Richardson Invs., Inc. v. Comm'r of Internal Revenue, Docket No. 3261-79.

• Decision Date: 11 May 1981
• Docket Number: Docket No. 3261-79.
• Citation: 76 T.C. 736
• Parties: RICHARDSON INVESTMENTS, INC., and SUBSIDIARIES (FORMERLY KNOWN AS RICH FORD SALES, INC.), A NEW MEXICO CORPORATION, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

76 T.C. 736

RICHARDSON INVESTMENTS, INC., and SUBSIDIARIES (FORMERLY KNOWN AS RICH FORD SALES, INC.), A NEW MEXICO CORPORATION, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 3261-79.

United States Tax Court

Filed May 11, 1981.

Petitioner, a Ford Motor Co. franchised dealer, maintained its inventory on the LIFO dollar-value, link-chain method utilizing one pool for new cars and new trucks. Held, sec. 1.472-8(c), Income Tax Regs., requires petitioner to utilize one pool for new cars and a separate pool for new trucks. John S. Campbell and John D. Laflin, for the petitioner.

Douglas R. Fortney, for the respondent.

STERRETT , Judge:

By statutory notice dated December 15, 1978, respondent determined deficiencies in income tax as follows:

+------------------------------------+
                ¦Year ended Dec. 31—  ¦Deficiency  ¦
                +-----------------------+------------¦
                ¦                       ¦            ¦
                +-----------------------+------------¦
                ¦1971                   ¦$109,701.31 ¦
                +-----------------------+------------¦
                ¦1972                   ¦11,791.00   ¦
                +-----------------------+------------¦
                ¦1974                   ¦20,900.50   ¦
                +------------------------------------+
                

The years 1971 and 1972 are in issue only because of petitioner's net operating loss carryback. The primary issue presented is whether petitioner, a retail automobile dealership engaged primarily in the purchase and retail sale of new and used cars and trucks, properly adopted the use of a single LIFO inventory pool in computing inventory values pursuant to the dollar-value, link-chain LIFO method under section 472, I.R.C. 1954.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.

Petitioner Richardson Investments, Inc. (formerly known as Rich Ford Sales, Inc.), is a New Mexico corporation with its principal place of business in Albuquerque, N. Mex., at the time the petition was filed. Petitioner, a Ford Motor Co. franchised dealer, during the calendar years 1971, 1972, 1973, and 1974 was engaged in the business of purchasing and selling at retail new and used Ford automobiles and trucks. Petitioner timely filed its corporate income tax returns, Forms 1120, for all relevant years with the Internal Revenue Service Center in Austin, Tex.

Prior to the calendar year 1974, the petitioner properly valued its new automobile and new truck inventory on the specific identification lower of cost or market, first-in/first-out (FIFO) method.

With its Federal income tax return for the calendar year 1974, the petitioner filed an “Application to Use LIFO Inventory Method” (Form 970) and properly elected to use the last-in/first-out (LIFO) method of valuing its inventory of new cars and new trucks. The LIFO election did not include used cars and trucks, parts and accessories, demonstrators, and campers and other recreational vehicles.

In electing to use the LIFO method of valuing its inventories of new cars and new trucks for 1974 and subsequent calendar years, petitioner properly elected to use the dollar-value, link-chain method of valuing inventory. As authorized by the regulations, the petitioner also elected the earliest acquisitions during the year to determine cost of goods and closing inventory in excess of those in opening inventory.

In electing to use the LIFO method of valuing its inventory, petitioner indicated on the filed Form 970 that it was employing a single pool for all new cars and new trucks. At all times beginning with the calendar year 1974, petitioner has consistently employed the LIFO procedures for both tax and financial accounting purposes.

The dollar-value LIFO method values inventory not in terms of specific items, but in terms of dollars. Total units of inventory are converted into units of dollars for the accounting period. Under the dollar-value LIFO method of valuing inventory, the physical description of inventory items loses relevance, and inventory is defined in terms of dollars at the base year's dollar value.

Petitioner's method—-the dollar-value, link-chain method—-is an index method. It is not a method by which specific physical units of inventory are valued. The physical units of inventory are used to develop an index, and the index is used to measure inflation and cost increase and to determine value of a particular inventory at base year costs. An index in a period of rising inflation would be a number greater than one and when applied to inventory in base year dollars, would show an increment of inflation. Specific items of inventory are used for the purpose of developing an index in the dollar-value, link-chain method. The dollar-value method of valuing inventory involves an averaging process and emphasizes statistical averages over specific identification certainty.

In the link-chain method, generally, a representative portion of the closing inventory in a year is valued at both current cost and by the unit cost used in valuing the closing inventory in the preceding year. The ratio of current year cost to cost used in prior year reflects the increase in prices for the year. In the year of conversion, the cost will be identical and the resulting index will be 1.00. In subsequent years, assuming rising prices, the ratio of current year cost to prior year cost will be a figure greater than 1.00. The object of the link-chain method is to relate statistically current price increases to all prior years. This is accomplished by attaining a so-called “cumulative index” for all years after the year of conversion. To obtain a cumulative index, the current index for the first year after conversion is multiplied by the current index of the year of conversion. Thereafter, the cumulative index is obtained by multiplying the current index by the prior year's cumulative index. Mathematically, the closing inventory valued at current prices, when divided by the cumulative index, will yield the value of closing inventory at base year cost—-the LIFO value of the closing inventory. Because both opening and closing inventories will be valued at base year cost, cost of goods sold will reflect current purchases at current prices.

Petitioner, in computing its LIFO inventories for new cars and new trucks, undertook the following computational steps:

(1) Listing of all items in new vehicle inventory as of yearend, including vehicles in transit, by body style (i.e., two-door, four-door, station wagon, sedan, etc.). The number of items for each body style and their aggregate costs are listed.

(2) Listing of all items in new vehicle inventory as of the beginning of the year, including vehicles in transit, by body style. In the year of changeover, calculations are made for both steps 1 and 2. For all subsequent years, the information obtained in step 1 of the prior year becomes step 2 of the current year.

(3) Average cost of each new vehicle in the beginning and ending inventory is determined by dividing the total number of items for each body style into the total inventory cost for each body style.

(4) Ending inventory quantity per category and body style is valued at beginning inventory price.

(5) To determine the index to reduce current inventory to base year costs, a current to base year index is computed. The current year's ending inventory is valued at actual cost and at beginning inventory cost. The current to base year index is obtained by dividing ending inventory at actual cost by ending inventory at beginning inventory cost. Ending inventory valued at base year costs is the ending inventory at actual cost divided by the index. In years after the year of conversion, the current to base year index is obtained by multiplying the current index times the prior year's cumulative index.

(6) Computation of increment (or decrement). The increment or decrement with reference to base year costs is the difference between the ending inventory valued at base year costs and the previous year's ending inventory at base year costs.

(7) The current year's inventory is then valued at earliest purchase cost (adjusted for cost increases between the first and the last purchases).

(8) The increment of inventory is then valued at earliest purchase value.

(9) Ending inventory at LIFO value. The previous year's inventory at base year costs is added to the increment at earliest purchase value.

(10) Total LIFO reserve. The total LIFO reserve is the ending inventory at actual cost less the ending inventory at LIFO value.

(11) The term “LIFO reserve” refers to the amount of increase in the petitioner's costs of sales resulting from its use of LIFO method of inventory valuation rather than specific identification lower of cost or market method.

Petitioner timely filed a Form 1139 for tentative carryback adjustments from 1974 to 1971, and 1972. The aforesaid carryback adjustment was allowed by the respondent and a refund was paid to petitioner for the calendar years 1971 and 1972.

Pursuant to an audit of petitioner's 1974 tax return, the respondent determined deficiencies for the calendar years 1971, 1972, and 1974. In computing the deficiencies, the respondent determined that the petitioner's LIFO reserve adjustment should be decreased from $487,311.11 to $204,282.74, a decrease of $283,028.37.

The statutory notice was prepared utilizing a separate pool for each model line and a separate pool for each model line body style. Respondent's position herein is that there should be one pool for each model line of new cars and new trucks, not body style pools. Petitioner concedes that petitioner's LIFO inventory reserve as set forth in its tax return is incorrect inasmuch as it fails to reflect the cost of vehicles in transit and an inventory write-down to 1973 costs. Respondent has conceded that in computing its new vehicle inventory under the LIFO method, petitioner properly included in its cost of new...