IPIC LIFO Advantages
Advantages of using the IPIC LIFO Method include:
Higher inflation indexes possible – Some companies have found CPI or PPI inflation rates to be consistently higher than their internal index inflation. For most large supermarket chains the advantage of using CPI vs. internal indexes has been substantial. An annual positive differential of 1% between CPI or PPI inflation and a company’s internal index inflation would reduce taxable income by $1 million annually for a company with $100 million in total inventory at FIFO cost at the beginning of a year.
Fewer pools possible – Supermarket chains not using IPIC LIFO are required to maintain as many as 12 pools. Supermarket chains using IPIC LIFO use between 3 and 6 pools because IPIC LIFO allows pooling based on the 8 different CPI Major Groups or 15 different 2-digit PPI codes and this is the number of pools typically required using this method. Having fewer pools will produce additional LIFO benefits because layer erosions are fewer since decreases in formerly separate pools will be offset by increases in others when pools are combined.
Index calculation simpler than internal index – Use of a published index precludes the need to calculate an internal index unless companies switch for tax LIFO only. Internal index calculations are usually a major undertaking and can be avoided if companies switch for book LIFO also. The IPIC LIFO weighted average index calculations can also be complicated if made manually but this problem is solved with automated LIFO software.
Treatment of “new items” in inventory – New items are inventory items that were purchased for the first time during the year and are on hand for the current year end. New items present a problem for internal index calculation because the inventory accounting system has no record of a prior year end unit price for the new item. The two methods for dealing with new items allowed by the IRS in calculating LIFO internal indexes are either potentially very time consuming or tend to understate the actual inflation. These problems go away completely using the IPIC method.
Simple way for manufacturers to use LIFO for labor and overhead inventories – It is fairly common for manufacturers to exclude labor and overhead inventories from the LIFO election scope because the IRS does not allow separate LIFO pools for these costs (this is called the components-of-cost method). This means that for labor and overhead inventories to be included in the LIFO election scope for LIFO internal index calculations, those costs must be added to the unit cost of each item. Unless a manufacturer uses standard cost accounting, inclusion of these labor and overhead costs for each item is not practical. This problem goes away using the IPIC method because W-I-P and finished goods inventory items, (raw materials, labor and overhead) are assigned to the appropriate PPI commodity code applicable to the ultimate finished good.
IRS audit exposure reduced for past years – Companies switching to the IPIC method are provided a “Safe Harbor” by the IRS with respect to methods used in years prior to the change. IRS audit exposure may be eliminated in these areas:
- Pooling – Many companies use pooling methods not authorized by the IRS. Taxpayers may elect the optional IPIC pooling rules thereby establishing an acceptable pooling method.
- Statistical sampling – Many companies use internal index sampling methods not acceptable to the IRS. For example, a company’s sampling method may exclude new items.
- Other – Some manufacturers still use the components of cost method despite its prohibition by the IRS. Some manufacturers also incorrectly apply raw materials only indexes to total inventory dollars including labor and overhead dollars. Companies can eliminate exposure from use of these methods by adopting IPIC.
Easy means of switching from the double-extension method – The IRS has been reluctant to permit changes from this submethod to the link-chain method, especially for companies whose annual turnover of inventory items is not rapid. Taxpayers can make this change without IRS consent when electing the IPIC method and electing the link-chain submethod as an automatic approval change.
IPIC LIFO need not be also used for financial reporting – Companies may adopt IPIC for tax purposes while continuing to use internal indexes for book LIFO. Higher tax LIFO expense may result without increasing the amount of the book LIFO expense if the internal indexes used for financial reporting are less than the IPIC tax indexes.