SERVICE ANNOUNCES GUIDELINES FOR APPLICATION FOR APPROVAL OF CHANGES IN ACCOUNTING METHOD

Rev. Proc. 86-47

SECTION 1. PURPOSE

The purpose of this revenue procedure is to provide a procedure whereby retail department stores using the retail method of valuing inventories and the last-in, first-out (LIFO) inventory identification method pursuant to the provisions of Rev. Proc. 72-21, 1972-1 C.B. 745, may expeditiously obtain the approval of the Commissioner of Internal Revenue to change from a list of groups or pools previously used by the United States Bureau of Labor Statistics (BLS) to a new expanded list of groups of pools.

SEC. 2. BACKGROUND

01. Section 446(e) of the Internal Revenue Code and section 1.446-1(e)(2)(i) of the Income Tax Regulations provide that a taxpayer must secure the consent of the Commissioner before it changes its methods of accounting for federal income tax purposes. Section 1.44- 1(e)(3)(i) requires that, in general, to obtain this consent a Form 3115, Application for Change in Accounting Method, must be filed within 180 days after the beginning of the tax year for which the proposed change is to be made. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit taxpayers to obtain consent to change their method of accounting in accordance with section 1.446-1(e)(2)(i).

02 Section 1.472-8(g)(1) of the regulations provides that any method of pooling authorized by the regulations and used by the taxpayer in computing its LIFO inventories under the dollar-value method shall be treated as a method of accounting. Any LIFO pooling method, once adopted, must be continued for all subsequent tax years unless a change is required by the Commissioner in order to clearly reflect income, or unless permission to change the method is granted by the Commissioner under section 1.446-1(e).

03 Section 1.472-1(k) of the regulations provides that if a taxpayer using the retail method of pricing inventories, authorized by section 1.471-8, elects to use in connection therewith the LIFO method, the apparent cost of the goods on hand at the end of the year, determined pursuant to section 1.471-8, shall be adjusted to the extent of price changes therein taking place after the close of the preceding tax year. The amount of any apparent inventory increase or decrease to be eliminated in this adjustment shall be determined by reference to acceptable price indexes established to the satisfaction of the Commissioner. Price indexes prepared by BLS that are applicable to the goods in question are acceptable to the Commissioner under 1.472-1(k).

04 Section 1.472-8(g)(2)(i) of the regulations provides that a taxpayer that is permitted or required to change its method of dollar- value LIFO pooling shall combine or separate the LIFO value of its inventory for the base year and each yearly layer of increment in order to conform to the new pools. Each yearly layer of increment in the pool or pools must be separately accounted for and a record thereof maintained, and any liquidation occurring in the new pool or pools subsequent to the formation thereof shall be treated in the same manner as if the new pool or pools had existed from the date the taxpayer first adopted the LIFO method. The combination or separation of the LIFO value of the inventory for the base year and each yearly layer shall be made in accordance with the appropriate method set forth in section 1.472-8(g)(2)(ii), unless the use of a different method is approved by the Commissioner. Section 1.472-8(g)(2)(ii) provides that in separating a pool, each item in the former pool shall be placed in an appropriate new pool. Every item in each new pool is then extended at its base-year unit cost and the extensions are totaled. The regulations provide further steps for the complete separation of the LIFO value of the dollar-value pool into the expanded pools.

05 Rev. Proc. 72-21 provides instructions and illustrations for the use of BLS indexes by a taxpayer that has elected to use the retail valuation method and the LIFO inventory identification method. Rev. Proc. 72-21 sets forth the 20 groups or pools used by BLS as the basis for the preparation of the indexes.

06 Beginning in February 1986, BLS replaced the 20-group list with a 23-group list. The additional groups are: (1) Group 21-- Recreation and Education; (2) Group 22--Home Improvements; and (3) Group 23--Auto Accessories. See Rev. Proc. 86-46, page 6, this Bulletin, which modifies and supersedes Rev. Proc. 72-21 by replacing the 20-group list with the 23-group list. Because the new indexes were introduced by BLS in February 1986, January 1987 will be the first month for which there will be a percent change based on a 12- month period. The January 1986 indexes for the new groups or pools are all 100.

07 Taxpayers that presently compute their LIFO inventory by reference to the pools set forth in Rev. Proc. 72-21 are required under section 1.472-1(k) of the regulations to change their LIFO pooling method to conform to the expanded number of pools set forth in Rev. Proc. 86-47.

08 Retail department stores that carry goods covered by the expanded groups presently use a miscellaneous pool or pools for these and other goods and use the BLS Store Total index, or develop their own index or indexes, to compute the LIFO value of the miscellaneous pool or pools. For these taxpayers, a change in method of accounting to comply with the provisions of Rev. Proc. 86-46 will involve a separation of the present miscellaneous pool or pools.

09 The procedure set forth in section 1.472-8(g)(2)(ii) of the regulations and the example provided therein presuppose that the taxpayer uses the double-extension method of computing its LIFO inventory value. Under that method, the quantity of each item in a dollar-value pool at the close of the tax year is extended at both base-year unit cost and current-year unit cost. The dollar-value LIFO retail method used by retail department stores, as illustrated in Rev. Proc. 72-21, is based upon the so-called "link-chain" method. Under this method, cumulative price indexes are developed and published by BLS with the acceptance of the Internal Revenue Service, and it is not possible to compute original base-year unit costs for items in each dollar-value pool.

SEC. 3. SCOPE

01 This revenue procedure applies to a retail department store that: (1) Uses the retail valuation method and the LIFO inventory identification method pursuant to the provisions of Rev. Proc. 72-21; (2) uses a miscellaneous pool or pools for goods described in new groups 21, 22, or 23; and (3) uses the BLS store total index, or develops its own index or indexes, in computing the LIFO value of this miscellaneous pool or pools.

02 Except as otherwise provided in section 3.03, this revenue procedure applies to a retail department store described in section 3.01 for its first tax year ending on (or with reference to) a date that is on or after Janurary 31, 1987.

03 If a retail department store described in section 3.01 for its tax year described in section 3.02 does not have the records necessary to (1) calculate the cost complement for each new expanded pool, or (2) separate its miscellaneous pool or pools into the new expanded pools, this revenue procedure applies to this retail department store for its first tax year beginning on (or with reference to) a date that is after January 31, 1987.

04 Those taxpayers that are required under this revenue procedure to change their method of accounting and to whom this revenue procedure does not apply should file a Form 3115 with the Commissioner in accordance with section 1.446-1(e)(3) of the regulations and Rev. Proc. 84-74, 1984-2 C.B. 736, if applicable.

SEC. 4. APPLICATION

01 In accordance with section 1.446-1(e)(3)(ii) of the regulations the 180-day rule is waived, and under section 1.446- 1(e)(2)(i) consent is hereby granted to taxpayers described in section 3.01 of this revenue procedure. This consent is granted for the tax year described in section 3.02 or section 3.03 of this revenue procedure and for which a taxpayer requests a change (year of change) by filing a current Form 3115, Application for Change in Accounting Method, in the manner described in section 6 of this revenue procedure. Consent is not granted unless the taxpayer complies with the provisions of this revenue procedure.

02 In accordance with section 1.472-8(g)(2)(i) of the regulations, which allows the Commissioner to approve a procedure for separating LIFO pools different from that described in section 1.472- 8(g)(2), the Service will approve the separation of present miscellaneous dollar-value pools of retail department stores into the expanded pools set forth in Rev. Proc. 86-46 in the manner set forth in sections 4.03 and 4.04 of this revenue procedure.

03 The procedures required of retail department stores in separating a miscellaneous pool or pools into the expanded pools set forth in Rev. Proc. 86-46 are based on the principles of sections 1.472-8(g)(3) and 1.472-8(e)(3)(vi) of the regulations. These procedures in general are as follows: (1) The base-year cost and layers of increment previously computed under the former pooling method are retained; (2) in using the new pooling method the new base year is the year is the year of change; and (3) since the retail method does not contemplate accounting for the individual items in inventory, the separation of the original base-year cost and layers of increment into the new pools is based on the relationship of the current retail value of each of the departments in the ending inventory with respect to the miscellaneous pool for the tax year immediately preceding the year of change. The year of change must be tax years described in sections 3.02 or 3.03 of this revenue procedure.

04 EXAMPLE. (1) The taxpayer, a retail department store, with a fiscal tax year ending January 31, has used Rev. Proc. 72-21 to compute the LIFO value of its dollar-value pools. For purposes of its LIFO inventory valuation, the taxpayer's base year began on February 1, 1983. The taxpayer's inventory includes departments A, B, C, and D that were all grouped together in one miscellaneous dollar-value LIFO pool prior to January 31, 1986. Departments A and B include merchandise described in new Group 21, and Departments C and D include merchandise described in new Group 22. The taxpayer does not sell any merchandise described in new Group 23. The LIFO inventory value at retail, at January 31, 1986, is computed as follows:

                Jan. 31, 1986     Pool ABCD ratio       Jan. 31, 1986

(2) The extension of the quantities of departments A, B, C, and D at their respective current-year retail prices at January 31, 1986, is as follows:

                                         Current

(3) In applying the provisions of this revenue procedure, the taxpayer separates former pool ABCD into two pools, AB and CD. The computation of the allocation of current retail value, by base year and layer, between the two pools is made on the basis of the ratio of total current retail value ($25,000) to total old base-year prices ($20,00) and the relationship of LIFO retail value to current retail value (new base-year prices) as of January 31, 1986, as follows:

                         I              II/I                II

(5) The ratio of the new base-year price of new pools AB and CD to the base-year price of former pool ABCD is 8,000/25,000 and 17,000/25,000, respectively. The allocation of the January 31, 1986, current retail value (new base-year price) of former pool ABCD to pools AB and CE is as follows:

                New base-year price

(6) The LIFO retail value of new pools AB and CD at January 31, 1986, as allocated, is as follows:

                Jan. 31, 1986,

(7) The above determined LIFO base and layers, at retail value, are then converted, by applying the appropriate cost complement percentages of the original pools for the various years, to produce the inventory valuation, at LIFO cost, for each pool.

(8) Once the separation of the original LIFO pool into the new pools has been completed, LIFO calculations are to be made as if the year of separation was the initial LIFO year. Increases in closing inventory at adjusted retail value (see step 9 in section 7.02 of Rev. Proc. 86-46) over new base-year prices (February 1, 1986) will result in increments and will be priced reflecting inflation from a base-year LIFO inventory as of the year of separation. Decreases in closing inventory at adjusted retail value under new base-year prices (February 1, 1986) will result in decrements and will be removed from inventory in reverse chronological order at the LIFO to current retail value relationship applicable to the year the inventory was initially recorded.

SEC. 5. COMPLIANCE WITH CONDITIONS

Taxpayers making a change in method of accounting with respect to its pooling method without complying with all the conditions of this revenue procedure will be deemed to have initiated the change without obtaining the consent of the Commissioner.

SEC. 6. MANNER OF EFFECTING CHANGE

01 Except as otherwise provided in section 6.02 of this revenue procedure, taxpayers described in section 3.01 of this revenue procedure must effect the change in their methods of accounting for their first tax year ending on (or with reference to) a date that is on or after January 31, 1987.

02 Taxpayers described in sections 3.01 and 3.03 of this revenue procedure must effect the change in their methods of accounting for their first tax year beginning on (or with reference to) a date that is after January 31, 1987.

03 The change is effected pursuant to the provisions set forth in this revenue procedure by filing a current Form 3115, in duplicate. The original of the Form 3115 must be attached to the taxpayer's timely filed federal income tax return for the tax year of the change (determined with regard to extensions) or to an amended return for such year filed no later than the extended time period prescribed in section 6081 of the Code and the regulations thereunder. Solely for purposes of the preceding sentence, a federal income tax return which is filed late, but within the time period described in section 6081 of the Code and the regulations thereunder, shall be treated as timely, regardless of the fact that the taxpayer has not been granted an extension of time for filing its income tax return. At the time the original of the Form 3115 is filed with the federal income tax return, a copy of the Form 3115 must be filed with the National Office, addressed to the Commissioner of Internal Revenue, Attention: CC:C:C:1, 1111 Constitution ave. N.W., Washington, DC 20224.

04 Taxpayers described in sections 3.01 and 3.03 of this revenue procedure must sign and attach to the original and duplicate of the Form 3115 a copy of the following statement:

Under penalties of perjury, I certify that the books and records of [insert name of taxpayer] do not contain sufficient information to (1) calculate the cost complement for each new expanded pool, or (2) separate the miscellaneous pool or pools into the new expanded pools for [insert the taxpayer's tax year that is the first tax year ending on (or with reference to) a date that is on or after January 31, 1987].

The original of this representation statement must also be attached to the taxpayer's filed federal income tax return for its first tax year ending on (or with reference to) a date that is on or after January 31, 1987. This statement must be signed by a person (or persons) that has the authority to bind the taxpayer. For example, an officer must sign on behalf of a corporation, a general partner on behalf of a partnership, a trustee on behalf of a trust, or a sole proprietor on behalf of himself or herself.

05 To assist in the processing of these changes in method of accounting and to ensure proper handling, reference to this revenue procedure shall be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "FILED UNDER REV. PROC. 86-47.["]

06 The signature of the individual preparing the application for the taxpayer must appear in the space at the bottom of page one on the Form 3115. An application made by an agent on behalf of a taxpayer must be accompanied by a power of attorney authorizing the agent to sign for the taxpayer. If the agent is also authorized to represent the taxpayer before the Service, to receive the original or a copy of correspondence concerning the request, or perform any other act(s) regarding the application on behalf of the taxpayer, the power of attorney must reflect such authorization(s). If the taxpayer is a member of an affiliated group that has elected to file a consolidated federal income tax return, the Form 3115 submitted on behalf of the taxpayer, as described above, must be signed by a duly authorized officer of the common parent. (See section 1.1502-77 of the regulations.)

SEC. 7. INQUIRIES

Inquiries in regard to this revenue procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, Attention: CC:C:C:1, 1111 Constitution Avenue N.W., Washington, DC 20224.

SEC. 8. EFFECTIVE DATE

For taxpayers described in section 3.01 of this revenue procedure, but not described in section 3.03, this revenue procedure is effective for the first tax year ending on (or with reference to) a date that is on or after January 31, 1987. For taxpayers described in sections 3.01 and 3.03, this revenue procedure is effective for the first tax year beginning on (or with reference to) a date that is after January 31, 1987.