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sale of merchandise is an income-producing factor.” Sec. 1.471-
1, Income Tax Regs.
The determination that a taxpayer must maintain inventories
has two important consequences for the computation of the
taxpayer’s taxable income. First, to the extent that costs
incurred by the taxpayer are reflected in items of inventory
that, at the end of the taxpayer’s taxable year, remain unsold,
such costs will not contribute to the cost of goods sold for that
year and, thus, will result in a correspondingly higher gross
income from sales for the year.2 Second, if a taxpayer is
required to use inventories, then, to reflect its income clearly,
it must use an accrual method of accounting with respect to
purchases and sales of inventory items. See sec. 1.446-
1(c)(2)(i), Income Tax Regs.3 The rationale behind this accrual
requirement is explained in Knight-Ridder Newspapers, Inc. v.
United States, 743 F.2d 781, 789 (11th Cir. 1984) (“According to
accounting wisdom, the income realized from the sale of
2 But cf. sec. 1.471-4, Income Tax Regs. (“Inventories at
cost or market, whichever is lower.”)
3 The taking of inventories does not of itself represent a
separate and distinct method of accounting. As Professor
Chirelstein states: “Rather, it is a component of the over-all
accounting procedure whose essential purpose is to establish the
cost of goods sold as a step towards determination of the
taxpayer’s gross income from business operations.” Chirelstein,
Federal Income Taxation, A Law Student’s Guide to the Leading
Cases and Concepts, par. 12.03 at 269 (8th ed. rev. 1999).
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