SECTION 9. INVENTORIES — Internal Revenue Bulletin 2002-3

.01 Cash discounts

(1) Description of change and scope . This change applies to a taxpayer that wants to change its method of accounting for cash discounts (discounts granted for timely payment) when they approximate a fair interest rate, from a method of consistently including the price of the goods before discount in the cost of the goods and including in gross income any discounts taken (the “gross invoice method”), to a method of reducing the cost of the goods by the cash discounts and deducting as an expense any discounts not taken (the “net invoice method”), or vice versa. See Rev. Rul. 73–65 (1973–1 C.B. 216). (2) Computation of § 481 adjustment for changes to net invoice method . In the case of a taxpayer changing from the gross invoice method to the net invoice method, a negative adjustment must be made to prevent duplications arising from the fact that the gross invoice method reported income upon timely payment for some or all of the goods that remain in inventory, and a positive adjustment must be made to prevent omissions arising from the fact that the gross method included the invoice price, unadjusted for the cash discounts, of some or all goods in cost of goods sold and the discount will be earned by payment in a subsequent taxable year. The net § 481 adjustment can be computed by deducting the “Applicable Discount” at the beginning of the year of change from the “Available

Discount” at the beginning of the year of change. The Available Discount is equal to the difference between the accounts payable balance under the gross invoice method and the net invoice method. The Applicable Discount is equal to the difference between the beginning inventory value under the gross invoice method and the net invoice method.

Example . Taxpayer’s accounts payable balance at the beginning of the year of change was $1,000x under the gross invoice method and $980x under the net invoice method. Taxpayer’s inventory value was $3,000x under the gross invoice method and $2,955x under the net invoice method. The Available Discount is $20 ($1,000x - $980x) and the Applicable Discount is $45 ($3,000x - $2,955x). Thus, Taxpayer’s net § 481(a) adjustment is a negative $25 ($20 - $45).

(3) Computation of § 481 adjustment for changes to gross invoice method . In the case of a taxpayer changing from the net invoice method to the gross invoice method, a positive adjustment must be made to prevent omissions arising from the fact that the net invoice method did not report income upon timely payment for some or all of the goods that remain in inventory, and a negative adjustment must be made to prevent duplications arising from the fact that the net method included the invoice price, adjusted for the cash discounts, of some or all goods in cost of goods sold and the discount will be earned by payment in a subsequent taxable year. The net § 481 adjustment can be computed by deducting the “Applicable Discount” at the beginning of the year of change from the “Available Discount” at the beginning of the year of change. The Available Discount is equal to the difference between the accounts payable balance under the gross invoice method and the net invoice method. The Applicable Discount is equal to the difference between the beginning inventory value under the gross invoice method and the net invoice method.

Example . Taxpayer’s accounts payable balance at the beginning of the year of change was $980x under the net invoice method and $1,000x under the gross invoice method. Taxpayer’s inventory value was $2,955x under the net invoice method $3,000x under the gross invoice method. The Applicable Discount is $45 ($3,000x — $2,955x) and the Available Discount is $20 ($1,000x - $980x). Thus, Taxpayer’s net § 481(a) adjustment is a positive $25 ($20 - $45).

(1) Description of change and scope . This change applies to a taxpayer that

.02 Estimating inventory “shrinkage” .

January 22, 2002 367 2002–3 I.R.B.

wants to change to a method of accounting for estimating inventory shrinkage in computing ending inventory, using:

(a) the “retail safe harbor method” described in section 4 of Rev. Proc. 98–29 (1998–1 C.B. 857); or (b) a method other than the retail safe harbor method, provided (i) the taxpayer’s present method of accounting does not estimate inventory shrinkage, and (ii) the taxpayer’s new method of accounting (that estimates inventory shrinkage) clearly reflects income under § 446(b).

(2) Scope limitations inapplicable . A taxpayer that wants to make this change is not subject to the scope limitations in section 4.02 of this revenue procedure.

(3) Additional requirements . If the taxpayer wants to change to a method of accounting for inventory shrinkage other than the retail safe harbor method, the taxpayer must attach to the application a statement setting forth a detailed description of all aspects of the new method of estimating inventory shrinkage (including, for LIFO taxpayers, the method of determining inventory shrinkage for, or allocating inventory shrinkage to, each LIFO pool).

(4) Audit protection . A taxpayer, whose present method of accounting estimates inventory shrinkage, does not receive audit protection under section 7 of this revenue procedure in connection with a change to the retail safe harbor method if, on the date the taxpayer files a copy of the Form 3115 with the national office, the taxpayer’s present method of estimating inventory shrinkage is an issue under consideration within the meaning of section 3.09 of this revenue procedure.

(5) Future change . A taxpayer that changes to the retail safe harbor method described in Rev. Proc. 98–29 will not be precluded, solely by reason of such change, from changing to another safe harbor method for estimating inventory shrinkage in computing ending inventory in the first year that such other safe harbor method is available.

.03 Small taxpayer exception from requirement to account for inventories under § 471 .

(1) Description of change . This change applies to a taxpayer (other than a taxpayer described in § 448(a)(3)) with “average annual gross receipts” (as

(a) The change is made using a cutoff method relative to payments made or received with respect to floor stocks on or before February 26, 2001. See section 2.06 of this revenue procedure. (b) A taxpayer making this change should clearly indicate on its application, or in an attachment thereto, if it is elect

defined in section 5.01 of Rev. Proc. 2001–10, 2001–2 I.R.B. 272) of $1,000,000 or less that wants to change from a method of accounting for inventoriable items (including, if applicable, from the method of capitalizing costs under § 263A) to the method described in Rev. Proc. 2001–10 for treating inventoriable items in the same manner as materials and supplies that are not incidental under § 1.162–3.

(2) Scope limitations inapplicable . The scope limitations in section 4.02 of this revenue procedure do not apply to this change.

(3) Manner of making the change . Taxpayers making this change should consult Rev. Proc. 2001–10 for additional guidance on the computation of the § 481(a) adjustment and the completion of the application.

(4) Automatic changes to the cash method under Rev. Proc. 2001–10 . A taxpayer desiring to make both this change and the change to the overall cash method under Rev. Proc. 2001–10 (see section 5.05 of the APPENDIX of this revenue procedure) may file a single application for both changes.

.04 “Floor stocks” payments made or received .

(1) Description of change and scope . This change applies to a taxpayer that wants to change its method of accounting for payments made or received with respect to “floor stocks” to conform with the holding of Rev. Rul. 2001–8 (2001–9 I.R.B. 726), or to elect the simplifying assumption regarding goods on hand set forth in Rev. Rul. 2001–8.

(2) Requirements . This change may only be made for the first taxable year in which payments are made or received with respect to floor stocks subsequent to February 26, 2001.

(3) Scope limitations inapplicable . The scope limitations in section 4.02 of this revenue procedure do not apply to this change.

ing to use the simplifying assumption of Rev. Rul. 2001–8 to identify the goods physically held on the floor stocks date for costing purposes.

.05 Qualifying volume-related trade discounts .

(1) Description of change and scope . This change applies to a taxpayer that wants to change its method of accounting to treat qualifying volume-related trade discounts as a reduction in the cost of merchandise purchased at the time the discount is recognized in accordance with § 1.471–3(b). A “qualifying volumerelated trade discount” means a discount satisfying the following criteria:

(a) the taxpayer receives or earns the discount solely as the result of the purchase of the merchandise to which the discount relates;

(b) the taxpayer is neither obligated nor expected to perform or provide any services in exchange for the discount; and

(2) Section 481 adjustment . The net § 481 adjustment attributable to the change is computed in a manner similar to the computation of a net § 481 adjustment in the case of a change to the net invoice method of accounting for cash discounts. See section 9.01(2) of the APPENDIX.

.06 Impermissible methods of valua- tion . This change applies to a taxpayer changing a method of accounting to restore a writedown or discontinue maintaining a reserve specifically described within § 1.471–2(f).