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The purpose of maintaining inventories is to assure that the
costs of producing or acquiring goods are matched with the
revenues realized from their sale. Hamilton Indus. v.
Commissioner, 97 T.C. 120, 130 (1991); Rotolo v. Commissioner,
88 T.C. 1500, 1515 (1987). Inventory accounting accomplishes
this by accumulating production or acquisition costs in an
inventory account rather than allowing an immediate deduction for
the costs when they are incurred. When the related goods are
sold, these costs are removed from the inventory account and
recorded as costs of sale, which reduce taxable income for the
year of sale. The matching principle is fundamental to inventory
accounting and is required by the definition of gross income for
a manufacturing or merchandising business. Sec. 1.61-3(a),
Income Tax Regs. An item is not removed from closing inventory
and reflected in cost of goods sold until the income from the
item is realized under the taxpayer's method of accounting.
Accounting for inventories is governed by sections 446 and
471. Section 446(b) provides that the taxpayer's method of
accounting must clearly reflect income in the opinion of the
Secretary. Section 471 provides that inventories shall be taken
on such basis as the Secretary prescribes and establishes "two
distinct tests to which an inventory must conform. First it must
conform 'as nearly as may be' to the 'best accounting practice,'
a phrase that is synonymous with 'generally accepted accounting
principles.' Second, it 'must clearly reflect the income.'"
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