Rev. Proc. 76-7

Section 1. Purpose.

The purpose of this Revenue Procedure is to set forth a type of footnote disclosure in annual financial statements that may be made 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.

Sec. 2. Background.

Section 472(e) of the Code states that a taxpayer who elects the LIFO method must use such method for all subsequent taxable years unless the Secretary or the Secretary's delegate 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, etc. 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 quantities 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 footnote in the annual financial statement that discloses the effect on net income as a result of the penetration of a LIFO layer is a departure from sequential layering, which is a part of the LIFO method, and therefore is considered a violation of the conformity requirement of section 472(e). 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 financial statement footnote.

.04 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 which 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 increased net income by approximately $XXX or $X per share.

¹ Also released as TIR-1434, dated Jan. 19, 1976.