Overview
This lecture covers key differences between tax and GAAP accounting methods for inventory, cost capitalization, bad debts, and the adoption or change of accounting methods.
Inventory and Cost of Goods Sold
- Tax and GAAP both allow LIFO, FIFO, or specific identification for inventory valuation.
- LIFO conformity rule: If you use LIFO for tax, you must use it for GAAP.
- In periods of rising prices, LIFO results in lower reported income; FIFO results in higher reported income.
- Universal Capitalization ("UNICAP") rules (Section 263A) require capitalization of certain indirect costs for tax, even if expensed under GAAP.
- UNICAP affects only timing; the expense is recognized when the inventory is sold.
Fixed Assets
- Depreciation methods may differ between tax and GAAP, affecting timing of expense recognition.
Bad Debts
- GAAP allows an allowance method to estimate bad debts; tax requires actual charge-off of specific receivables.
- Reserves or allowances (e.g., for warranties) are not deductible for tax purposes.
Related Party Transactions
- Special rules apply (previously covered), affecting deductibility and recognition of certain items.
Accounting Methods: Adoption and Change
- Accounting methods address the timing of income or deductions, not their character.
- Adoption of a permissible method occurs on the first return; adoption of an impermissible method requires using it on two returns.
- Correcting an impermissible method before the second return requires only an amended return.
- Changing methods requires IRS approval.
- If the change increases income, report it evenly over four years.
- If the change benefits the taxpayer (e.g., increased deductions), take it all in the year of change.
Key Terms & Definitions
- LIFO (Last-In, First-Out) — Inventory method where latest goods purchased are the first expensed/sold.
- FIFO (First-In, First-Out) — Inventory method where earliest goods purchased are the first expensed/sold.
- Specific Identification — Inventory method matching costs to specific items sold.
- UNICAP (Section 263A) — Tax rule requiring capitalization of certain indirect costs into inventory.
- Allowance Method — GAAP method estimating uncollectible accounts.
- Charge-off Method — Tax rule requiring direct write-off of specific bad debts.
- Accounting Method — Refers to the timing of income/expense recognition.
Action Items / Next Steps
- Read Chapter 9, focusing on mixed-use issues and examples.
- Practice using the accounting method matrix in preparation for exams.
- Review examples in the reading to reinforce key concepts.