BIR Ruling [DA-001-01]

January 12, 2001 BIR RULING [DA-001-01] 41, 145 RR2 176-98 KPMG Laya Mananghaya & Co . 22/F Antel 1000 Corporate Centre 139 Valero Street, Salcedo Village Makati City Attention: Atty . Ronald L . Carreon Gentlemen : This refers to your letter dated June 5, 2000 requesting, on behalf of your client, Hui Shung Phils. Corp. (HSPC), for an authority to change its accounting method on inventory costing from "first-in-first-out" to "weighted average" method effective July 1, 2000. It appears that HSPC is a 100% owned subsidiary of Hui Shung Agriculture & Food Corp. (HSAFC). a Taiwanese publicly-listed company; that HSPC is duly registered with the Securities and Exchange Commission (SEC) under SEC Registration No. AS096-001997 dated February 5, 1996; that HSPC is engaged in edible oil manufacturing, feeds processing, livestock farming, agriculture farming and other relevant businesses; that from the time of its incorporation HSPC has consistently adopted the manual basis using the "first-in-first-out" method in costing its inventories; that in order to facilitate early monthly closing of the company's books of accounts HSPC will install computerized cost accounting system; that the computer system to be adopted is IBM AS/400 which recognizes only the "weighted average" costing method; that with such change, the "first-in-first-out" is no longer compatible with said system; that the change will lead to a more accurate indication of HSPC's income and financial position at any given period and further facilitate the early closing of the corporation's books of accounts; that under the "first-in-first-out" method, goods are sold in the order that they are purchased or in "first-come-first-sold basis"; that in said method the inventory is expressed in terms of the latter or recent prices while the cost of goods sold is representative of the older or earlier prices; that the "first-in-first-out" method may result to an improper matching of costs against revenues because the goods sold are stated at earlier or older prices resulting in understatement of cost of sales; that under the "weighted average" method the new unit costs are determined after every purchase, the average unit costs are computed by dividing the balance of costs of goods by the balance of units to get a moving average unit cost; that such cost is then multiplied by the units on hand to get inventory value; that effective July 1, 2000, HSPC will adopt IBM AS/400 as its computerized accounting system; and that the change of accounting system was duly approved by Regional Director Alberto R. Paggabao, Jr. of BIR, Revenue Region No. 4 in its letter permit numbered 005711 dated August 12, 1999. In reply, please be informed that on the basis of the above representations, HSPC is hereby granted permission to change its accounting method of inventory costing from "first-in-first-out" to "weighted average" method pursuant to the provisions of Section 41 of the Tax Code of 1997, in relation to Section 145 of Revenue Regulations No. 2, the pertinent portion of which provide, viz: "Section 41. Inventories Whenever in the judgment of the Commissioner, the use of inventories is necessary in order to determine clearly the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Secretary of Finance, upon the recommendation of the Commissioner, may, by rules and regulations, 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. CAaSHI "If a taxpayer, after having complied with the terms and conditions prescribed by the Commissioner, uses a particular method of valuing its inventory for any taxable year, then such method shall be used in all subsequent taxable years unless: "(i) with the approval of the Commissioner, a change to a different method is authorized; or "(ii) the Commissioner finds that the nature of the stock on hand (e.g., its scarcity, liquidity, marketability and price movements) is such that inventory gains should be considered realized for tax purposes and, therefore, it is necessary to modify the valuation method for purposes of ascertaining the income, profits, or loss in a more realistic manner: Provided, however , That the Commissioner shall not exercise its authority to require a change in inventory method more often than once every three (3) years: Provided, further , That any change in an inventory valuation method must be subject to approval by the Secretary of Finance. "Section 145. Valuation of Inventories . The law provides two tests to which each inventory must conform. (1) it must conform as nearly as possible to the best accounting practice in the trade or business, and (2) it must clearly reflect the income. It follows, therefore, that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventory or basis of valuation, as long as the method of basis used is substantially in accord with these regulations, an inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer is, as a general rule, regarded as clearly reflecting his income." aSTECI Considering that the "first-in-first-out" method of inventory is no longer compatible with HSPC's newly installed computerized accounting system and the "weighted average" method will conform to the best accounting practice in its trade or business, this Office hereby grants authority to HSPC the use of "weighted average" method in their inventory costing effective July 1, 2000. (BIR Ruling No. 176-98 dated December 14, 1998) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) LILIAN B. HEFTI Deputy Commissioner Legal and Inspection Group