 Hello and welcome to the session in which we will discuss the Uniform Cost Capitalization Rules or Section 263A known as the UNICAP. What is the UNICAP or Uniform Cost Capitalization Rules? Well, simply put, if I want to summarize it in one statement, tax laws, which is Congress, require large businesses that account for inventories to capitalize certain direct and indirect costs associated with inventories. Now, we should be familiar with this statement up to this point. If you study financial accounting, which you should, if you are looking at this lecture, we always capitalize costs directly associated with inventory, whether we are manufacturing that inventory or we are buying this inventory. If we are buying it, the purchase price, the cost of transportation, any cost necessary, if we are manufacturing the inventory, well, direct material, direct labor, manufacturing overhead. We should be familiar with this. What's in addition or what's new about this concept is the indirect cost associated with inventory. So we're going to have to deal with indirect cost that's going to be added to the inventory. Now bear in mind, these rules applies to large businesses. So what is a large business? What is a small business? You may need to know this. A small business is a business that has a gross receipt of less than 27 million on average for the past three years. And this number is for 2021. So if you're looking at 2025, they may increase this average to 30 million. Simply put, you look back three years prior to the year that you are in, you average your receipts. If they are less than 27 million, you are considered a small business. If you are considered a small business, don't worry about the UNICAP rules. It does not apply to you. So simply put, the Congress intended these rules to apply to large businesses. Why? For what purpose? Well, who wants to guess? For what purpose? They want their money earlier. They want to accelerate tax revenue for the government. How? Deferring deduction for the capitalized cost. Because here's what's going to happen every time you spend money, you incur a cost. The company will have to decide whether this is an expense or whether this is an asset. If it's an expense, it's a deduction. If it's a deduction, it's going to lower your taxes. If it's an asset, no deduction now. When it's going to be deducted, when sold, when sold, then when sold, it's going to be later. So they're deferring your deduction till later because they want their money now. That's that's the whole purpose of it. Usually there's a lag usually between by the time you spend the money and the time to acquire or manufacture the inventory until you sell it. Therefore, they get their money a little bit earlier. And the other purpose is to reduce variation in the cost. Businesses include an inventory. Yeah, right. They really want their money back. But what number two is saying is they want everybody to be using the same method. Congress mainly targeting, obviously, large manufacturers and resellers by the by the mere fact that it's 27 million. Well, I would say medium, not really large, but medium and large manufacturers and resellers. Before we proceed any further, I have a public announcement about my company, Farhat Lectures dot com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true, false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. So let's talk about inventory and let's start with small businesses because it's important or you would appreciate how what inventory is when you look at small versus large, so you appreciate the unicap roles. Well, business need to keep track of their inventory. Why? Because inventory, whether you buy it or manufacture it, it starts as an asset inventory. Then it turns into an expense through cost of goods sold. You remember this is the matching principle. So you need to know how to account for your inventory because inventory will turn into cost of goods sold. Usually, not usually, the cruel method is required for taxpayer. Whether you are a cash or a cruel, usually they want to use to a cruel. Simply put, they want you to use the method that you are using for financial accounting. Usually it's the accrual. And what do you do? You capitalize direct material, direct labor, manufacturing overhead. If you are manufacturing this, if you are buying the inventory, well, direct cost that's associated with the inventory. Also, you do have the option of your small business to treat inventory. If it's not a large amount as non-incidental, as non-incidental material and supplies, simply put, expense when you use it or consume it. Now let's switch to the unicap rules that applies to large businesses. Well, the difference is indirect cost is being capitalized. So the unicap rules require capitalization of most indirect cost of production. That's the main difference. So direct material, yes, direct labor, yes, manufacturing overhead. Yes, that's that's we already know from small businesses. Then add the indirect cost. So how do we come up with this indirect cost? Well, the taxpayer or the business will have to classify their cost into three categories, a production cost, which is direct material, direct labor, manufacturing overhead. Then we have general administration cost, which is usually non-production. Then we have what's called mixed services. Mixed services are activities that benefit categories one and activities a category one, which is the production in two and two activities such as legal human resource department. What's going to happen here is this. We have to determine what are the mixed services? What are some services that benefit the production? And if it benefits the production somehow, we have to allocate this cost to the production, in other words, capitalize that cost. So we might we might end up capitalizing compensation pays to employees in the purchasing department. General administrative department, if it's related to production directly, even the IT department to the extent that these groups provide support of the production process. So this is the idea also interest on loan related to the production of inventory. So if we took out a loan and that loan specifically for the production, well, interest on that loan is usually in expense. Well, guess what? Now we have to allocate this interest to the inventory treated as an asset, capitalize the interest. Again, what's the purpose of this is to not to let you take the deduction now, take the deduction later when you sell the product. All storage costs for wholesaler, offsite storage, purchasing cost, handling, processing, assembly and repackaging, those are part of the indirect cost. So on the CPA exam, I I saw maybe one or two questions that are previously released. They ask you, what are some indirect costs? So basically, you have to know what is the indirect cost? That's basically what they test you on. Let's take a look at an example to illustrate this concept. Adam company is a landscaping company and sell mulch to customers as a wholesaler. So they do some let's give a word, but they also sell mulch. Ryan, a landscaper earns $50,000 for for Adam company. That's he works there. He earns 50,000. However, Ryan spends 10% of his time on purchase as a purchasing agent for mulches for. So he does part of his work is, you know, he helps with maybe contacting the suppliers, making sure we are being built properly, so on and so forth. What's going to happen is this assume Adam is required to apply the Unicap rule. So Adam is a large company. How would Ryan's salary be allocated? So how do we treat this 50,000? Well, if it's a small company, if it's a small company, Unicap does not apply, we are going to treat the salary as a period cost. However, if the Unicap rule apply, we're going to take 10% of add of Ryan's salary, which is $5,000 and add this $5,000 to the inventory, to the mulch. So what happened is this, we are deferring a deduction of $5,000 until we sell that mulch. That's what we're doing. So the government is accelerating their tax revenue. They don't want you to take the deduction now. They want you to take the deduction later. That's that's the whole purpose of it because for financial accounting purposes, you would expense the salary for tax purposes. You are only going to expense 45,000 and 5,000 will be treated as inventory, which will be expensed later. So this is the whole purpose or the main idea. This simple example would explain the main idea of the Unicap. Now you have to know what cost of that of that Unicap is capitalized, what cost is what cost is capitalized, what cost is expense for the CPA exam. What I showed you on the previous slide is sufficient. In the real world, you have to be a little bit more creative. What should you do now? Go to Farhat Lectures, look at additional MCQs. I know for a fact, at least I have one or two questions that are previously released, AI CPA questions about this topic. Go ahead, practice them, invest in yourself and invest in your career. Good luck, study hard, and of course, stay safe.