Thursday, June 30, 2011

Senate Leader and Industry Oppose Administration Effort to Repeal LIFO Accounting

Senator Orrin Hatch (R-Utah), Ranking Member of the Finance Committee, opposes the Obama Administration’s proposal to repeal the last-in first-out (LIFO) inventory accounting method. The Senator said that repeal of LIFO would raise taxes on US manufacturers by roughly $69 billion, threatening firms’ ability to hire new workers and make new capital investments. The Chamber of Commerce has cautioned that LIFO repeal could force many companies out of business who lack the ability to obtain the debt financing needed to pay the taxes resulting from repeal of LIFO, which is an accounting method that has been expressly permitted by the Internal Revenue Code since the 1930’s. According to the Chamber, businesses that use LIFO assume for accounting purposes that they sell first the inventory most recently acquired or manufactured. Industries that often experience rising inventory costs typically account for inventory using the LIFO method. This is because LIFO accounting allows them to match current sales income with the current higher cost of that inventory. In short, said the Chamber, the LIFO method enables businesses to avoid phantom profits caused by inflation.

In general, for Federal income tax purposes, taxpayers must account for inventories if the production, purchase, or sale of merchandise is a material income-producing factor to them Under the LIFO method, it is assumed that the last items entered into the inventory are the first items sold. Because the most recently acquired or produced units are deemed to be sold first, cost of goods sold is valued at the most recent costs; the effect of cost fluctuations is reflected in the ending inventory, which is valued at the historical costs rather than the most recent costs.

Unlike U.S. GAAP, IFRS do not treat LIFO as a permitted method of accounting. The SEC recently indicated its support for global accounting standards and it continues to work toward making a determination by 2011 as to whether to incorporate IFRS into the U.S. financial reporting system. SEC staff has also noted that if the SEC were to decide to move to IFRS, the transition date for U.S. issuers would be no earlier than 2015. The Joint Committee on Taxation noted that the seemingly inevitable shift from GAAP to IFRS raises the issue of whether companies will be able to continue using LIFO for tax purposes in light of the conformity requirement.

If LIFO is repealed, said the Joint Committee on Taxation, taxpayers that currently use LIFO would be required to write up their beginning LIFO inventory to its first in, first out (FIFO) value in the first taxable year beginning after December 31, 2012. The resulting increase in income is taken into account ratably over 10 taxable years beginning with the first taxable year beginning after December 31, 2012.

The Committee noted that proponents of the FIFO method argue that LIFO permits deferral of inflationary gains in a taxpayer’s inventory even when those gains arguably have been realized by the business. They note that outside of the inventory context, inflationary gains are generally taxed when the gain is realized, i.e., upon sale of the appreciated asset, and LIFO offers self-help against inflation that is not available in other contexts.

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