The Income Tax Management Method of Inventory Valuation Is Not GAAP!
Over the years, I’ve been asked if it is appropriate to estimate the value of inventories for tax returns and compilation and review engagements. At one point, I was asked the question so often I looked for my intermediate accounting college text to see if I’d missed something!
First, let me say the use of estimates of inventory valuations may be appropriate in some circumstances. I remember the manager of a precast concrete products company that could estimate the cubic yards in a 60 foot high pile of sand and come within 10 cubic yards of actual. Another example was the superintendent of a grain cooperative that could throw stones at the side of a grain silo and measure the depth to which the silo was filled within a few feet of actual. Before these estimates could be used for financial or tax reporting, however, they were always tested by other calculations or auditing procedures.
As I recall for tax purposes, the quantities of inventories must be tested at least periodically. Because inventories are often major income determinants, financial statements presented in accordance with GAAP require at least an annual physical count of inventories for all levels of service, audits, reviews and compilations. This is also true for statements presented using other reporting frameworks.
Financial statements prepared on an interim basis must be prepared using the same reporting framework as annual statements. Even for monthly compilations, unadjusted annual inventory balances carried forward without adjustments represent a departure from GAAP or other reporting framework. An estimate such as the gross profit method can, however, be used for interim statements.
A staff person at one of my seminars asked me if it was appropriate for her partner to use a client’s estimate of inventories’ values after discussing taxable income before the inventory adjustments with that client. What do you think? The income tax management method of inventory valuation is not acceptable for GAAP, for other reporting frameworks or for tax purposes! At the least, it may be a frivolous tax position. At the outside, it could be called fraud!
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by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs. He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms. Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations. He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.