Internal Revenue Service

Attn: CC:PA:LPD:PR (Notice 2005-25)

Room 5203

P.O. Box 7604

Ben Franklin Station

Washington, DC 20044

Re: Notice 2005-25, Use of Rolling Average Cost

Dear Sir or Madam:

The American Institute of Certified Public Accountants (AICPA) is submitting comments regarding the government's intent to issue guidance addressing the use of rolling average cost in response to Notice 2005-25's request for public comments on the IRS and Treasury Priority Guidance Plan.

The section 471 regulations indicate that the most common inventory valuation methods that meet the requirements of section 471 are: (1) cost; and (2) cost or market, whichever is lower. [Reg. section 1.471-2(c).] The section 471 regulations also define cost to include a reasonable approximation of cost. [Reg. section 1.471-3(d).] The section 472 regulations allow a taxpayer using the last-in, first-out (LIFO) method to determine current year cost using most recent purchases, average cost, earliest acquisition cost, or any other proper method. [Section 1.472-8(e)(2)(ii).] Rev. Rul. 71-234 and Rev. Rul. 77-480 hold that the determination of average cost under sections 471 and 472, respectively, may not consider costs incurred prior to the beginning of the year (a "rolling average cost").

At the time that these rulings (and the letter rulings on which they were based) were first issued, taxpayers' inventory costing systems were less sophisticated. As a result, it was not uncommon to find that when an inventory system averaged costs, the averaging process took place infrequently, sometimes only once a year. In those circumstances, in periods of rapidly increasing prices, it was possible for the cost of the items in the ending inventory under a rolling average cost method to be lower than any cost incurred in the current year. The IRS originally rejected the rolling average cost method for this reason.

In contrast, today's cost accounting systems are much more sophisticated, typically averaging acquisition costs very frequently, sometimes after every acquisition. Under these circumstances, the weight accorded to the costs incurred in prior years is so slight that the ending inventory cost more nearly approximates first in, first out (FIFO).

Unfortunately, because the number of inventory costing systems employing a rolling average cost is proliferating, the ban on using a rolling average cost method in Rev. Rul. 71-234 and Rev. Rul. 77-480 poses significant and, in our view, unwarranted exposure for taxpayers with such systems.

In Rev. Proc. 2002-17 and Rev. Proc. 2006-14, the IRS allowed the use of a replacement cost method for certain taxpayers because replacement cost approximated their actual cost. Because rolling average cost also can approximate actual cost, the IRS and Treasury should reconsider Rev. Rul. 71-234 and Rev. Rul. 77-480 to allow the use of rolling average cost whenever it approximates actual cost consistent with the holdings of Rev. Proc. 2002-17 and Rev. Proc. 2006-14.

These comments were developed by members of our Tax Accounting Technical Resource Panel and approved by the AICPA Tax Executive Committee. If you have any questions, please contact me at tpurcell@creighton.edu; or Christine Turgeon, Chair, AICPA Tax Accounting Technical Resource Panel, at christine.turgeon@us.pwc.com; or George White, AICPA Technical Manager, at gwhite@aicpa.org.

Sincerely,

Thomas J. Purcell III

Chair, AICPA Tax Executive Committee