Repeal Of Last-in, First-out (lifo) Accounting

If you're not an accountant you may not be familiar with the "last-in

, first-out" (LIFO) accounting method. But repealing it has become part of President Barack Obama's 2011 Deficit Reduction Plan. Some companies use the LIFO method to calculate the value of their inventory and as a means of reducing tax liability.

What is LIFO? LIFO is the opposite of FIFO, the "first-in, first-out" method, which is based on the assumption that the first goods purchased are the first ones sold. Therefore, at the end of the year, the cost of the remaining goods reflects the most recent purchases. Companies have the option of using LIFO instead, which makes the assumption that the first goods purchased are the ones still in the firm's inventory at the end of the year. Since the cost of goods is usually rising, LIFO will associate the higher cost to the goods that are already sold so that a corporation can reduce current income and attribute lower values to the end-of-the-year inventory. This allows a business to reduce its short-term profit and thus its tax liability. But it also reduces a company's on-paper profitability, and, as such, is not widely used. For 2010, approximately 12 percent of the businesses in the S&P 500 held a total of $62 billion in LIFO reserves.

Why is it an issue now? As part of his 2011 Deficit Reduction Plan, President Obama has recommended disallowing LIFO in 2012 as an accounting method for tax reporting purposes. Because LIFO reduces a company's tax burden, some experts estimate that repealing it would generate as much as $53 billion in tax revenue by 2016 for the U.S. government.

Why repeal LIFO? LIFO has been allowed by the tax code since 1939, but was not used heavily by corporations until the 1970s and '80s when they were trying to diminish the impact of inflation. However, International Financial Reporting Standards (IFRS) do not allow for LIFO; in fact, the practice is only used in the U.S. and Japan. Changing the accounting standards to phase out the use of LIFO over time would be one way to make U.S. standards more comparable with international standards.

Who favors the repeal? Advocates of repealing LIFO point out that the method favors companies that keep a lot of inventory on hand, while the government should be encouraging "leaner" companies that turn over their inventory more quickly. Repealing LIFO will also help reduce the federal deficit as companies make a large one-time tax payment on the difference between LIFO and FIFO amounts. After that, however, these corporations will not face a larger tax burden as long as annual prices continue to increase. They also argue that LIFO is not a particularly useful management tool; it only serves as a means of deferring taxation for a fairly small number of companies.

Who opposes repeal? Opponents argue that repealing LIFO would impose a huge one-time tax burden on companies that are already struggling in a shaky economy. They suggest that companies without the money on hand to produce such cash might lay off workers or go bankrupt. They maintain that LIFO is actually a more accurate expression of true corporate profits and serves as a means for companies to handle inflation.

by: Liliana DeVita

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