Academic journal article Journal of Accountancy

The Death of LIFO? Changing Inventory Method Requires Managing the Accounting-Tax Differences

Academic journal article Journal of Accountancy

The Death of LIFO? Changing Inventory Method Requires Managing the Accounting-Tax Differences

Article excerpt


* Voluntary changes in inventory costing methods generally are applied retrospectively for financial reporting purposes. For taxation, entities generally may recognize resulting effects that increase tax liability ratably over four years.

* Such considerations could come to the fore with the proposed adoption by U.S. public entities of IFRS, which does not permit last in, first out (LIFO) for financial accounting. Many companies use LIFO primarily because it allows lower income reporting for tax purposes. The conformity rule of IRC [section] 472(c) requires those companies to also use it for financial accounting purposes.

* For this and other reasons, CPAs may be called upon to advise companies switching from LIFO to FIFO (first in, first out) or average cost.

* A change from LIFO to FIFO typically would increase inventory and, for both tax and financial reporting purposes, income for the year or years the adjustment is made.

* Although the implications of IFRS for LIFO remain far from clear, companies now using the method may want to consider reducing inventories and LIFO reserves in anticipation of a required change.

Few differences between IFRS and U.S. GAAP loom larger than accounting for inventories, particularly the disallowance of the last-in, first-out (LIFO) method in IFRS. The proposed shift of U.S. public companies to IFRS could affect many companies currently using LIFO for both financial reporting and taxation. This is because the conformity rule of IRC [section] 472(c) requires taxpayers who apply LIFO for tax purposes to also apply it for income measurement in financial reporting, and IFRS does not permit LIFO for book accounting.

Therefore, CPAs may be called upon to help manage inventory method changes. Companies using LIFO would have to switch to FIFO or average cost. The change would place companies in violation of the conformity requirement. Absent relief from the Treasury Department, it would require them to change their tax method of inventory reporting.

This article highlights the impact of LIFO accounting, widely used in the U.S. but scarcely used elsewhere. It could be eliminated if U.S. GAAP were to fully conform to IFRS inventory accounting. If LIFO were to disappear, many U.S. companies could face large income tax liabilities from accelerated income recognition. In 2007, Exxon Mobil Corp. reported its aggregate replacement cost of inventories at year-end exceeded the inventories' LIFO carrying value by $25.4 billion. The Sherwin-Williams Co. reported that if it had used FIFO instead of LIFO, its net income for 2005 would have been $40.8 million higher (Exxon Mobil Corp., 2007 SEC Form 10-K; The Sherwin-Williams Co., 2007 SEC Form 10-K).

The proposed SEC road map released in November contemplates some large U.S. companies voluntarily adopting IFRS, starting with filings in 2010. Its application could be mandated for large public companies starting in 2014.

Another major difference between IFRS and GAAP is that IFRS requires entities to carry inventory at the lower of cost or net realizable value. GAAP, on the other hand, values inventories at current replacement cost, which has a ceiling of net realizable value and a floor of net realizable value minus a normal profit margin.


Currently, the GAAP guidance under Statement no. 154, Accounting Changes and Error Corrections, calls for changes in inventory costing methods to be retrospectively applied to the prior financial statements presented in annual reports (paragraph 7), unless it is impracticable to do so. In that case, the new principles can be applied prospectively (paragraphs 8-9). An entity makes retrospective application only for the direct effects of the change (paragraph 10). However, indirect effects--for example, bonuses--are reflected prospectively (paragraph 10). …

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