Special Challenges for Supermarkets
The use of the LIFO method in this industry is probably more common than for almost any other industry. We estimate the LIFO method usage rate at over 90% because of the consistency of inflation for supermarket merchandise over many years together with significant inventory balances (single store cost inventory balances ranging from $300,000 to $2,500,000).
Supermarket chain LIFO calculations are more complicated than those for most other industries. This has been one of our primary practice areas since our LIFO expertise and automated software is more useful to companies whose LIFO calculations are complicated. Complicated LIFO situations along with complicated IRS LIFO Regs. are much more likely to result in IRS Regs. noncompliance because of improper method and submethod elections and application of improper computational methodology. They are also more prone to computational errors when spreadsheet assisted manual calculations are used for numerous steps.
Supermarket LIFO Complexities
- Large number of inventory items – Most supermarket chains stock roughly 30,000+ SKUs and turnover is relatively high. Approximately 100 different CPI most-detailed commodity codes are applicable but a substantially greater number of most-detailed PPI commodity codes apply.
- Use of 10% method – Most supermarket chains use the optional IPIC 10% method to reduce the number of required CPI/PPI category breakdowns to approximately 30-50 less detailed categories (you are not in compliance with the IRS Regs. if < 30 categories are used). The use of spreadsheet-assisted manual calculation for the 10% method computations historically results in errors.
- Retail inventory method (RIM) & use of physical inventory counts to get CPI/PPI breakdowns – The widespread use of the RIM in this industry & lack of item cost inventory accounting necessitates the use of physical inventory counts to obtain the necessary store inventory breakdowns by CPI or PPI categories. Our experience with this type of inventory accounting and the fact that the standardized list of supermarket chain 10% method CPI and PPI categories we created has been used as the industry standard for the past 15 years has resulted in more widespread usage of the IPIC LIFO method for supermarkets and has considerably reduced the amount of time required for proper LIFO calculations. Click on the following link to go to a separate web page specifically addressing the topic of Supermarket LIFO count procedures.
- Retail LIFO method complications – The Retail LIFO method is different than the RIM. Retail LIFO is used only for LIFO pools for which the RIM is used but the Cost LIFO method can also be used for LIFO pools for which the RIM is used. Refer to our Glossary web page for the definitions of these methods. Retail LIFO is more complicated than Cost LIFO because the inventory at base is calculated using retail inventory balances and LIFO indexes that measure retail price inflation and cost complements (of the gross profit margin percentages) must be multiplied times the layers at retail to calculate LIFO layers at cost.
- Warehouse & store inventories for larger chains – Different inventory accounting methods are used for warehouse v. store inventories & the methods of obtaining CPI/PPI category breakdowns are different. Item cost methods are used for warehouse inventories & a mixture of RIM and cost is used for store inventories.
- Use of CPI or PPI indexes – The IRS Regs. allow retailers to use CPI or PPI indexes. Most supermarkets used CPI indexes through 2005. After that time, the use of PPI indexes has become much more common because PPI inflation for supermarkets has consistently exceeded CPI inflation in the past several years. The LIFO-PRO software supports CPI & PPI indexes and we have helped many companies make the switch from CPI to PPI indexes. The computations required for supermarket PPI LIFO calculations are more complicated because additional breakdowns are required and the PPI categories published changes every six months (approximately 30 new categories are added every six months and a like number are discontinued). Keeping up with these changes takes a lot of time but this process is automated in our software so that when discontinued categories are entered and read by our software, it automatically reassigns the inventory balances to the proper PPI replacement category. Click on the following link to go to a separate web page specifically addressing the topic of Supermarkets increasing tax deferral by using PPI indexes
- Use of internal indexes for GAAP for large companies – Most publicly traded and many other large supermarket chains use internal indexes to calculate LIFO inflation for GAAP and use the IPIC method for tax purposes and the use of two different methods increases the chances of errors. Calculation of accurate internal indexes is a challenge for some of the same reasons proper IPIC method calculations are a challenge.
- Selective LIFO elections – Historically many supermarkets have excluded certain departments from their LIFO election scope. The most commonly excluded departments are fresh meat, produce, deli, bakery, floral and pharmacy. Since virtually all goods stocked by supermarkets experience inflation over time, our normal recommendation is that all goods should be on LIFO to maximize tax savings.
Planning & Implementation of the IPIC Method for Supermarkets
The Food Marketing Institute (FMI) provided a great deal of guidance regarding the use of the IPIC LIFO method by supermarkets in earlier years. The FMI and FMI members actually wrote the IPIC method IRS Regulations in 1982 in collaboration with the IRS as a result of FMI’s desire to develop a simpler LIFO methodology that would allow more widespread usage of the method by smaller supermarket chains. The FMI went a step further and produced a booklet in January 1983 entitled Handbook for LIFO Tax Valuations-Inventory Price Index Computation Method (IPIC) that was a practical how-to guide that was used extensively by supermarkets until 1998. This handbook included a list of the 21 different 10% method CPI categories that was the minimum number required for compliance with IRS Regs. before 1998. The FMI prior to 1998 also made service bureau LIFO calculations for a number of small companies using specialized LIFO software developed by a FMI member company because the calculations required were prone to error when made by in-house accountants without extensive LIFO experience.
The FMI is no longer a LIFO resource for its members and has not been since sometime in the 1990s and the specialized LIFO software referred to above is no longer used. The Handbook the FMI published in 1983 is also now obsolete because of the 1998 changes in the makeup of the CPI categories by the BLS and because of the mandatory method changes incorporated in the new IPIC LIFO Regs. issued in 2002.
We have succeeded the FMI in their role of providing guidance to implement and use the IPIC LIFO method for supermarkets. In 2003, we published our Guide for Planning & Implementation of the IPIC LIFO Method for Supermarket Chains which not only supersedes the 1983 FMI Handbook but provides much more comprehensive guidance. This guide includes a list of the 33 different 10% method CPI categories and 55 different 10% method PPI categories that has been the minimum number required for compliance with the revised IRS IPIC LIFO Regs. published in 2002.
We serve clients in all industries except auto dealers but we made our name serving retailers using the IPIC method. Our LIFO-PRO software is used for the tax LIFO calculations for over 60% (by dollar volume) of supermarkets in the U.S. and most of these companies use our LIFO consulting services. We sell licenses to use our LIFO-PRO software to companies or their CPAs and also provide LIFO service bureau calculations to companies or their CPAs. Our LIFO-PRO software is the only comprehensive, commercially available non-auto dealer LIFO program sold. There have been numerous spreadsheet templates created to use for IPIC LIFO calculations but these are very much prone to error because it is not possible to fully automate many aspects of the LIFO computations in a spreadsheet and even if you could, it is very difficult to secure a spreadsheet to prevent changes.
Recent developments affecting supermarket LIFO
FIN 48 & IRS preparer penalty implications – Many LIFO computation shortcuts have been used in all industries including supermarkets. The most common supermarket LIFO shortcuts are: 1) not using the appropriate 10% method CPI or PPI categories (using too few categories or only a single category for each pool) and 2) incorrect 10% method math. Most non-large case IRS audit supermarkets faced little IRS scrutiny in the past because of the lack of LIFO experience possessed by most IRS field agents and this resulted in relatively few IRS LIFO audit adjustments. These companies and their CPAs have played “IRS audit roulette” because of the low level of LIFO IRS scrutiny.
The LIFO IRS Regs. compliance standard has been drastically raised by these new pronouncements. The numerous LIFO shortcuts (to the IRS Regs. requirements) used are all “undisclosed positions taken” that clearly are not “more likely than not” to be sustained on their merits and therefore practitioners may not sign tax returns for these taxpayers. The likelihood of IRS audit or audit adjustment are not factors to be considered in the application of this rule; only whether the CPA has knowledge of IRS Regs. noncompliance is pertinent. FIN 48 requires valuation reserves to be established for IRS Regs. noncompliance in some cases.
Use of PPI rather than CPI indexes – Many larger supermarkets chains, as well as some smaller ones, use PPI rather than CPI indexes because there has been substantially higher inflation for PPI since the early 2000s. More-detailed breakdowns are required by the IRS Regulations when PPI indexes are used. We have helped a number of our clients change methods to switch from using CPI to PPI indexes. Some non-publicly traded supermarkets use CPI for book LIFO and PPI for tax LIFO. We have written a guide addressing the steps necessary to make this change. The guide includes a list of 55 different PPI LIFO count codes necessary to comply with the IRS’s rules pertaining to the 10% Method. Contact LIFO-PRO at (402)-330-8573 or at firstname.lastname@example.org for more information on the topic of Special Challenges for Supermarkets on LIFO.