Mixed Service Inventory Costs

Jenny L. Meyer, MBA, CPA/ABV

We recently detailed some of the basics of the uniform capitalization rules under IRC Sec. 263A.  This code section requires that certain costs normally expensed be capitalized into inventory.  One of the cost components that must be considered are mixed service costs.  All companies have departments that perform administrative, service or support activities that are necessary for the overall operation of the company.  These departments are not directly involved in the manufacturing process, but they do benefit and support the manufacturing department operations and therefore are subject to UNICAP.  Some examples of these mixed service departments: 

• Accounting
• Human Resources
• Legal Services
• Technology
• Warehouse and Storage 

Each year when determining the 263A adjustment for tax purposes, an allocation of these mixed service costs must be included. So how do you determine how much of these costs to allocate?  A taxpayer could develop their own reasonable allocation method based on factors or relationships that reasonably relate the mixed service department costs to the benefits received.  Measures based on the total output of each department (i.e. number of hours provided to a department as a fraction of the total number of service hours provided to all departments) are acceptable. 

The IRS has also approved a simplified service cost method of allocating these expenses.  With this method, the production mixed service costs equal: 

Total production costs for the year (excluding mixed service costs and interest)              Total Mixed
Total business costs (excluding mixed service costs, interest and income taxes)        X        Service Costs 

The result is included with your additional 263A costs when you complete your UNICAP calculations. 

Mixed service costs are an important component and should not be overlooked when analyzing total inventory costs to capitalize.  These costs and the allocation should be reviewed annually when you calculate your 263A adjustment.

What Is UNICAP All About?

Jenny L. Meyer, MBA, CPA/ABV, Senior Manager, Tax

You may have heard the terms UNICAP or 263A, but what does it mean?  IRC Section 263A details the uniform capitalization rules that require certain costs normally expensed be capitalized as part of inventory for tax purposes.  These rules apply to: (1) real or tangible personal property produced by the taxpayer, and (2) real or personal property acquired by the taxpayer for resale.  

There are a few exceptions to this rule.  If a taxpayer is allowed to use the cash method of accounting, they are not required to apply these capitalization rules.  Another allows resellers whose average annual gross receipts for the three previous tax years do not exceed $10 million to be exempt from this rule.  

So if you don’t meet an exception, you must look at what costs to capitalize.  Costs include:

1. Direct Costs – direct material costs that become an integral part of the property and direct labor costs.  These normally would already be included in inventory.
2. Indirect Costs – all costs that are not direct but directly benefit or are incurred by production activities.
3. Service Costs – a type of indirect cost that can be identified specifically with a service department.  These are usually general and administrative expenses. 

Once the costs are identified, the taxpayer must determine what adjustment must be added to ending inventory for tax purposes.  To minimize the burden of these rules, many taxpayers use the simplified production method. The first step is to calculate the absorption ratio – which is the additional 263A costs (those costs identified that are not already included in inventory for book purposes) divided by total inventory costs (Section 471 costs).  This ratio is then multiplied by total ending inventory resulting in the UNICAP adjustment.  This adjustment is then added to the ending inventory resulting in the ending tax inventory reported on your tax return.  

These rules apply to many taxpayers and must be included in the year-end tax preparation.  Your tax preparer should assist in making these calculations and complying with the rules of IRC Section 263A.

Manufacturing Growth Slows In October, but There Was Some Good News

Jon K. Waitukaitis, CPA, Audit Manager

US manufacturing growth weakened in October as exports, factory production, and inventories declined.  However, despite the slower of pace of growth, it marked the 27^th straight month of continued expansion in this key sector as well as the 29^th consecutive month of expansion in the national economy. 

The Institute for Supply Management (ISM) reported that activity in the manufacturing sector dipped down to 50.8 from 51.6 in September, despite expectations that this metric would improve to 52.1.  A score above 50.0 indicates expansion, while a score of 50.0 or below signals contraction.  The small drop in the ISM index is mainly the result of from declining production (dipped to 50.1 from 51.2), inventories (dipped to 46.7 from 52.0), and exports (dipped to 50 from 53.5).  

However, there is some good news in that the new orders index (a signal of future demand) rose to 52.4 from 49.6.  In addition, prices paid for raw materials and supplies dropped to 41.0 from 56.0, the lowest point since April 2009.  The drop in prices is a relief for manufacturers who’ve had to deal with high commodity prices this year.  It also suggests that earlier concerns this year about inflation might be unfounded. 

Overall, the decline in the index supports other economic reports that the manufacturing sector has cooled off after an extended period of rapid growth.  No doubt contributing to slowdown has been the political turmoil in the US and the debt crisis in Europe.

Factory Output on the Rise

Jon K. Waitukaitis, CPA, Audit Manager

The US manufacturing sector has been one of the keys to our economic recovery since the recession hit in 2008.  And while 2011 has seen its share of slumps, there are signs that manufacturing is starting to gather momentum yet again. 

Factory output increased 0.5 percent in October, the fourth straightly monthly gain.  The auto industry recovery has played a primary role in improvement of factory activity.  

Supply chain disruptions from the earthquake and tsunami that hit Japan earlier this spring coupled with high fuel costs caused a slow-down in factory activity earlier this year.  Now that the crisis in Japan has faded a bit, the supply chains are flowing more freely – a welcomed relief from many US auto plants who depend on Japanese parts.  In addition, consumer demand is up.  In October, car sales increased 7 percent over the same month last year so there has been some reduction in inventory. 

Optimism for a better 2012 is playing a role as well.  Many manufacturers are anticipating increased demand, boosted by the foreign sector, causing considerations for capital investments.  The demand from overseas is a situation expected to continue on for some time, especially while the Fed is focused on the need to bolster the economy – keeping the dollar weak. 

Still, the outlook remains mixed for many, consumers may not be able to sustain their spending growth if unemployment remains high and Europe may be on the brink of another recession, dragged down by their debt crisis.  In addition, other reports suggest the manufacturing sector is growing at more of a slow and steady pace.  The Institute for Supply Management’s (ISM) index slipped in October down to 50.8 from 51.6 in September.  However, even with the small decline, the ISM reading marked the 27^th consecutive month of growth for the manufacturing sector.

Financial Accounting Foundation Announces Webcast, Roundtables on Private Company Plan

Jon K. Waitukaitis, CPA, Audit Manager

The Financial Accounting Foundation (FAF) announced it will sponsor a November 18 webcast and three roundtables in early 2012 on the Request for Comment Plan to Establish the Private Company Standards Improvement Council. 

The Plan was published in early October and is now out for comment until January 14, 2012.  

The FAF’s proposal is to create a Private Company Standards Improvement Council (PCSIC) to replace the Private Company Financial Reporting Committee, which is jointly sponsored by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA).  The PCSIC would propose modifications to U.S. GAAP for the FASB to consider. 

Under the FAF’s proposal, the PCSIC would comprise a chairman and 11-15 members.  The chairman would be a member of the FASB.  PCSIC members would be selected and appointed by the Trustees.  Members would include users, preparers, and practitioners who have significant experience with private company financial statements.  In addition, all seven FASB members would attend its 4-6 annual meetings at FASB headquarters in Norwalk, CT.  PCSIC meetings would be webcast and open to the public, except for discussions of an administrative nature.    

A full copy of the FAF’s proposal can be found here