rp-03-20.pdf

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing.

This collection currently includes the publisher’s available advance-release directory. Historical bulletin renditions are discovered separately; an advance-release record alone does not certify the collection archive complete.

Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.204: Changes in accounting periods and in methods of accounting.
(Also Part 1, §§ 263A, 446, 471, 472, 481, 7121; 1.263A-1, 1.446-1, 1.471-2, 1.471-4,
1.472-2, 1.481-1)

Rev. Proc. 2003-20
SECTION 1. PURPOSE
This revenue procedure provides a safe harbor method of accounting (the “Core
Alternative Valuation” (CAV) method) for remanufacturers and rebuilders of motor
vehicle parts (“remanufacturers”) and resellers of remanufactured and rebuilt motor
vehicle parts (“resellers”) that use the lower of cost or market (LCM) inventory valuation
method to value their inventory of cores held for remanufacturing or sale. The CAV
method is provided by the Commissioner pursuant to his authority under § 446 of the
Internal Revenue Code in order to minimize disputes, provide certainty, and simplify
inventory computations. This revenue procedure also provides a procedure for
qualifying remanufacturers and resellers currently using an LCM method to obtain
automatic consent of the Commissioner to change to the CAV method. In addition, this
revenue procedure provides a procedure for qualifying remanufacturers and resellers
not currently using an LCM method to obtain automatic consent to change to an LCM
method in conjunction with a change to the CAV method.
SECTION 2. BACKGROUND

2
.01 In General.
(1) Remanufacturers acquire inventories of used motor vehicle parts (e.g., wiper
motors, engines, transmissions, and alternators for automobiles, trucks, buses, etc.) for
use in remanufacturing. These used parts are frequently referred to within the
remanufacturing industry as “cores.” Remanufacturers rebuild motor vehicle parts from
cores through use of new and used component parts and sell the resulting products as
remanufactured replacement parts. Resellers acquire cores in conjunction with their
resale activity and sell the cores to a remanufacturer or another reseller in the
distribution chain.
(2) Remanufacturers and resellers acquire cores from customers (“customer cores”)
who purchase remanufactured replacement parts. To encourage a customer to return
the core, remanufacturers and resellers generally offer the customer a credit (offset
against the purchase price). Remanufacturers and resellers also acquire cores from
third-party suppliers of cores (businesses that specialize in supplying cores to meet
specific needs, referred to within the industry as “core suppliers” or “core brokers”) and
occasionally acquire cores directly from other sources.
(3) Controversy exists as to the proper market valuation of cores under the LCM
method. See Consolidated Manufacturing, Inc. v. Commissioner, 249 F.3d 1231 (10
th

Cir. 2001), rev'g in part, 111 T.C. 1 (1998). In order to reduce controversy and minimize
disputes, the Service has determined that it is appropriate to provide a safe harbor
procedure for the LCM valuation of cores in inventory.
.02 Section 471 of the Internal Revenue Code, which governs the treatment of
inventories, provides two tests to which each inventory must conform: (1) it must

3
conform as nearly as may be to the best accounting practice in the trade or business;
and (2) it must clearly reflect income. Section 1.471-2(c) of the Income Tax Regulations
provides that the bases of valuation most commonly used by business concerns and
which meet the requirements of § 471 are (1) cost and (2) cost or market, whichever is
lower. Section 1.471-2(c) also provides that any goods in an inventory that are
unsalable at normal prices or unusable in the normal way because of damage,
imperfections, shop wear, changes of style, odd or broken lots, or other similar causes,
including second-hand goods taken in exchange, should be valued, if such goods
consist of raw materials held for use or consumption, upon a reasonable basis taking
into consideration the usability and condition of the goods, but in no case shall such
value be less than the scrap value.
.03 Section 1.471-3(b) defines the cost of merchandise purchased since the beginning
of the taxable year as the invoice price less trade or other discounts, except strictly cash
discounts approximating a fair interest rate, which may be deducted, or not, at the
option of the taxpayer, provided the taxpayer follows a consistent course. To this net
invoice price should be added transportation or other necessary charges incurred in
acquiring possession of the goods. In the case of merchandise produced by the
taxpayer, § 1.471-3(c) defines cost as (1) the cost of raw materials and supplies
entering into or consumed in connection with the product, (2) expenditures for direct
labor, and (3) indirect production costs incident to, and necessary for, the production of
the particular article, including in such indirect production costs an appropriate portion of
management expenses, but not including any cost of selling or return on capital,
whether by way of interest or profit. See §§ 1.263A-1 and 1.263A-2 for more specific

4
rules regarding the treatment of production costs.
.04 Section 1.471-4(a) provides that, under ordinary circumstances and for normal
goods in inventory, “market” means the aggregate of the current bid prices prevailing at
the date of the inventory of the basic elements of cost reflected in inventories of goods
purchased and on hand, goods in process of manufacture, and finished manufactured
goods on hand. The basic elements of cost include direct materials, direct labor, and
indirect costs required to be included in inventories by the taxpayer (e.g., under § 263A
and its underlying regulations for taxpayers subject to that section). For taxpayers to
which § 263A applies, for example, the basic elements of cost must reflect all direct
costs and all indirect costs properly allocable to goods on hand at the inventory date at
the current bid price of those costs, including but not limited to the cost of purchasing,
handling, and storage activities conducted by the taxpayer, both prior to and
subsequent to acquisition or production of the goods.
.05 Section 1.471-4(c) provides that if inventory is valued upon the basis of cost or
market, whichever is lower, the market value of each article on hand at the inventory
date shall be compared with the cost of the article, and the lower of such values shall be
taken as the inventory value of the article.
.06 Section 1.471-2(f) provides deducting from inventory a reserve for price changes,
or an estimated depreciation in the value of the inventory, is not in accord with the
regulations underlying § 471.
.07 Section 472(b) and § 1.472-2 require taxpayers using the last-in, first-out (LIFO)
method to inventory their goods at cost.
.08 Section 446(e) and § 1.446-1(e)(2)(i) require that, except as otherwise expressly

5
provided, a taxpayer must secure the consent of the Commissioner before changing a
method of accounting for federal income tax purposes. Section 1.446-1(e)(3)(ii)
authorizes the Commissioner to prescribe administrative procedures setting forth the
terms and conditions deemed necessary to permit a taxpayer to obtain consent to
change a method of accounting in accordance with § 446(e).
SECTION 3. SCOPE
.01 Applicability. This revenue procedure applies to remanufacturers and resellers
that want to change to the CAV method described in section 4 of this revenue
procedure to value inventories of cores. For purposes of this revenue procedure,
“cores” include electrical, mechanical, hydraulic, and other operating motor vehicle
parts, including parts of automobiles, trucks, buses, motorcycles, boats, construction
equipment, farm machinery, and other on- and off-road motorized equipment. The CAV
method applies only to cores held in inventory for remanufacturing or, in the case of a
reseller, held for sale to a remanufacturer or another entity in the distribution chain. The
CAV method only applies to cores valued under the LCM method.
.02 Inapplicability.
This revenue procedure does not apply to a taxpayer that values
its inventory of cores at cost (including a taxpayer using the LIFO method) unless the
taxpayer concurrently changes (under section 6.02 of this revenue procedure) from cost
to the LCM method for its cores (including labor and overhead related to the cores in
raw materials, work-in-process and finished goods).
A taxpayer that wants to
concurrently change from cost to the LCM method must: (a) not be otherwise prohibited
from using the LCM method; (b) comply with the general rules relating to inventories
under § 471 and the regulations thereunder; and (c) in the case of taxpayers using the

6
LIFO method, use the LCM method and a permitted method for identification as
determined and defined in section 10.01(1)(b) of the APPENDIX of Rev. Proc. 2002-9,
2002-3 I.R.B. 327, 368-69.
SECTION 4. THE CORE ALTERNATIVE VALUATION METHOD
.01 In General.
(1) A taxpayer using the CAV method values its inventory of cores at LCM,
determines cost in accordance with section 4.02 of this revenue procedure, and
determines market in accordance with section 4.03 of this revenue procedure.
(2) The CAV method will be a permissible method of accounting provided the
taxpayer follows the rules and computational methodology described in sections 4.02
through 4.05 of this revenue procedure and, if the taxpayer is changing from another
method to the CAV method, the provisions of section 6 of this revenue procedure
regarding changes in method of accounting. All computations under the CAV method,
however, are subject to verification upon examination of the taxpayer’s income tax
returns.
.02 Determination of Cost.
(1) In general. Under the CAV method, the taxpayer is required to use as the cost
of each core in ending inventory the invoice price adjusted, as appropriate, for
discounts, freight costs, and other direct and indirect costs properly allocable to the
cores as described in §§ 1.471-3 and 1.263A-1. If the core was acquired from a core
supplier or broker, the invoice price is the amount paid to the core supplier or broker. If
the core was acquired from a customer, the invoice price is the sum of any credit
allowed to the customer and any amount paid to the customer. Consolidated

7
Manufacturing, Inc. v. Commissioner, 249 F.3d 1231 (10th Cir. 2001), aff’d on this
issue, 111 T.C. 1 (1998).
(2) Service may redetermine appropriate cost. As a general rule, the taxpayer must
follow the form that the taxpayer used for the transaction. See, for example, In re
Steen, 509 F.2d 1398, 1402 n. 4 (9th Cir. 1975) and Commissioner v. Danielson, 378
F.2d 771, 775 (3d Cir. 1967). If the Service determines, however, that the taxpayer’s
use of the credit amount as the invoice price does not clearly reflect income (for
example, because the taxpayer artificially inflated both the price of the remanufactured
core and the credit amount solely to manipulate gross receipts for tax avoidance), the
Service may examine the substance of the transaction to determine the appropriate cost
for a core. See, for example, Gregory v. Helvering, 293 U.S. 465, 55 S. Ct. 266, 79 L.
Ed. 596 (1935).
.03 Determination of Market Value.
(1) In general. Under the CAV method, the market value under § 1.471-4 of each
core in ending inventory is the “allowable supplier price” adjusted, as appropriate, for
other direct and indirect costs properly allocable to the core as described in §§ 1.471-4
and 1.263A-1. The allowable supplier price will be considered to be the replacement
cost for purposes of §§ 1.471-4 and 1.263A-1.
(2) Allowable supplier price. For purposes of this revenue procedure the “allowable
supplier price” is the amount the taxpayer would pay in an arm’s length transaction to
acquire a particular core from a core supplier or core broker, plus the related
transportation cost that would be incurred to acquire possession of the core from the
core broker or supplier at year-end. If the taxpayer has purchased a particular type of

8
core from several core suppliers or core brokers during the tax year, the allowable
supplier price for that core type will be deemed to be the weighted-average price,
including transportation cost, the taxpayer would have to pay in an arm’s length
transaction to acquire the particular core type at year-end from the core suppliers or
core brokers from whom the cores were purchased during the tax year. If the taxpayer
has not purchased a particular core type from a core supplier or core broker during the
tax year, the taxpayer must identify its largest (in dollar terms) supplier of cores during
the current tax year that also sells the particular core type in the ordinary course of its
business; the allowable supplier price will be the arm’s length price from that supplier for
the core type at year-end plus the transportation cost that would be incurred to acquire
the core type from that supplier. If none of the taxpayer’s suppliers sell the particular
core type, the taxpayer must reasonably determine the allowable supplier price based
on the arm’s length price for the core type at year-end, plus the transportation cost, in
the geographical area or market in which the taxpayer regularly participates. In any
case, no further adjustments will be allowed in determination of allowable supplier price.
(3) Example of allowable supplier price calculation using weighted-average price.
Taxpayer, a remanufacturer, had 4 units of Part X customer cores in inventory at year-
end. Taxpayer acquired these customer cores from customers in transactions in which
taxpayer sold to the customers remanufactured parts and received cores from the
customers in exchange for credits toward the purchase price of the remanufactured
parts. During the tax year, Taxpayer purchased 8 units of Part X cores from suppliers
(2 units of Part X from Core Supplier A and 6 units of Part X from Core Supplier B).
Therefore, Taxpayer purchased 25% (2 of 8 units) of the total number of Part X

9
acquired for the year from Core Supplier A and 75% (6 of 8 units) of the total number of
Part X acquired for the year from Core Supplier B. At the end of the taxable year, the
price Taxpayer would have to pay in an arm’s length transaction to acquire Part X,
including transportation cost, was $20 from Core Supplier A and $16 from Core Supplier
B. Taxpayer would determine the allowable supplier price for Part X customer cores
under the CAV method as follows:
# of Units % of Total Units
Purchased Purchased End of Year
During Year During Year Price
Core Supplier A 2 25% $20
Core Supplier B 6
75% $16
Total 8

CAV Core Supplier Price for Part X Customer Cores = (25% x $20) + (75% x 16) = $17.
.04 Comparison of Cost and Market. Under the CAV method, the market value of
each core in ending inventory, as determined under section 4.03 of this revenue
procedure, shall be compared with the cost of each core in ending inventory, as
determined under section 4.02 of this revenue procedure, and the lower of such values
shall be the inventory value of the core. This analysis must be performed on a part-by-
part basis.
.05 Write-down of Defective Cores. Under the CAV method, a taxpayer may not
reduce the value of a defective core under § 1.471-2(c) until the taxpayer discovers that
the core is subnormal and scraps the core or offers the core for sale at a bona fide
selling price that is less than cost. In no case may a taxpayer value a core at less than
the scrap value. A taxpayer may not reduce the value of cores based on anticipated
defect percentages or historical defect experience rates. If a taxpayer complies with the
requirements of this revenue procedure, the Service will not disallow a write-down of a

10
defective core in the year it is scrapped on the grounds that the decline in the value of
the core actually occurred in a preceding taxable year.
SECTION 5. AUDIT PROTECTION FOR TAXPAYERS CURRENTLY USING THE
SAFE HARBOR METHOD
If a taxpayer within the scope of this revenue procedure was consistently using
the CAV method provided in section 4 of this revenue procedure before February 10,
2003, the taxpayer’s use of the CAV method will not be raised by the Service as an
issue in a taxable year that ends before February 10, 2003. Moreover, if such
taxpayer’s use of the CAV method has already been raised as an issue in examination,
appeals, or before the Tax Court in a taxable year that ends before February 10, 2003,
the issue will not be further pursued by the Service.
SECTION 6. CHANGES IN METHOD OF ACCOUNTING
.01 In General. A change in the treatment of customer cores in inventory to the CAV
method provided by this revenue procedure is a change in method of accounting to
which the provisions of §§ 446 and 481 and the regulations thereunder apply.
Therefore, a taxpayer within the scope of this revenue procedure that wishes to change
to the CAV method for a taxable year ending on or after December 31, 2002, must file a
Form 3115, Application for Change in Accounting Method.
.02 Automatic Change for Taxpayers Within the Scope of this Revenue Procedure.
(1) Automatic change to the CAV method. A taxpayer within the scope of this
revenue procedure that wants to change to the CAV method must follow the automatic
change in accounting method provisions of Rev. Proc. 2002-9, as modified by Rev.
Proc. 2002-19, 2002-13 I.R.B. 696, Announcement 2002-17, 2002-8 I.R.B. 561, and

11
Rev. Proc. 2002-54, 2002-35 I.R.B. 432, with the following modifications:
(a) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply to a
taxpayer that wants to change to the CAV method for its first taxable year ending on or
after December 31, 2002, provided the taxpayer's method of accounting for cores is not
an issue under consideration in examination (within the meaning of section 3.09 of Rev.
Proc. 2002-9) at the time the Form 3115 is filed with the national office;
(b) In lieu of the label required by section 6.02(4) of Rev. Proc. 2002-9, taxpayers
are instructed to write “Filed under Rev. Proc. 2003-20” at the top of the form; and
(c) Taxpayers making concurrent changes under subsections (2) or (3) of this
section should include the concurrent change with the change to the CAV method in a
single application.
(2) Change from cost to LCM. An automatic change in method of accounting to the
CAV method under this revenue procedure also includes, where applicable, a
concurrent change from the cost method to the LCM method.
(3) Change from LIFO. An automatic change in method of accounting to the CAV
method under this revenue procedure also includes a concurrent change from the LIFO
method to a permitted method for identification as determined and defined in section
10.01(1)(b) of the APPENDIX of Rev. Proc. 2002-9. A taxpayer that desires to
discontinue LIFO to use the CAV method must make a concurrent change from its cost
method to the LCM method.
SECTION 7. RECORD KEEPING
Section 6001 provides that every person liable for any tax imposed by the Code,
or for the collection thereof, must keep such records, render such statements, make

12
such returns, and comply with such rules and regulations as the Secretary may from
time to time prescribe. The books or records required by § 6001 must be kept at all
times available for inspection by authorized internal revenue officers or employees, and
must be retained so long as the contents thereof may become material in the
administration of any internal revenue law. § 1.6001-1(e). In order to satisfy the record
keeping requirements of § 6001 and the regulations thereunder, a taxpayer that uses
the CAV method should maintain records supporting all aspects of its inventory
valuation including but not limited to cost of supplier cores.
SECTION 8. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 2002-9 is modified and amplified to include this automatic change in
section 9 of the APPENDIX.
SECTION 9. EFFECTIVE DATE
This revenue procedure is effective for taxable years ending on or after
December 31, 2002.
SECTION 10. DRAFTING INFORMATION
The principal authors of this revenue procedure are Willie E. Armstrong, Jr. and
W. Thomas McElroy, Jr. of the Office of the Associate Chief Counsel (Income Tax and
Accounting). For further information regarding this revenue procedure contact Mr.
Armstrong or Mr. McElroy at (202) 622-4970 (not a toll free call).