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II. Statute and Principal Regulation
Section 471(a) provides the following general rule:
Whenever in the opinion of the Secretary the use of
inventories is necessary in order clearly to determine
the income of any taxpayer, inventories shall be taken
by such taxpayer on such basis as the Secretary may
prescribe as conforming as nearly as may be to the best
accounting practice in the trade or business and as
most clearly reflecting the income.[2]
As the regulations point out, section 471(a) establishes two
distinct tests to which an inventory must conform:
(1) It must conform as nearly as may be to the
best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
Sec. 1.471-2(a), Income Tax Regs.
In accordance with the authority provided by section 471(a),
the Secretary has promulgated rules for taxpayers maintaining a
perpetual (book entry) system of keeping inventories. In
pertinent part, section 1.471-2(d), Income Tax Regs., reads as
follows:
Where the taxpayer maintains book inventories in
accordance with a sound accounting system in which the
respective inventory accounts are charged with the
actual cost of the goods purchased or produced and
credited with the value of goods used, transferred, or
sold, calculated upon the basis of the actual cost of
the goods acquired during the taxable year * * * the
net value as shown by such inventory accounts will be
deemed to be the cost of the goods on hand. The
balances shown by such book inventories should be
2 The Tax Reform Act of 1986, Pub. L. 99-514, sec. 803(b)(4),
100 Stat. 2356, designated the quoted language as sec. 471(a).
Before amendment, the quoted language was the entirety of sec.
471.
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