Rev. Proc. 75-10

Section 1. Purpose.

The purpose of this Revenue Procedure is to amplify the provisions of Rev. Proc. 73-37, 1973-2 C.B. 501, relating to last-in, first-out (LIFO) inventories, to take into account recent actions by the Financial Accounting Standards Board (F.A.S.B.) and the Securities and Exchange Commission (SEC) as they relate to financial disclosures in annual reports of taxpayers who are electing to value inventories under the LIFO method in accordance with section 472 of the Internal Revenue Code of 1954.

Sec. 2. Background.

Rev. Proc. 73-37 sets forth the procedure to be used by the Internal Revenue Service in the examination of Federal income tax returns involving the LIFO inventory requirements of section 472(c) of the Code in the year a taxpayer elects to use the LIFO inventory method and for which the principles set forth in Accounting Principles Board Opinion No. 20 (A.P.B. 20) issued by the Accounting Principles Board of the American Institute of Certified Public Accountants in July 1971, require that the income ascertained under the former method of accounting be shown in a footnote to the financial statements. Section 4. of Rev. Proc. 73-37 provides that in the examination of returns, if a taxpayer is required by A.P.B. 20 to show in a footnote to the financial statements its income under the inventory method previously used as a justification for the change to the LIFO inventory method, the LIFO election for tax purposes will not be terminated solely because of the application of A.P.B. 20.

Section 472(c) of the Code and the regulations issued thereunder provide, in effect, that a taxpayer may not use the LIFO inventory method unless he establishes to the satisfaction of the Secretary or his delegate that he has used no procedure other than the LIFO method for purposes of an annual report to shareholders, partners, other proprietors, beneficiaries, or for credit purposes.

Rev. Rul. 74-586, 1974-2 C.B. 156, sets forth the Service position with respect to the types of disclosures that may result in a termination of a LIFO election under the provisions of section 472(c) and (e) of the Code.

A.P.B. 20 deals with changes in accounting principles and their justification. It states that the presumption that an entity should not change an accounting principle may be overcome only if the enterprise justifies the use of an alternative acceptable accounting principle on the basis that it is preferable. For this reason, it requires that the nature of and justification for a change in accounting principle and its effect on income should be disclosed in the financial statements of the period in which the change should explain clearly why the newly adopted accounting principle is preferable.

A.P.B. 28 deals with interim financial reporting and applies the provisions of A.P.B. 20 to a change in accounting practice made during an interim period. It also provides disclosure requirements to be made in interim statements as well as disclosure requirements to be made in an annual report where an accounting change was made in the fourth quarter of a year by a taxpayer who issued interim statements only for the first three quarters that do not reflect the effect of the change.

F.A.S.B. 3, issued on December 31, 1974, amends A.P.B. 28 to provide specific disclosure requirements for both interim statements and annual statements where the LIFO election is made.

Accounting Series Release (A.S.R.) No. 159, issued by the SEC on August 14, 1974, requires a taxpayer subject to SEC requirements to provide in its annual reports a "management's analysis section" explaining changes in accounting principles or in the method of their application that have a material effect on net income as reported.

Rule 3-07 of Regulation S-X requires that a disclosure made in the year of change be repeated at any time the financial statements for that year are subsequently reported. Instructions to registration statements and annual reports filed with the Commission require a summary of operations which includes information or explanation of material significance, including accounting changes. Securities Exchange Act of 1934 Release No. 11079 requires that a five year summary of operations be included in the annual reports to shareholders.

The disclosure requirements of A.P.B. 28, F.A.S.B. 3, A.S.R. 159, Rule 3-07 of Regulation S-X (Rule 3-07), and Securities Exchange Act of 1934 Release No. 11079 (Release No. 11079) go beyond the specific provisions of Rev. Proc. 73-37. Moreover, they could be applicable to taxpayers who are reelecting the LIFO inventory method after previously discontinuing it or taxpayers who are presently using LIFO for a portion of their inventories and who are extending their election in accordance with section 472 of the Code to cover all or a greater portion of their inventories.

Sec. 3. Application.

.01 In the examination of returns of taxpayers who are electing the LIFO method under section 472 of the Code, reelecting such method with the approval of the Secretary or his delegate, or extending an existing LIFO election to cover all or a greater portion of the taxpayer's inventories, the LIFO election will not be terminated for Federal income tax purposes solely because a taxpayer discloses information consistent with the requirements of A.P.B. 20, A.P.B. 28, F.A.S.B. 3, A.S.R. 159, Rule 3-07, and/or Release No. 11079. However, since the above disclosure requirements relate solely to the year in which LIFO is elected, reelected, or extended, the LIFO election of a taxpayer may be terminated for similar disclosures in any subsequent taxable year. In this connection, see Rev. Rul. 74-586 which indicates the type of disclosures that may result in a termination of a LIFO election under section 472.

.02 The disclosures permitted under 3.01 above may be reflected directly or indirectly in annual financial statements for such year, or other annual reports of earnings such as news releases, reports to creditors, presidents' letter section of the annual financial statements, oral and written statements at stockholders' meetings, and security analysts' meetings, etc., provided that in any such annual report the earnings are based upon LIFO and also contain the requisite disclosures under 3.01 above. In this connection see Rev. Rul. 75-49, page 151, which holds that a LIFO election is invalid where a taxpayer issued financial statements for a given taxable year based solely on the FIFO inventory method and later filed its Federal income tax return for such year and attempted to elect the LIFO inventory method for such year.

.03 For purposes of the disclosures permissible under 3.01 above with respect to A.P.B. 20 and A.S.R. 159, language similar to the following is acceptable to the Service:

Footnote in Financial Statements--"The Company has changed its method of accounting for inventories to a last-in, first-out (LIFO) method. This was done because the rapid increase in prices during the year would result in an over-statement of profits if use of the first-in, first-out (FIFO) method were continued since inventories sold were replaced at substantially higher prices. The effect on reported earnings for the year was a decrease of $xxxx, or $xxx per share."

Excerpt in Management's Analysis of Summary of Earnings--"In order not to overstate reported profits as a result of inflation during the year, the company changed its method of accounting for inventory from first-in, first-out (FIFO) to last-in, first-out (LIFO). This was necessary because of the rapid increase in prices in 197X which caused inventories sold to be replaced at substantially higher prices. The effect of the change was to decrease reported earnings by $xxxx, or $xxx per share."

.04 For purposes of 3.01 through 3.03 above, the disclosures permitted by this Revenue Procedure with respect to any taxpayer extending an existing LIFO election under section 472 of the Code shall be strictly limited to the effect on earnings attributable to the portion of the inventory subject to the extension. For example, a taxpayer presently and properly using LIFO for division A and FIFO for division B, who elects to extend the LIFO election to division B may not, under this Revenue Procedure, disclose what the earnings for division A would have been under FIFO or any other inventory method.

.05 For purposes of 3.01 above as it relates to the disclosure in the five year summary of operations under Rule 3-07 and Release No. 11079 of the effect of the change to the LIFO method, such disclosure is strictly limited to the effect on the year of change included in such summary and not for subsequent taxable years. Thus, for example, if a taxpayer changes to LIFO for 1974, the effect of the change on the earnings for 1974 may be reflected in 1974 and the years in which 1974 is included in subsequent annual reports, but the effect of the change on the earnings for 1975 and subsequent years may not be disclosed. See Rev. Rul. 74-586.

Sec. 4. Effect on Other Documents.

Rev. Proc. 73-37 is amplified.

¹ Also released as TIR-1339, dated January 23, 1975.