Update on Use of Cash Method    

In "Rev. Proc. 2000-22 Allows Certain Taxpayers to Use Cash Method," TTA, December 2000, p. 870, Christopher Hesse of the AICPA's Tax Accounting Technical Resource Panel provided information on Rev. Proc. 2000-22, on certain taxpayers' ability to use the cash method of accounting.

On Dec. 7, 2000, the IRS issued Rev. Proc. 2001-10, which modifies and supersedes Rev. Proc. 2000-22. The significant changes to Rev. Proc. 2000-22 are disclosed in Section 2.09 and include:

• Section 3 of Rev. Proc. 2000-22 is modified to clarify that the use of the cash method for taxpayers with average annual gross receipts of less than $1 million does not apply to taxpayers described in Sec. 448(a)(3) (defining "tax shelters").
• Section 4.02 is added to clarify the proper time to account for the cost of inventoriable items, such as merchandise purchased for resale and raw materials purchased for use in producing finished goods. Such items are treated as materials and supplies not incidental under Regs. Sec. 1.162-3. Materials and supplies treated as not incidental are consumed and used in the year in which a taxpayer sells the merchandise or finished goods. Such inventoriable items are deductible only in that year; if the taxpayer actually pays for the inventoriable items in a later year, the cost is deductible in the later year.
• The conformity requirement of Section 5.07 has been removed.
• The automatic consent provisions of Section 6.02 have been revised. Rev. Proc. 2001-10 clarifies that taxpayers that do not currently account for inventories may use the procedure to obtain permission to treat inventoriable items in the same manner as materials and supplies not incidental under Regs. Sec. 1.162-3.
• Section 6.03 of Rev. Proc. 2001-10 provides guidance on the computation of the adjustment required under Sec. 481(a) for automatic changes in accounting methods. This adjustment results from both increases and decreases in account balances (such as accounts receivable, accounts payable, accrued liabilities and inventory).

The most significant change in Rev. Proc. 2001-10 is the elimination of the conformity requirement. This is a positive step by the IRS, in that taxpayers no longer have to fear violating the cash-method-of-accounting exception merely by reporting financial results to management, owners and creditors in accordance with generally accepted accounting principles. CPAs will no longer be placed in the uncomfortable position of recommending upgrades to accounting systems that would force a client to switch to the accrual method. Many accounting software packages automatically compute accrual-basis financial results, as well as cash-basis results. The inadvertent printing of an accrual-basis financial statement may have caused a client/taxpayer to violate the conformity requirement of Rev. Proc. 2000-22. The AICPA applauds the IRS change that eliminated the conformity requirement.