Key Takeaways
- Inventory required if merchandise is material income-producing factor.
- Small Business Taxpayer (Tax Year 2024: $30M): exempt from §471 inventory rules.
- LIFO Conformity Rule: must use LIFO for financial reports if used for tax.
- LIFO: lower income in inflation. FIFO: higher income in inflation.
- LCM prohibited with LIFO.
- UNICAP (§263A): capitalize direct and indirect costs into inventory.
Last updated: January 2026
Inventory & COGS
Why This Matters for the Exam
Inventory rules are tested extensively. Know LIFO vs. FIFO effects, the conformity rule, and UNICAP exemptions.
Expect at least 3-4 questions on inventory.
Who Must Use Inventory?
| Rule | Description |
|---|---|
| General | If merchandise is material income factor |
| Exception | Small Business Taxpayer exempt |
Small Business Taxpayer Inventory Exception
| Tax Year | Threshold | Treatment |
|---|---|---|
| Tax Year 2024 | $30M | Treat as non-incidental materials |
| 2025 | $31M | Deduct when paid or used |
Inventory Valuation Methods
| Method | Description |
|---|---|
| Cost | Invoice price + freight, less discounts |
| Lower of Cost or Market (LCM) | Compare cost to replacement cost |
| Retail Method | Estimate based on selling price |
LIFO vs. FIFO (Inflation)
| Method | Ending Inventory | COGS | Taxable Income |
|---|---|---|---|
| FIFO | Higher | Lower | Higher |
| LIFO | Lower | Higher | Lower |
LIFO Conformity Rule
| Rule | Requirement |
|---|---|
| If LIFO for tax | Must use LIFO for financial statements |
| Applies to | Reports to shareholders, creditors |
| No exceptions | Cannot use FIFO for bank, LIFO for IRS |
LCM Prohibition with LIFO
| Rule | Description |
|---|---|
| LCM | Prohibited with LIFO |
| Reason | Prevents "double benefit" |
UNICAP (§263A)
| Rule | Description |
|---|---|
| Requires | Capitalize direct + indirect costs |
| Applies to | Production, resale activities |
| Exempt | Small Business Taxpayer ($30M) |
UNICAP Costs to Capitalize
| Include | Exclude |
|---|---|
| Direct materials | Marketing |
| Direct labor | R&D |
| Utilities (production) | Selling expenses |
| Indirect labor | Distribution |
| Insurance (production) |
Real-World Scenario
Scenario: Hardware store ($25M receipts) wants LIFO for tax. Bank requires FIFO statements.
- LIFO Conformity: If use LIFO for tax, must use for bank.
- Result: Cannot use LIFO for tax if bank requires FIFO.
On the Exam
Expect 3-4 questions on inventory, typically:
- LIFO/FIFO Questions: "Which method = lower tax in inflation?"
- Conformity Questions: "What is LIFO Conformity Rule?"
- UNICAP Questions: "Which costs are capitalized?"
The key is to remember: LIFO = lower tax in inflation. LIFO Conformity = must match financial reports. LCM prohibited with LIFO. Small Business ($30M) exempt from UNICAP.
Test Your Knowledge
LIFO for tax—what is required for financial statements?
A
B
C
D
Test Your Knowledge
Rising prices (inflation). Which method = lowest taxable income?
A
B
C
D
Test Your Knowledge
$50M manufacturer. Which UNICAP cost must be capitalized?
A
B
C
D