471, the General Rule for Inventories: "Whenever in the opinion of the Secretary or his delegate the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary or his delegate may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income." This one sentence is then "interpreted" by the IRS in several pages of Regulations, and in greater detail than the basic law itself. The basic law contains two tests to which every inventory must conform: First, it must conform as nearly as possible to the best accounting practice in the trade or business, and Second, it must clearly reflect income. It follows, then, from the first test that inventory rules cannot be uniform but must follow trade customs within the scope of the best accounting practice in the particular trade or business. The second test, the clear reflection of income, requires that the inventory practice of a taxpayer be consistent from year to year. Consistency, however, is not sufficient as a test if, in other respects, the inventory fails "clearly to reflect income." Consistency in turn has three aspects: 1. Consistency in the method or basis used from year to year; 2. Consistency in the method or basis applied as to all items in one inventory; and 3. Consistency in the method used in the opening and closing inventories of the taxable year. Thus, inventories must be calculated according to acceptable accounting practices and must also clearly reflect income. The regulations, in explaining the basic law, indicate that the most common inventory valuation methods are cost and cost or market, whichever is lower. These terms are then defined as follows: "Cost" in regard to "normal" inventory is defined in three different ways: (1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods; 16 THE QUARTERLY
Object Description
Title |
Tax aspects of inventories |
Author |
Hausman, Donald I. |
Subject |
Inventories -- Taxation |
Personal Name |
Hausman, Donald I. |
Portrait |
Hausman, Donald I. |
Office/Department |
Touche, Ross, Bailey & Smart. Chicago Office |
Citation |
Quarterly, Vol. 13, no. 4 (1967, December), p. 16-20 |
Date-Issued | 1967 |
Source | Originally published by: Touche, Ross, Bailey & Smart |
Rights | Copyright and permission to republish held by: Deloitte |
Type | Text |
Format | PDF image with OCR under text, scanned at 400dpi |
Collection | Deloitte Digital Collection |
Digital Publisher | University of Mississippi. Digital Accounting Collection |
Date-Digitally Created | 2009 |
Language | eng |
Identifier | Quarterly_1967_December-p16-20 |