Wiley GAAP 2008

Differences between GAAP and Income Tax Accounting for Inventories

Full absorption costing—income tax

Prior to the Tax Reform Act of 1986 (TRA 1986), production costing for GAAP and for income tax purposes were very similar. However, TRA 1986 included provisions referred to as Uniform Capitalization (UNICAP) which changed inventory costing for income tax purposes by requiring certain additional indirect costs that are not capitalizable under GAAP be capitalized rather than expensed for income tax purposes. TRA 1986 requires that manufacturers capitalize rather than expense these additional items:

1. Depreciation and amortization in excess of that reported in financial statements.

2. Percentage depletion in excess of cost.

3. Rework labor, scrap, and spoilage costs.

4. Allocable general and administrative costs related to the production function.

For income tax purposes, these costs, as well as the indirect production costs listed above for inventory costing under GAAP, are allocated to the WIP and finished goods inventories. Examples of general and administrative costs that must be allocated include payroll department costs, wages of security guards, and the president's salary. The difference between the GAAP and tax inventory carrying values is a temporary difference, which requires deferred income tax accounting (discussed in Chapter 17).

Uniform capitalization rules—income tax vs. GAAP

TRA 1986 established the UNICAP rules for inventory costs for tax purposes. The Emerging Issues Task Force ...