Accounting for Automotive Inventory

Automotive Inventory 

Automotive dealerships are inventory-driven enterprises managed by accurately measuring inventories against expenses and revenue using Last-In, First-Out [LIFO], or Specific Identification valuation methods. 

⇒ Financial Statements, forecasts, projections, and cash-flow decisions are based on inventory and accounting information.

Inventory Accounting Methods

⇒ Dealerships have broad discretion in selecting inventory accounting methods.

⇒ Sometimes the methods are adapted and developed for specific purposes.

⇒ Different inventory categories require other accounting methods to accurately reflect the dealership’s income.

⇒ Dealerships employ different methods for new vehicles, used vehicles, and spare parts, and procedures for the same vary from branch to branch or entity to entity.

⇒ Efficient inventory management is not a one-size-fits-all formula.

⇒ Unpredictable supply and demand require tight inventory controls to manage tied-up and available working capital efficiently.

⇒ Tight controls are also a prerequisite for exploring new channels to meet consumer demand that can satisfy the financial and operational needs of the enterprise.

Last-in, First out (LIFO)

Dealerships use LIFO to report lower profits and defer income tax, resulting in lower income tax liabilities. 

LIFO requires data collection and clerical work, which is time-consuming and costly. However, the costs should be weighed against the expected deferral of income at the lowered tax rates through TCJA legislation. As a result, multi-entity dealerships with high-volume sales typically derive significant LIFO advantages. 

⇒ LIFO assumes that the last item sold will always be the first item sold.

⇒ As a result, more expensive recently purchased vehicles are recorded in Cost of Sales while inventory balance is based on earlier, lower costs.

⇒ Cost and revenue are accurately matched, while material costs are entirely recovered.

⇒ LIFO is a popular method among car dealerships.

⇒LIFO brings additional tax considerations for C corporations considering an S corporation conversion.

⇒ Exposure to BIG tax [Corporate-Level Built-In-Gains Tax] payable in four installments over four years.

⇒ Potential increase in the Cost of Sales

⇒ Loss of the ability to shift the weight of future tax liabilities and the ability to open cash-flow channels.

Smaller dealerships in periods of low inflation can benefit from LIFO despite reduced inventory. However, with rising inflation and significant reductions in stock, the selection of appropriate inventory methods is critical.

New Vehicle Alternative LIFO Inventory Method (ALM)

ALM accounts for inflation on an individual vehicle model level. As a result, it provides the most beneficial inventory valuations. 

⇒ Designed for auto dealers using the LIFO method to calculate new car or new light-duty truck inventory values

⇒ Since it requires no annual comparability adjustments, it simplifies dollar-value accounting.

Inventory Price Index Computation (IPIC) Method for Calculating Inflation

Bookkeepers can simplify inventory valuation for car dealerships using the IPIC method to compute inflation for LIFO using the pricing indexes published by the US Bureau of Labor Statistics [BLS].    The car dealerships determine base year prices for opening and closing inventory values. IPIC will often reduce the error margin for inflation calculations because it calculates inflation using the inventory, resulting in lower deductions.

Specific Identification Method [SIM] Car Dealership Accounting

The SIM is a more accurate valuation method when tracking the actual costs of goods sold against the inventory. 

⇒ This is useful for car dealerships that can track inventory items individually using RFID tags and serial or stock numbers.

⇒ The SIM can match cost to revenue very accurately.

⇒ Accountants for car dealerships using this method will typically use cost or market replacement costing methods, whichever is the lowest.

⇒ SIM can simplify the dishonest manipulation of ending inventory numbers to produce tax benefits.

Lower of Cost or Market (LCM) Inventory Method

The LCM is especially useful when valuing inventory that can quickly lose value. Stock can be written down in alignment with replacement cost by recording the purchase price or the market value, whichever is lower. 

⇒ It assumes that selling prices will fall when purchase prices go down.

⇒ Car dealerships can declare losses for stock sold below net realizable value during the period they occurred.

⇒Car dealerships can adjust their year-end inventory value:

⇒ Because year-end valuation procedures use average wholesale values for individual items.

⇒ When individual items fall below their recorded cost, the year-end inventory is reduced.

⇒ As a result, the Cost of Sales goes up, and taxable income goes down.

Addressing Taxation and Compliance in Dealerships

Dealerships encounter distinct tax challenges and must adhere to accounting regulations to prevent fines and protect their reputation.

Tax Challenges in the Automotive Sector

Dealerships deal with industry-specific taxes, including sales, payroll, and inventory taxes. Utilizing tax professionals familiar with the dealership industry can offer crucial guidance and assure regulatory adherence.

Adhering to Accounting Standards

It’s important for dealerships to keep up with accounting norms, such as those set by the Financial Accounting Standards Board (FASB), to guarantee precise financial reports and maintain stakeholder trust.

Incorporating Technology for Efficiency

The accounting field has been reshaped by digital advancements, allowing dealerships to enhance operations and efficiency.

Benefits of Specialized Accounting Software

Software designed for dealership accounting can provide comprehensive features like inventory control, financial reporting, and analysis of real-time data. Adopting such software can increase efficiency, minimize errors, and support informed decision-making.

Advancing with Automation

Incorporating automation, including machine learning and robotic process automation, can transform dealership accounting by streamlining repetitive tasks, cutting costs, and allowing focus on strategic goals.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services.  This article cannot serve as a substitute for such professional services or advice.  Any decision or action that may affect the reader’s business should not rely solely on the contents of this article but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation.  This article is subject to change at any time and for any reason.