The Internal Revenue Service has reversed itself on the rolling-average method of valuing inventory and will now consider it valid for tax purposes.

The IRS has traditionally viewed rolling-average inventory valuation as a method of accounting that does not clearly reflect income, especially when inventory is held for several years or costs fluctuate substantially. However, many industries consider the rolling-average method an accurate estimate of costs and use it for financial statements.

The IRS issued Revenue Procedure 2008-43, saying it will generally view the rolling-average method as clearly reflecting income for federal income tax purposes. The IRS said it now recognizes that using a rolling average for financial statement purposes can produce an accurate approximation of costs. The revenue procedure provides two safe harbors under which a taxpayer's rolling-average method is deemed to clearly reflect income. It also outlines the procedures a taxpayer can use to obtain automatic consent to change to a rolling-average method.

However, if inventory is held for several years or costs fluctuate substantially, a rolling-average cost method may or may not clearly reflect income, depending on the particular facts and circumstances, the IRS cautioned. In addition, if a taxpayer does not use a rolling-average method for financial accounting purposes, then the rolling-average method may not accurately determine costs or clearly reflect income for federal income tax purposes.

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