Offset Rising Inflation and Other
Negative Economic Factors |
Is your business feeling the effects of the current economic downturn? While certain business sectors have been hit especially hard, the impact is trickling down to virtually every industry. Many |
The Future
of LIFO:
Could it be Repealed?
|
International Financial Reporting Standards (IFRS) are closer to becoming a reality in the United States now that the SEC set out a proposed timetable for adopting them. A universal accounting language around the world is expected to provide investors of publicly traded companies with comparable information and greater transparency in financial reporting.
However, LIFO is prohibited in valuing inventory under IFRS.
If the U.S. and the Financial Accounting Standards Board were to fully adopt the international accounting language, experts say Congress is likely to make major changes to the LIFO rules or even repeal them. A LIFO repeal would cause large tax increases for auto dealerships, retailers, manufacturers and other businesses.
Couldn't a company just use LIFO for tax purposes and not for accounting purposes? Unfortunately, a tax law provision states that a business cannot use tax LIFO unless it also uses financial statement LIFO.
Congress has discussed eliminating LIFO in the past, but industry groups lobbied hard to maintain its use. For example, the LIFO Coalition of 115 trade associations was formed to help lawmakers understand the impact a repeal would have on businesses. In a recent letter to the Accounting Standards Board of Japan, the coalition's leader wrote: "Under U.S. tax law, repeal could effectively serve as a massive retroactive tax increase, punishing companies for using an accounting method that has been legal and accepted for three quarters of a century."
Current status: LIFO is safe for now. But many industry leaders are concerned about the adoption of international accounting standards and the possibility that Congress could look at LIFO as a way to raise revenue. Stay tuned. |
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| | "Anyone may arrange his affairs so that his taxes shall be as low as possible ... nobody owes any public duty to pay more than the law demands." -- U.S. Court of Appeals Judge Learned Hand
(1872-1961) | |
business owners have been forced to rein in their costs or reduce the size of their workforce -- or both. However, by making an accounting change at the end of the year, you may be able to give your firm a financial boost without having to cut back on supplies or terminate workers. It all has to do with the method your firm uses to account for its inventory. If you're still using the First-In, First-Out (FIFO) method, you might decide to switch to the Last-In, First-Out (LIFO) method.
Although LIFO may also be used when your firm is flush with money, companies often switch from FIFO when times get tough. This strategy is particularly appropriate at a time when inflation is heating up. Reason: A business that maintains an inventory must subtract the cost of goods sold from its gross receipts in order to determine its taxable income for the year.
By changing to the LIFO method, a company is able to increase the cost of goods sold for tax purposes and thereby reduce the amount of its taxable income. In turn, this lowers a company's overall tax bill.
Let's make a quick comparison of the two approaches. The basic difference is fairly easy to understand. If you use the FIFO inventory method, the first inventory items purchased are treated as the first items sold. Although this seems to reflect the natural order of events, it doesn't value inventory at the lowest possible amount when prices increase. That is because the most expensive items on hand-the last items your firm purchased-are treated as remaining in inventory.
On the other hand, LIFO treats the inventory items purchased last as being the first ones sold. Items that were purchased at lower cost in the past are the ones remaining in inventory. Therefore, using this method more accurately reflects the current cost of goods sold.
Now that the cost of inventory is increasing across various business sectors -- fueled in part by rising gas prices -- your firm may switch to LIFO to reflect the higher prices being paid for the items currently being purchased.
In this case, your closing inventory will reflect the lower prices paid for items using the LIFO accounting method. Ultimate result: A lower taxable profit on the bottom line.
Is that the end of the story? Not quite. Although the basic premise for LIFO is relative simple, the implementation is complex. Regulations must be followed to the letter. In recent years, the IRS has been auditing some companies' calculations of LIFO inventories and taxpayers can face expensive consequences if they have not met the requirements.
It is important to maintain comprehensive records of LIFO computations. Accurately maintained records can help withstand IRS challenges and avoid additional taxes, interest and penalties.
In addition to these complexities, a company may choose from several different IRS-approved methods permitted for LIFO. Your tax adviser can help determine the best method for your situation.
Finally, remember that LIFO is a valuable option for businesses when the quantity of goods on hand is stable or growing. However, if your firm needs to sell off much of its older inventory, your taxable income will actually increase because you are selling off older, cheaper inventory.
In summary: As a general rule, LIFO can reduce taxes and thereby offset the cost of rising inflation and other negative economic factors. If you haven't already considered a switch, your tax adviser can help decide if it would be advantageous for your business.
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