Uniform capitalization (UNICAP) is a federal tax rule that requires direct and indirect costs incurred in the production of property to be capitalized to the property. The property produced must be real or tangible personal property and includes inventory and non-inventory property, and assets or assets improvements produced by the taxpayer. Production includes efforts to construct, manufacture, build, improve, etc. Methods used to calculate UNICAP vary. The common methods, simplified service cost method and simplified production method, are used in this calculation.
Allocate Mixed Service Cost to Production
Identify the total mixed-service costs for the taxable period. Mixed-service contributes to the entire organization, both production and non-production, and are related to service or support functions. Refer to IRS guidelines for detailed descriptions on the types of costs to include as mixed costs.
Total your production costs incurred for the year, both direct and indirect. These production costs have not been capitalized as inventory and referred to as Section 263A costs. Exclude the mixed service costs of step 1 and interest from this total. Refer to IRS guidelines for details on costs to include.
Total all production and non-production costs by including production calculated in step 2 and non-production costs in this total. Non-production costs are those costs that are not related to production. Exclude the mixed service costs that were calculated in step 1.
Determine the portion of mixed-service costs to allocate to production by dividing your total production costs calculated in step 2 by total costs for the year calculated in step 3. Multiply this quotient by total mixed service costs calculated in step 1. This is the mixed service cost that is allocable to production. Do not capitalize this amount.
Determine the Cost to Capitalize
Total your additional production costs incurred for the year by adding the mixed service costs calculated from the previous step to the indirect costs that were allocated to production. The indirect cost is calculated according to the accounting policy of your company. These costs have not been previously capitalized.
Calculate the absorption ratio by dividing your additional production costs incurred for the taxable year as calculated in step 5 by the total inventory costs incurred for the taxable year. Inventory cost includes those amounts incurred in production of direct material, direct labor and indirect costs. Refer to IRS Section 471 guidelines for exceptions.
Use the absorption ratio to determine the additional production costs from step 5 to capitalize by multiplying the absorption ratio against the total ending inventory. Capitalize the result to ending inventory.
Subtract the amount to be capitalized as calculated in step 3 from the total additional production costs calculated in step 5. Include the result in the cost of goods sold.