Grant of Request to Change Method of Costing Inventories from "FIFO" to "Average Cost" or "Weighted Average" Method

March 30, 1999 BIR RULING NO. 041-99 41-000-00-041-99 Punongbayan & Araullo 6th Floor, Vernida IV Bldg. Alfaro Street, Salcedo Village 1200 Makati City Attention: Atty . V . C . Mamalateo Tax Partner Gentlemen : This refers to your letter dated June 19, 1998 requesting, on behalf of your client, Orion-Squire Capital Inc. (Orion), for authorization and/or approval of the change in its method of costing inventories from "first-in-first-out" to the "average cost" or "weighted average" method. cdll It is represented that Orion was incorporated on May 8, 1987; that it is engaged in business as a stock and bond broker and dealer in securities; that its primary purpose is: "To engage in the business of stock, and bond brokers and dealers in securities and in all activities directly or indirectly connected therewith or incidental thereto" that as a dealer in securities, Orion has adopted, and consistently used the "first-in-first-out" method in costing its inventories; and that in order to more accurately reflect its income, Orion has decided to shift its method of costing inventories to the "average cost" or "weighted average"; that under the "average cost" or "weighted average" method, the weighted average unit costs are determined by dividing the total costs of identical units of each commodity (i.e. marketable securities) available for sale during a given period by the number of units of that commodity; that the costs which are charged against revenue represent the weighted average unit costs of the securities sold; that the same weighted average unit cost is used in determining the cost of merchandise (i.e. marketable securities remaining in the inventory; that since the "weighted average" method is normally used in cases wherein commodities are identical (and at times commingled) to each other, Orion deemed the "weighted average" method more preferable, considering that the marketable securities which comprise its inventory, are generic in nature, intangible, and are usually indistinguishable from each other; and that this method conforms with industry accounting practices, and leads to a more accurate indication of income and financial position at any given period. In reply, please be informed that Section 41 of the Tax Code of 1997, provides as follows: "SEC. 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 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. 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 his 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." LibLex Furthermore, pursuant to the provisions of Section 148, Revenue Regulations No. 2 which provides, viz: xxx xxx xxx "SEC. 148. Inventories by dealers in securities . A dealer in securities who in his books of account regularly inventories unsold securities on hand either "(a) At cost; "(b) At cost or market, whichever is lower; or "(c ) At market value may make his return upon the basis upon which his accounts are kept provided, that a description of the method employed shall be included in or attached to the return, that all the securities must be inventoried by the same method and that such method must be adhered to in subsequent years, unless another method be authorized by the Commissioner of Internal Revenue . . . . (Emphasis supplied) Accordingly, Orion may be allowed to adopt the "average cost" or "weighted average" method of costing their inventory from the previous method used, "first-in-first-out" method. 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, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue