Rev. Rul. 73-65

Advice has been requested whether, under the circumstances described below, it is appropriate to reflect cost of inventories at invoice price net of cash discounts.

The taxpayer is engaged in the sale of merchandise and uses the overall accrual method of accounting. It has consistently followed the practice of reporting cash discounts as income for the taxable year in which the purchase invoices were paid, with inventory valued at gross invoice price. The taxpayer now desires to change its practice to one in which all inventories acquired during the taxable year and on hand at the close of the taxable year are valued at invoice prices net of cash discounts, whether or not taken.

The specific question presented is whether, under the circumstances, the method of computing inventory cost by including the invoice price net of cash discounts, whether or not taken, is a proper method of accounting for inventory costs that is permissible under section 471 of the Internal Revenue Code of 1954.

Section 471 of the Code provides that whenever in the opinion of the Secretary or his delegate the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary or his delegate may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

Section 1.471-3(b) of the Income Tax Regulations defines the term "cost" for purposes of determining the inventory valuation of merchandise purchased since the beginning of the taxable year. In such case, cost is the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price must be added transportation or other necessary charges incurred in acquiring possession of the goods.

Generally accepted accounting principles allow cash discounts to be treated as income items or cash discounts not taken to be treated as expense items. Under the gross invoices valuation method, the gross invoice prices are charged to purchases and cash discounts are accounted for as income items. On the other hand, under the net invoice valuation method only the net invoice prices are charged to purchases. Any cash discounts that are not taken advantage of are recorded as expense items. See Warfield-Pratt-Howell Co. v. Commissioner, 13 B.T.A. 305 (1928).

Section 1.471-3(b) of the regulations, in giving taxpayers the option to deduct cash discounts, has given recognition to the generally accepted accounting principles in this area. The taxpayer's net invoice method of valuation for cost of merchandise purchased during the year comes within the generally accepted accounting principles stated above.

Accordingly, it is held that the method of using the net purchase price of merchandise in recording purchases and computing inventory costs is a permissible method of inventory valuation that clearly reflects income. The taxpayer, in order to change to such method, must secure the consent of the Commissioner in accordance with sections 446 and 481 of the Code and the regulations thereunder.