Rev. Proc. 77-33

Section. 1. Purpose

The purpose of this Revenue Procedure is to expand the guidelines contained in Rev. Proc. 76-7, 1976-1 C.B. 546, relating to a footnote disclosure that may be used by taxpayers employing the last-in, first-out (LIFO) inventory method as described in section 472 of the Internal Revenue Code of 1954 in the taxable year in which a LIFO layer is penetrated.

The expanded guidelines in this Revenue Procedure permit a taxpayer to make the disclosure in various types of annual reports, news releases, and statements. Further, under the expanded guidelines, a taxpayer is permitted to show the effect of the penetration on the cost of goods sold as well as on income.

Sec. 2. Background

Section 472(e) of the Code states, in part, that a taxpayer who elects the LIFO method must use such method for all subsequent taxable years unless the Secretary determines that the taxpayer has used for any such subsequent year some procedure other than the LIFO method to ascertain the income, profit, or loss of such subsequent taxable year for the purpose of a report or statement covering such taxable year to shareholders, partners, or other proprietors, or beneficiaries, and requires a change to a method different from LIFO, beginning with such subsequent taxable year or any taxable year thereafter.

Sec. 3. Application

.01 Sequential layering is inherent in the LIFO method. In a taxable year in which inventories are reduced, this reduction may result in a penetration of LIFO inventory carried at costs prevailing in prior years. As a result of the penetration of a LIFO layer, income for the taxable year in which the penetration occurs may be significantly increased.

.02 A written or oral statement, such as a footnote in the annual financial statement, that discloses the effect on net income as a result of the penetration of a LIFO layer is considered a violation of the conformity requirement of section 472(e) of the Code. Nevertheless, the Internal Revenue Service, under the discretionary authority contained in section 472(e), will not terminate a taxpayer's LIFO election solely because of such disclosure.

.03 The computations made to determine the income effect of a penetration of a LIFO layer must be made on the same basis employed by the taxpayer in actually valuing its LIFO increments. For example, if the taxpayer actually values inventory increments on the basis of the average cost method, such method must also be used in determining the effect on income as a result of the penetration for purposes of the disclosure statement.

.04 The disclosure permitted in section 3.02 may be reflected in annual financial statements for the year in which the penetration occurs or in other annual reports of earnings for such year such as news releases, reports to creditors, the president's letter section of annual financial statements, or oral and written statements at stockholders' meetings and security analysts' meetings, etc., provided that in any such annual report, the earnings are based upon the LIFO method.

.05 For purposes of the disclosure permitted in section 3.02, an explanatory statement describing the inventory methods utilized, the type(s) of raw materials or commodities purchased, and/or an explanation of the economic conditions that gave rise to the liquidation of LIFO layers is permissible. In addition, language similar to the following is acceptable to the Service:

During 197___, inventory quantities were reduced. This reduction resulted in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of 197___ purchases, the effect of which decreased cost of goods sold by approximately $XXX and increased net income by approximately $XX or $X per share.

Sec. 4. Effect On Other Documents

This Revenue Procedure supersedes Rev. Proc. 76-7.