CC:DOM:CORP:R(REG-107644-98)
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC
Re: Comments Regarding Proposed IPIC LIFO Regulations (REG-107644-98)
Dear Sir/Madam:
The Food Marketing Institute (FMI) is pleased to respond to the Internal Revenue Service’s (IRS’s) notice regarding proposed amendments to the regulations that relate to the last-in, first-out (LIFO) and inventory price index computation (IPIC) methods of accounting for inventories. 65 Fed. Reg. 31841 (May 19, 2000).
FMI is a non-profit association that conducts programs in research, education, industry relations and public affairs on behalf of its 1,500 members and their subsidiaries. Our membership includes food retailers and wholesalers, as well as their customers, in the United States and around the world. FMI’s domestic member companies operate approximately 21,000 retail food stores with a combined annual sales volume of $300 billion, which accounts for more than half of all grocery sales in the United States. FMI’s retail membership is composed of large multi-store chains, small regional firms, and independent supermarkets. Our international membership includes 200 members from 60 countries.
A. Background
Under the current regulations, the dollar-value LIFO method measures increases or decreases in inventory quantities by comparing the total cost of the quantity of goods on hand at the beginning and end of the taxable year in terms of equivalent-value dollars, or base-year cost. 65 Fed. Reg. at 31841. The current-year dollar cost of beginning and ending inventory may be converted into a base-year dollar cost using price indexes. Id. Then, the quantity of base-year cost in beginning and ending inventory can be compared and the increase (increment) or decrease (liquidation) can be measured. Id.
The Secretary is directed to promulgate rules that allow appropriate governmental price indexes to be used in the LIFO method. In 1982, the IRS prescribed the IPIC method, under which inventory price indexes are computed with reference to consumer price indexes (CPI’s) or producer price indexes (PPI’s) that are compiled by the U.S. Bureau of Labor Statistics (BLS). 65 Fed. Reg. at 31841.
We should note that the original development and issuance of the IPIC method for LIFO tax valuation came about to a substantial degree because of the work conducted by the Food Merchandisers LIFO Advisory Committee from mid-1975 through 1982. The initial mission of the LIFO Advisory Committee was to secure the approval of the IRS for the ongoing issuance of an index produced by BLS to be used by food merchandisers for LIFO index purposes. When the cost and complexities of this endeavor resulted in abandonment, the committee turned its support to what developed into the IPIC method. Although some of the complexities and the 80 percent limitation feature did not meet the original committee’s satisfaction, the regulations permitted access to LIFO accounting – especially for smaller firms. The LIFO Advisory Committee stated that the use of selected published indexes for LIFO valuation purposes, as provided for in the IPIC method, is one of the most significant conceptual breakthroughs in tax accounting that has occurred in many years. A copy of the “Handbook for LIFO Tax Valuations Inventory Price Index Computation Method,” (hereinafter Handbook for LIFO), which was published by FMI in January 1983, is attached for your information.
B. Comments on Proposed Amendments to LIFO and IPIC Standards
1. Elimination of Requirement To Use 10 Percent Categories and BLS Weights
Current Section 1.472-8(e)(3)(iii) provides detailed rules for assigning inventory items to index categories published by the BLS in either the “CPI Detailed Report” or the “PPI Detailed Report.” The rules hinge on whether the total current-year cost of the items in a single detailed index category is greater or less than 10 percent of the total inventory value. 64 Fed. Reg. at 31841-42.
The proposed regulations eliminate the requirement to use 10 percent categories and BLS weights to determine an appropriate index and instead require taxpayers to classify inventory items into the most detailed index category listed in the “CPI Detailed Report” or the “PPI Detailed Report.” As discussed more fully below, the proposed change in accounting methods will impose an unfair and substantial burden on supermarket retailers that currently use the 10 percent categories and BLS weight approach. Accordingly, the IRS should continue to permit taxpayers to use 10 percent categories and BLS weights for purposes of inventory price index computation.
In the supermarket industry it would be very difficult to sort by the most detailed CPI or PPI index categories. The IPIC method used in our industry is described in FMI’s Handbook for LIFO mentioned earlier. Virtually all retail grocery companies use CPI categories because their inventory mix correlates more closely than PPI categories. Most retail grocers using the IPIC method sort their year-end inventory dollars by approximately 20 of the less detailed CPI categories. Twenty is a sufficient number of categories to ensure that none of the categories exceeds 10 percent of inventory.
If all items in a particular category are not present in inventory, an accounting is made of which of the most detailed CPI categories are actually represented in the inventory so that only the indexes and BLS weights for these categories are used in the weighted average pool index calculations. Very few retail grocers’ inventory systems provide the ability to track the actual costs of specific goods at their stores. Retail grocers have historically relied on third party professional inventory services to conduct periodic physical inventory counts of store retail dollars by departments that do not correlate directly to CPI category groups. Retail grocers using the IPIC method then ask their inventory services to count by the 20 CPI categories as well, for an additional fee. This is the only practical means of sorting store inventories by CPI categories. Warehouse inventories can be sorted by CPI categories because the purchase costs by item are maintained in the inventory systems, however, the majority of retail grocers’ inventories are maintained at stores and most small grocers do not own warehouses.
As noted above, the proposed regulations will require taxpayers to classify inventory items into the most detailed index category listed in the “CPI Detailed Report” or the “PPI Detailed Report.” Most supermarkets have an inventory system set up to provide breakdowns of inventory dollars by only a few different store departments. Only a few of these departments correspond to the necessary CPI categories. Most grocery retailers do not maintain a perpetual inventory record of individual items for store inventories. If stores were required to break down inventories by the most detailed CPI or PPI categories, approximately 140 CPI categories or 450 PPI categories might apply to the stocked inventory. The requirement to sort by at least seven times as many (140 vs. 20) CPI categories would be especially difficult for small grocers whose inventory systems are typically less sophisticated.
While use of the 10 percent categories and BLS weights makes IPIC index calculations more complicated, this method has been used for two decades and supermarkets and their consultants have developed the means to perform the required calculations. Software automates all aspects of calculations once stores have sorted inventories by CPI categories, made an accounting of the CPI categories present in inventory and calculated the necessary cost complements.
The retail grocery industry is unique in that there is not much difference in inventory mix from one store to the next in the industry. The smaller format stores do not sell or carry as much non-food inventories, not all stores have pharmacy departments and the mix of warehouse goods varies some from that carried in stores for larger chains with their own warehouses. The food distribution industry’s mix of inventory is probably more homogeneous than any other for which IPIC LIFO is used so extensively.
While the unique aspects of supermarkets’ use of IPIC LIFO should not dictate IPIC LIFO methods for all industries, we believe that a fairly high percentage of all inventories for which IPIC LIFO is used are represented by grocery companies. The combined sales of retail grocers in the U.S. is about $500 billion and their inventories exceed about $60 billion. Measured by dollars, at least 90 percent of these companies use LIFO and probably at least 80 percent use IPIC LIFO.
The additional complexity of using the 10 percent categories and BLS weights is outweighed by the convenience provided to many retailers and the fact that it is much less burdensome than the alternative requirement to sort inventories by many times more CPI or PPI categories. Accordingly, the IRS should continue to permit the use of the present method .
3. Double-Extension or Link-Chain Method of Index Computation
Since few companies using IPIC LIFO use Double-Extension methodology, the proposed regulations provide welcome clarification regarding this issue since it specifically permits use of either methodology.
6. Selection from “CPI Detailed Report” or “PPI Detailed Report”
Under the current regulation, retailers may select indexes from either the “CPI Detailed Report” or the “PPI Detailed Report,” unless equally appropriate indexes may be selected from either. In the latter case, a retailer using the retail inventory method must select from the “CPI Detailed Report” and all other retailers must select from the “PPI Detailed Report.” 65 Fed. Reg. at 31843. In contrast, the proposed regulation would eliminate the requirement that retailers determine whether the two reports contain equally appropriate indexes and simply require that retailers using the retail inventory rely on the “CPI Detailed Report” and all others use the “PPI Detailed Report.” Id. For the reasons discussed more fully below, we believe that retailers using the IPIC method that do not use the “retail inventory method” should be allowed to continue to use CPI categories for IPIC calculations.
1) Number of categories: The CPI contains less than 200 commodity categories, whereas the PPI identifies almost 4,000 Table 6 categories. Whether a company uses the 10 percent categories and BLS weights or the most detailed categories in the future, sorting dollars by the PPI categories -- or even making an accounting of the PPI categories for which inventory is stocked -- would be much more costly and time-consuming than using CPI categories.
2) Stage of production: Most supermarkets purchase their inventory from wholesale companies and not producers (manufacturers, food producers or processors). The PPI is a measure of selling prices from producers. This means that the PPI prices are one step removed from the cost of most grocery store inventory purchases. Therefore, the PPI is no more appropriate than CPI from this standpoint since the CPI retail selling prices are also one transaction removed from the purchase costs.
3) Correlation of index categories to inventory mix: CPI indexes are generally used in the supermarket industry because there is a far greater correlation between the products stocked on store shelves to the CPI Detailed Report categories than there is to the PPI Detailed Report categories. Recordkeeping would be far more detailed for “PPI Detailed Report” categories. For example, medical and personal care goods, which are found in the pharmacy and health and beauty aids departments in many supermarkets, fall into three CPI detailed categories, whereas the “PPI Detailed Report” divides the same products into to approximately 50 categories within the Chemicals and Allied Products Group (06). The detailed PPI categories include such narrow classifications as cephalosporins, antispasmodic/antisecretory products, and ophthalmic and optic preparations.
4) Pooling method change: Additional time and cost would be required to convert the pooling method from CPI to PPI General Categories. Repoolings required for such a conversion would be complicated particularly for small retailers.
We understand the definition of “retail inventory method” as used in the proposed regulations is the calculation of base period inventory and increments or decrements using retail dollars. This definition is different from the common usage of this term in retail industries to describe the method of calculating cost complements of gross markup percentages by departments or classes of goods for use in converting retail inventory FIFO balances to cost balances.
The taxpayers most affected by having to sort their inventory dollars by the many more PPI categories would be smaller companies whose inventory systems are typically not as sophisticated as for larger companies.
7. Elimination of Requirement to Convert Published Indexes into Retail Price Indexes or Cost Price Indexes
We agree this is a good idea, but do not think it should be tied to using PPI indexes for retailers not using the inventory method.
The fact that the components of cost of sales can change from year to year means that the cost complements may not be directly comparable from year to year and time consuming calculations are required to calculate cost complements that are comparable. If these calculations are not done correctly, errors could result that may materially distort the LIFO indexes calculated. FMI believes the application of cost complements to adjust indexes poses a greater possibility of distorting the indexes calculated than not making this adjustment.
Also, there is a problem with this adjustment in theory since profit margins specific to a company are used for the adjustment and not those implicit in the difference between CPI and PPI indexes.
* * *
Please consider the foregoing comments favorably as you prepare the final amendments to the regulations governing the use of the LIFO and IPIC methods.
Sincerely,
George R. Green
Vice President
General Counsel
Attachment
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC
Re: Comments Regarding Proposed IPIC LIFO Regulations (REG-107644-98)
Dear Sir/Madam:
The Food Marketing Institute (FMI) is pleased to respond to the Internal Revenue Service’s (IRS’s) notice regarding proposed amendments to the regulations that relate to the last-in, first-out (LIFO) and inventory price index computation (IPIC) methods of accounting for inventories. 65 Fed. Reg. 31841 (May 19, 2000).
FMI is a non-profit association that conducts programs in research, education, industry relations and public affairs on behalf of its 1,500 members and their subsidiaries. Our membership includes food retailers and wholesalers, as well as their customers, in the United States and around the world. FMI’s domestic member companies operate approximately 21,000 retail food stores with a combined annual sales volume of $300 billion, which accounts for more than half of all grocery sales in the United States. FMI’s retail membership is composed of large multi-store chains, small regional firms, and independent supermarkets. Our international membership includes 200 members from 60 countries.
A. Background
Under the current regulations, the dollar-value LIFO method measures increases or decreases in inventory quantities by comparing the total cost of the quantity of goods on hand at the beginning and end of the taxable year in terms of equivalent-value dollars, or base-year cost. 65 Fed. Reg. at 31841. The current-year dollar cost of beginning and ending inventory may be converted into a base-year dollar cost using price indexes. Id. Then, the quantity of base-year cost in beginning and ending inventory can be compared and the increase (increment) or decrease (liquidation) can be measured. Id.
The Secretary is directed to promulgate rules that allow appropriate governmental price indexes to be used in the LIFO method. In 1982, the IRS prescribed the IPIC method, under which inventory price indexes are computed with reference to consumer price indexes (CPI’s) or producer price indexes (PPI’s) that are compiled by the U.S. Bureau of Labor Statistics (BLS). 65 Fed. Reg. at 31841.
We should note that the original development and issuance of the IPIC method for LIFO tax valuation came about to a substantial degree because of the work conducted by the Food Merchandisers LIFO Advisory Committee from mid-1975 through 1982. The initial mission of the LIFO Advisory Committee was to secure the approval of the IRS for the ongoing issuance of an index produced by BLS to be used by food merchandisers for LIFO index purposes. When the cost and complexities of this endeavor resulted in abandonment, the committee turned its support to what developed into the IPIC method. Although some of the complexities and the 80 percent limitation feature did not meet the original committee’s satisfaction, the regulations permitted access to LIFO accounting – especially for smaller firms. The LIFO Advisory Committee stated that the use of selected published indexes for LIFO valuation purposes, as provided for in the IPIC method, is one of the most significant conceptual breakthroughs in tax accounting that has occurred in many years. A copy of the “Handbook for LIFO Tax Valuations Inventory Price Index Computation Method,” (hereinafter Handbook for LIFO), which was published by FMI in January 1983, is attached for your information.
B. Comments on Proposed Amendments to LIFO and IPIC Standards
1. Elimination of Requirement To Use 10 Percent Categories and BLS Weights
Current Section 1.472-8(e)(3)(iii) provides detailed rules for assigning inventory items to index categories published by the BLS in either the “CPI Detailed Report” or the “PPI Detailed Report.” The rules hinge on whether the total current-year cost of the items in a single detailed index category is greater or less than 10 percent of the total inventory value. 64 Fed. Reg. at 31841-42.
The proposed regulations eliminate the requirement to use 10 percent categories and BLS weights to determine an appropriate index and instead require taxpayers to classify inventory items into the most detailed index category listed in the “CPI Detailed Report” or the “PPI Detailed Report.” As discussed more fully below, the proposed change in accounting methods will impose an unfair and substantial burden on supermarket retailers that currently use the 10 percent categories and BLS weight approach. Accordingly, the IRS should continue to permit taxpayers to use 10 percent categories and BLS weights for purposes of inventory price index computation.
In the supermarket industry it would be very difficult to sort by the most detailed CPI or PPI index categories. The IPIC method used in our industry is described in FMI’s Handbook for LIFO mentioned earlier. Virtually all retail grocery companies use CPI categories because their inventory mix correlates more closely than PPI categories. Most retail grocers using the IPIC method sort their year-end inventory dollars by approximately 20 of the less detailed CPI categories. Twenty is a sufficient number of categories to ensure that none of the categories exceeds 10 percent of inventory.
If all items in a particular category are not present in inventory, an accounting is made of which of the most detailed CPI categories are actually represented in the inventory so that only the indexes and BLS weights for these categories are used in the weighted average pool index calculations. Very few retail grocers’ inventory systems provide the ability to track the actual costs of specific goods at their stores. Retail grocers have historically relied on third party professional inventory services to conduct periodic physical inventory counts of store retail dollars by departments that do not correlate directly to CPI category groups. Retail grocers using the IPIC method then ask their inventory services to count by the 20 CPI categories as well, for an additional fee. This is the only practical means of sorting store inventories by CPI categories. Warehouse inventories can be sorted by CPI categories because the purchase costs by item are maintained in the inventory systems, however, the majority of retail grocers’ inventories are maintained at stores and most small grocers do not own warehouses.
As noted above, the proposed regulations will require taxpayers to classify inventory items into the most detailed index category listed in the “CPI Detailed Report” or the “PPI Detailed Report.” Most supermarkets have an inventory system set up to provide breakdowns of inventory dollars by only a few different store departments. Only a few of these departments correspond to the necessary CPI categories. Most grocery retailers do not maintain a perpetual inventory record of individual items for store inventories. If stores were required to break down inventories by the most detailed CPI or PPI categories, approximately 140 CPI categories or 450 PPI categories might apply to the stocked inventory. The requirement to sort by at least seven times as many (140 vs. 20) CPI categories would be especially difficult for small grocers whose inventory systems are typically less sophisticated.
While use of the 10 percent categories and BLS weights makes IPIC index calculations more complicated, this method has been used for two decades and supermarkets and their consultants have developed the means to perform the required calculations. Software automates all aspects of calculations once stores have sorted inventories by CPI categories, made an accounting of the CPI categories present in inventory and calculated the necessary cost complements.
The retail grocery industry is unique in that there is not much difference in inventory mix from one store to the next in the industry. The smaller format stores do not sell or carry as much non-food inventories, not all stores have pharmacy departments and the mix of warehouse goods varies some from that carried in stores for larger chains with their own warehouses. The food distribution industry’s mix of inventory is probably more homogeneous than any other for which IPIC LIFO is used so extensively.
While the unique aspects of supermarkets’ use of IPIC LIFO should not dictate IPIC LIFO methods for all industries, we believe that a fairly high percentage of all inventories for which IPIC LIFO is used are represented by grocery companies. The combined sales of retail grocers in the U.S. is about $500 billion and their inventories exceed about $60 billion. Measured by dollars, at least 90 percent of these companies use LIFO and probably at least 80 percent use IPIC LIFO.
The additional complexity of using the 10 percent categories and BLS weights is outweighed by the convenience provided to many retailers and the fact that it is much less burdensome than the alternative requirement to sort inventories by many times more CPI or PPI categories. Accordingly, the IRS should continue to permit the use of the present method .
3. Double-Extension or Link-Chain Method of Index Computation
Since few companies using IPIC LIFO use Double-Extension methodology, the proposed regulations provide welcome clarification regarding this issue since it specifically permits use of either methodology.
6. Selection from “CPI Detailed Report” or “PPI Detailed Report”
Under the current regulation, retailers may select indexes from either the “CPI Detailed Report” or the “PPI Detailed Report,” unless equally appropriate indexes may be selected from either. In the latter case, a retailer using the retail inventory method must select from the “CPI Detailed Report” and all other retailers must select from the “PPI Detailed Report.” 65 Fed. Reg. at 31843. In contrast, the proposed regulation would eliminate the requirement that retailers determine whether the two reports contain equally appropriate indexes and simply require that retailers using the retail inventory rely on the “CPI Detailed Report” and all others use the “PPI Detailed Report.” Id. For the reasons discussed more fully below, we believe that retailers using the IPIC method that do not use the “retail inventory method” should be allowed to continue to use CPI categories for IPIC calculations.
1) Number of categories: The CPI contains less than 200 commodity categories, whereas the PPI identifies almost 4,000 Table 6 categories. Whether a company uses the 10 percent categories and BLS weights or the most detailed categories in the future, sorting dollars by the PPI categories -- or even making an accounting of the PPI categories for which inventory is stocked -- would be much more costly and time-consuming than using CPI categories.
2) Stage of production: Most supermarkets purchase their inventory from wholesale companies and not producers (manufacturers, food producers or processors). The PPI is a measure of selling prices from producers. This means that the PPI prices are one step removed from the cost of most grocery store inventory purchases. Therefore, the PPI is no more appropriate than CPI from this standpoint since the CPI retail selling prices are also one transaction removed from the purchase costs.
3) Correlation of index categories to inventory mix: CPI indexes are generally used in the supermarket industry because there is a far greater correlation between the products stocked on store shelves to the CPI Detailed Report categories than there is to the PPI Detailed Report categories. Recordkeeping would be far more detailed for “PPI Detailed Report” categories. For example, medical and personal care goods, which are found in the pharmacy and health and beauty aids departments in many supermarkets, fall into three CPI detailed categories, whereas the “PPI Detailed Report” divides the same products into to approximately 50 categories within the Chemicals and Allied Products Group (06). The detailed PPI categories include such narrow classifications as cephalosporins, antispasmodic/antisecretory products, and ophthalmic and optic preparations.
4) Pooling method change: Additional time and cost would be required to convert the pooling method from CPI to PPI General Categories. Repoolings required for such a conversion would be complicated particularly for small retailers.
We understand the definition of “retail inventory method” as used in the proposed regulations is the calculation of base period inventory and increments or decrements using retail dollars. This definition is different from the common usage of this term in retail industries to describe the method of calculating cost complements of gross markup percentages by departments or classes of goods for use in converting retail inventory FIFO balances to cost balances.
The taxpayers most affected by having to sort their inventory dollars by the many more PPI categories would be smaller companies whose inventory systems are typically not as sophisticated as for larger companies.
7. Elimination of Requirement to Convert Published Indexes into Retail Price Indexes or Cost Price Indexes
We agree this is a good idea, but do not think it should be tied to using PPI indexes for retailers not using the inventory method.
The fact that the components of cost of sales can change from year to year means that the cost complements may not be directly comparable from year to year and time consuming calculations are required to calculate cost complements that are comparable. If these calculations are not done correctly, errors could result that may materially distort the LIFO indexes calculated. FMI believes the application of cost complements to adjust indexes poses a greater possibility of distorting the indexes calculated than not making this adjustment.
Also, there is a problem with this adjustment in theory since profit margins specific to a company are used for the adjustment and not those implicit in the difference between CPI and PPI indexes.
* * *
Please consider the foregoing comments favorably as you prepare the final amendments to the regulations governing the use of the LIFO and IPIC methods.
Sincerely,
George R. Green
Vice President
General Counsel
Attachment
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