How to Calculate 263A

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Internal Revenue Service Code Section 263A describes how businesses must apply certain direct and indirect costs to the value of inventory rather than simply deducting them as current-year expenses. The process, "uniform capitalization," results in the delay of tax deductions for certain costs until the inventory is sold.

Not for the Timid

  • The basic idea is to reclassify the expenses as inventory when they pertain to pre-sale and pre-production, as well as the actual production period. You start by identifying costs subject to uniform capitalization. That can include costs of the design, bidding, purchasing, direct materials, direct labor, indirect production costs, storage, handling and excise tax. You then allocate a percentage of mixed service costs, a combination of production and administrative costs, to production. You next compute an "absorption ratio," which is the ratio of current-year additional Section 263A costs to total inventory costs. Finally, apply the ratio to indirect production costs and allocated mixed service costs, and add the result to the value of ending inventory.

Much Fine Print

  • Some companies are exempt from Section 263A for various reasons, including the size and type of business. Normally, specially trained cost accountants interpret and apply Section 263A because of its complexity. Businesses use different cost accounting practices, which means how one figures Section 263A costs will be different from another.

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