LB&I Concept Unit
Unit Name
Introduction to Dollar Value LIFO
Primary UIL Code
00472.08-00 Dollar Value Method
Library Level Title
Knowledge Base
Corporate/Business Issues & Credits
Shelf
Inventory and IRC 263A
Book
Inventory LIFO
Chapter
Dollar Value Method
Document Control Number (DCN)
COR-C-015
Date of Last Update
06/10/20
Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain a
comprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law.
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General Overview
Introduction to Dollar Value LIFO
Any taxpayer may elect to determine the cost of Last In-First Out (LIFO) inventories under the “dollar-value” LIFO method, provided
the taxpayer uses the method consistently and it clearly reflects income in accordance with the rules of Treas. Reg. 1.472–8 Dollar-
value method of pricing LIFO inventories.
The dollar-value method of valuing LIFO inventories is a method of determining cost by using “base-year” costs expressed in total
dollars rather than the quantity and price of specific goods as the unit of measurement. Under this method, the taxpayer groups goods
contained in the inventory into a pool(s). The method groups related inventory and uses an overall price index, under one of three
approaches, to approximate changes in inventory cost. Rather than tracking individual units, taxpayers measure value based on the
total value of the pool.
The term “base-year cost” is the aggregate of the cost of all items in a pool determined as of the base date. The base date is the
beginning of the taxable year for which the taxpayer first adopts the LIFO method. The taxable year for which the taxpayer first adopts
the LIFO method for any item in the pool is the “base year” for that pool.
Liquidations (decrements) and increments of items contained in the pool are reflected only in terms of a net liquidation or net
increment for the pool. Fluctuations may occur in quantities of various items within the pool, new items that properly fall within the pool
may be added, and old items may disappear from the pool, all without necessarily changing the dollar value of the pool.
An increment in the LIFO inventory occurs when the end of the year inventory for any pool expressed in terms of base-year cost is
more than the beginning of the year inventory for that pool expressed in terms of base-year cost. Pool liquidation occurs when the
year’s ending inventory is less than beginning inventory after correcting for inflation. Because liquidations and increments are reflected
only on a net basis, the dollar-value LIFO method minimizes liquidation in most cases.
In determining the inventory value for a pool, the taxpayer adjusts the increment, if any, for changing unit costs or values by reference
to a percentage, relative to base-year-cost, determined for the pool.
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Detailed Explanation of the Concept
Introduction to Dollar Value LIFO
Analysis Resources
IRC 472(b)(2) states that if the taxpayer uses the LIFO inventory method, it must value the
inventory at cost regardless of market value. Lower of cost or market write-downs are not
allowed.
Treas. Reg. 1.472-8 covers the dollar-value method of pricing LIFO Inventories. This method
measures inventory based on dollars and not particular units. The taxpayer groups the
inventory into a pool or pools.
There are various methods the taxpayer can choose for computing the LIFO value:
Double-extension Method
Link-chain Method
Inventory Price Index Computation (IPIC)
Retail Inventory Method (RIM)
The following two sections first describe various LIFO methods then provide examples.
IRC 472(b)(2)
Treas. Reg. 1.472-8(b)
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Detailed Explanation of the Concept (cont’d)
Introduction to Dollar Value LIFO
Analysis Resources
Double-extension Method
The Double-extension method is described in Treas. Reg. 1.472-8(e)(2) and is the preferred
method per the regulations.
Used in industries where the composition of pools does not change much.
Measures cumulative inflation in one step, from the base year (first LIFO year) to the current
year.
Extends quantity of each pool item at both base-year unit cost and current-year unit cost,
then totals the respective extensions at the two costs.
Compares items in ending inventory at current-year cost to the same items at base-year
cost to derive an inflation index (LIFO Index).
The cumulative inflation is calculated as follows:
Treas. Reg. 1.472-8(e)(2)
Treas. Reg. 1.472-8(e)(2)(ii)
The total current-year cost of items making up a pool may be determined:
1. by reference to the actual cost of the goods most recently purchased or produced using
the earliest acquisition method, or
2. by the average unit cost, equal to the aggregate cost of all of the goods purchased or
produced throughout the taxable year divided by the total number of units purchased or
produced, or
3. any other method which, in the opinion of the Commissioner, clearly reflects income.
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Detailed Explanation of the Concept (cont’d)
Introduction to Dollar Value LIFO
Analysis Resources
Link-chain Method
The Link-chain method is described in Treas. Reg. 1.472-8(e)(1) & Treas. Reg. 1.472-
8(e)(3)(iii)(D)(iii).
The taxpayer can use this method if the taxpayer can demonstrate the Double-extension
method is impractical or unsuitable.
Measures the cumulative inflation in two steps:
- For the period between the current year and the year immediately prior to the current year
(current-year index),
- From the base year (LIFO year #1) to the year prior to the current year (prior-year
cumulative index).
To find the current-year index, compare items in ending inventory at current-year unit cost to
the same items at prior-year unit cost.
The annual inflation is calculated as follows:
- [End of year quantity multiplied by (current-year cost divided by end of year quantity)] then
multiplied by prior-year cost.
Multiply the current-year index by the prior-year cumulative index to calculate the current-
year cumulative index.
Divide the current-year cost by the current-year cumulative index to calculate the base-year
cost (See “General Overview”).
Treas. Reg. 1.472-8(e)(1)
Treas. Reg. 1.472-8(e)(3)(iii)(D)(iii)
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Detailed Explanation of the Concept (cont’d)
Introduction to Dollar Value LIFO
Analysis Resources
Inventory Price Index Computation (IPIC) Method
The IPIC method is described in Treas. Reg. 1.472-8(e)(3).
The IPIC method values inventories under LIFO. This method uses an external index found in
the Bureau of Labor Statistics (BLS). The index is used to value the items in inventory. The
taxpayer must assign every item to the most detailed BLS category for the selected BLS table
that contains that item.
When using the IPIC method, the taxpayer may compute the inflationary index using either:
Double-extension method, or
Link-chain method
Under the IPIC method the taxpayer may use:
IPIC method pooling
Regular LIFO pooling
When using the IPIC method pooling:
Manufacturers pool items by the Producer Price Index (PPI) 2-digit commodity code (Treas.
Reg. 1.472-8(b)(4)).
Retailers/Wholesalers pool by the PPI 2-digit commodity code. Retailers only may pool by
Consumer Price Index (CPI) major groups (Treas. Reg. 1.472-8(c)(2)).
Treas. Reg. 1.472-8(e)(3)
Treas. Reg. 1.472-8(b)(4)
Treas. Reg. 1.472-8(c)(2)
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Detailed Explanation of the Concept (cont’d)
Introduction to Dollar Value LIFO
Analysis Resources
Inventory Price Index Computation (IPIC) Method (cont’d)
5% Rules with IPIC Method Pooling (Treas. Reg. 1.472-8(b)(4) and (c)(2)): If a major
category of inventory (an IPIC Pool) is less than 5% of the total current-year costs, then the
taxpayer may combine the less than 5% category with the largest major category of inventory
(an IPIC Pool). This eliminates small pools and increases the size of the largest pool.
To use this method a taxpayer:
Must make an election to use the 5% Rule.
Must sort inventory into BLS categories.
May combine major categories with less than 5% of total current-year costs into a single
miscellaneous IPIC pool.
May combine the miscellaneous pool with largest IPIC pool when a miscellaneous IPIC pool
is less than 5%.
Must retest the pools every three years (high non-compliance area)
Other IPIC Method Pooling Audit Issues
Taxpayers may value some items in a single major category on First In-First Out (FIFO) and
value other items on LIFO.
Major categories with less than 5% may grow beyond 5% and taxpayers may not be
retesting them every three years.
Treas. Reg. 1.472-8(b)(4)
Treas. Reg. 1.472-8(c)(2)
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Detailed Explanation of the Concept (cont’d)
Introduction to Dollar Value LIFO
Analysis Resources
Retail LIFO Method
The Retail LIFO method is described in Treas. Regs. 1.472–1(k) and 1.472-8.
The Retail LIFO method is a dollar-value LIFO method which uses retail sales values to
calculate increments and decrements to the LIFO layers.
The taxpayer converts the retail value of the closing inventory to cost by applying a cost
complement. The cost complement reflects the relationship of the retail values to the cost.
Compute the cost complement as follows, per Treas. Reg. 1.471-8:
The numerator is the value of beginning inventory plus the cost of goods purchased during
the taxable year.
The denominator is the retail selling prices of beginning inventory plus the retail selling
prices of goods purchased during the year adjusted for all permanent markups and
markdowns, including markup and markdown cancellations and corrections. The
denominator is not adjusted for temporary markups or markdowns.
A retailer may determine its annual-inflation index under a traditional dollar-value technique
(Double-extension or Link-chain) or by using indexes the government publishes.
Treas. Reg. 1.471-8
Treas. Reg. 1.472–1(k)
Treas. Reg. 1.472–8
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Examples of the Concept
Introduction to Dollar Value LIFO
Examples
Double-extension Method
Establish the extended base-year cost (BYC) for the first year when LIFO was elected by multiplying the quantities on hand at the
beginning of the base year by the unit costs for each item on hand at the beginning of the base year.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Double-extension Method (cont’d)
Calculate current-year costs (CYC) for the first tax year. Calculate the end of year (EOY) extended cost for each item by multiplying
the end of year (EOY) quantity for each item on hand by the end of year unit cost for each item. The sum of the EOY extended costs is
the total current-year cost (CYC).
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Double-extension Method (cont’d)
Compute the current year Inflation index for the base year by (1) multiplying the end of year quantities (EOYQ) by end of year (EOY)
unit costs to determine EOY extended cost, then (2). multiply base-year (BYC) unit cost by EOY quantity to determine BYC extended
cost, then, (3) divide the EOY extended cost by BYC extended cost.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Double-extension Method (cont’d)
Deflate the current-year cost to base-year cost by dividing current-year cost by the current-year index. When the ending inventory is
deflated to base-year cost, determine if a new base year layer is created. If a new base year layer is created, the layer is inflated to
current cost to create a new LIFO layer. Add the LIFO layers together to calculate the LIFO inventory value. Calculate the LIFO
reserve by subtracting the LIFO inventory from the FIFO inventory value. The FIFO inventory value is the EOY Extended Cost for all
items at the end of the most recent year.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Double-extension Method (cont’d)
Calculate current-year cost (CYC) for the second tax year. Calculate the end of year (EOY) extended cost for each item by multiplying
the end of year (EOY) quantity for each item on hand by the end of year unit cost for each item. The sum of the EOY extended costs is
the total current-year cost (CYC).
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Double-extension Method (cont’d)
Determine if a new base year layer is created. If not, then reduce the layers and re-calculate LIFO for the remaining base layers.
Calculate the LIFO inventory value and LIFO reserve.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Link-chain Method (cont’d)
Compute the current year index by multiplying the end of year quantities (EOYQ) by end of year (EOY) costs and divide that amount
by the end of year quantities by beginning of year costs. Then compute the current year cumulative index by multiplying the current
year’s index by the base-year cost index of 1.000 in the year of election.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Link-chain Method (cont’d)
Deflate the current-year cost to base-year cost by dividing the current-year cost by the current year’s cumulative index. When the
ending inventory is deflated to base-year cost, determine if a new base year layer is created. If a new base year layer is created, the
layer is inflated to current cost to create a new LIFO layer. Add the LIFO layers together and calculate the LIFO inventory value.
Calculate the LIFO reserve by subtracting the LIFO inventory from the current costs (FIFO) inventory cost.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Link-chain Method (cont’d)
Deflate the current-year cost to base-year cost and determine if a new base year layer is created. If a new base year layer is created,
the layer is inflated to current cost to create a new LIFO layer. Add the LIFO layers and calculate the LIFO inventory value. Calculate
the LIFO reserve by subtracting the LIFO inventory from the current costs (FIFO) inventory cost.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Link-chain Method (cont’d)
Determine if a new base year layer is created. If not, then reduce the layers and recalculate LIFO for the remaining base layers.
Calculate the LIFO inventory value and LIFO reserve.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Link-chain Method (cont’d)
Deflate the current-year cost to base-year cost and determine if a new base year layer is created. If a new base year layer is created,
then the layer is inflated to current cost to create a new LIFO layer. Add the LIFO layers together and calculate the LIFO inventory
value. Calculate the LIFO reserve by subtracting the LIFO inventory from the current costs (FIFO) inventory cost.
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Examples of the Concept (cont’d)
Introduction to Dollar Value LIFO
Examples
Calculating IPIC LIFO Using 7 Steps
Step 1 - Compute current cost
Step 2 - Compute inflation
Select a BLS Table and appropriate month
Assign all inventory item in the pool to BLS categories
Compute the category inflation index
Computation of the IPI
Step 3 - Reduce current cost to base
Step 4 - Determine current year base layer
Step 5 - Value current year base layer at current year cost
Step 6 - Total all LIFO Layers
Step 7 - Compute LIFO reserve
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Index of Referenced Resources
Introduction to Dollar Value LIFO
IRC 472
Treas. Reg. 1.446-1(e)
Treas. Reg. 1.471-1
Treas. Reg. 1.471-8
Treas. Reg. 1.472-8(b)
Treas. Reg. 1.472-8(c)
Treas. Reg. 1.472-8(e)
Treas. Reg. 1.472-8(g)
FAA 20080401F
TAM 9129004
Form 3115 - Application for Change in Accounting Method
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Training and Additional Resources
Introduction to Dollar Value LIFO
Type of Resource Description(s)
White Papers/Guidance White Paper Analysis - Manufacturer Natural Business Unit Pooling Goods Purchased for
Resale
White Paper Analysis - Establishing LIFO Pools
Issue Toolkits Issue Snapshot - LIFO IPIC Pools for Manufactured Goods and Goods Purchased for
Resale
Issue Snapshot - LIFO Pooling Under Dollar Value Method
Issue Snapshot - Establishing Pools Under the Dollar Value LIFO Method
Issue Snapshot - Representative Sample Allowed to Compute a LIFO Index
Other Training Materials
Basic LIFO Inventory PPT - 2012-03
IPIC LIFO PPT - 2012-03
Overview of IPIC method and BLS Reports PPT - 2015-04
Databases / Research Tools United States Bureau of Labor Statistics (BLS) - Producer Price Indexes and Percent
Changes for Commodity Groupings and Individual Items, Not Seasonally Adjusted
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Glossary of Terms and Acronyms
Term/Acronym Definition
BLS United States Bureau of Labor Statistics
BOY Beginning of the Year
BYC Base Year Cost
CY Current-year
CYC Current-year Cost
EOY End of the Year
EOYQ End of the Year Quantities
IPIC Inventory Price Index Computation
IRC Internal Revenue Code
FIFO First In-First Out
LIFO Last In-First Out
PPI Producer Price Index
PY Prior year
RIM Retail Inventory Method
Treas. Reg. Treasury Regulation
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