taxes

Motor Fuels Tax Audit Procedures Manual - Ch. 153

Chapter 8 - Inventories

Introduction

The use of the correct beginning and ending inventories is important when determining total gallons to account for and total fuel dispersed. In examining the history, verify whether the reported ending inventory is equal to the succeeding month's beginning inventory.

Reported inventories should be only that inventory located in Texas.

Inventories should always be tax-free since the report does not provide for tax-paid inventories. Special situations do arise.

If a company goes out-of-business during the audit period, it is important to verify that all ending inventory has been accounted for. The last report should show a zero (0) ending inventory. This is accomplished by including the ending inventory in taxable sales.

Book Inventories

Often, taxpayers use "book" inventories or "plug" inventories. It is important to verify that inventories reported were actual physical ("stick") inventories. Book inventories or plug figures can distort taxable sales and/or uses if the drop method (Beginning inventory plus purchases minus the ending inventory) of computing tax liability is used. The constant use of book inventories may result in an inventory greater than actual storage capacity.

When book inventories are used, it may be necessary to conduct or observe a physical inventory at the end of a report period.

Tax-paid purchases cannot be included in the inventory on monthly returns. Credit should normally be taken against taxable sales on each monthly report, however, tax-paid inventories can be created by unusual situations and require special handling. There are basically three situations that illustrate this:

SITUATION #1: A new business has tax-paid inventory on hand on the first day of business. Rather than inventory, this should be included as tax-paid purchases on the first monthly report. If the taxpayer has included the tax-paid beginning inventory as tax-free inventory, then the taxpayer has overpaid and an audit adjustment should be made.

SITUATION #2: A taxpayer has purchased during the report period, more tax-paid fuel than is sold. If reported, this will result in credit gallons an open collection record will occur. Credit gallons will be shown on the fuels taxpayer history as individual collection records.

Taxpayers will sometimes try to deduct these credit gallons as an overpayment, or on subsequent returns. Overpayments are reviewed and verified on the original return. If the overpayment is valid, the overpayment will be converted to dollars and refunded.

A taxpayer may have omitted the tax-paid fuel portion from the ending inventory on a monthly report, but included it as tax-paid purchases in the following month's report.

Or, a taxpayer may have claimed a refund for the credit gallons. Any refunds issued to the taxpayer will be shown on the Refund section of the fuels taxpayer history; they may also be shown on the Payment section or the collections Record section of the history. If a refund was issued, then it should be documented in the audit schedules so that a credit is not given twice.

SITUATION #3: If a distributor or supplier maintains a tax-paid inventory in his service station storage by reporting on net or gross deliveries to his service station storage and elects to change to reporting on meter readings he should report the beginning inventory of his service station storage as a tax-paid purchase.

Stick or Physical Inventory

A common method of determining inventory occurs when the taxpayer lowers a calibrated stick into the tank. The depth in inches of the fuel in the tank is determined from the wetness on the stick. The taxpayer then refers to the inches shown on a tank chart similar to the 96" Diameter Gauge Chart at the end of this Chapter to determine the gallons of fuel in this tank. This method is most common for underground service station storage tanks.

NOTE: The manufacturer will usually supply his customer with a chart similar to the one shown.

EXAMPLE: For a 6,000 gallon capacity tank, if a "stick" or physical inventory is taken and there are 33 inches of fuel left in the tank, then there are approximately 1,843 gallons of fuel in the tank.

Above ground tanks are sometimes equipped with sight gauges or other devices for determining the actual depth of fuel. The measurement is still compared to the proper gauge chart in order to determine the gallons.

Computerized Inventory

Many taxpayers now use computerized inventory equipment. These devices monitor tanks constantly. The operator/owner is supplied with a computer printout on demand.

Tank Capacity Formula

The formula for determining the gallon capacity of a tank follows.

Pi X Radius2 X Length or Height X 7.48 = GALLONS 231 cubic inches = one gallon
1,728 cubic inches = One cubic foot
One cubic foot = 7.48 gallons

GIVEN: The approximate capacity of a tank is 32 feet long and 8 feet in diameter.
THEN: 3.1416 X 4 X 4 X 2 X 7.48 = 12,032 gallons.

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(Revised 02/2004)