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Sucking the LIFO Out of Inventory

The government sees billions of dollars in potential tax revenue sitting on the shelves of company
warehouses.

Marie Leone
July 15, 2010 | CFO Magazine

Explaining accounting to Congress is never easy. But last spring, Bill Jones, vice
chairman of O’Neal Industries, says he witnessed a few “aha” moments as he went door-
to-door on Capitol Hill to lobby against the elimination of “last-in, first-out” (LIFO)
accounting.

As Ron Travis, O’Neal’s vice president of tax, explained to members of Congress why the
majority of companies use LIFO, “lightbulbs started going off,” recalls Jones. Until then,
he says, “they thought LIFO was just a funny-sounding acronym.”

LIFO allows companies to calculate the cost of goods sold based on the price of the most
recently purchased (“last-in”) inventory, rather than inventory that was purchased more
cheaply in the past and has been sitting on the shelf. That boosts the cost of goods sold,
which lowers profits — and, thus, taxable income. LIFO is particularly important to
companies that have slow-moving inventory — such as industrial manufacturers and
distributors — and are therefore vulnerable to rising prices. O’Neal, a manufacturer and
distributor of metals and metal products, has used LIFO for 63 years, almost as long as
the method has been allowed for tax purposes (the Internal Revenue Service first
sanctioned it in 1939).

“We normally replace every piece of inventory we sell with a higher-priced piece of
inventory,” explains Travis. “Under LIFO, all of the inflation that is built into our product is
not recognized for tax or book purposes.”

Jones and Travis breathed a sigh of relief last year when Congress quietly dropped plans
to eliminate LIFO. But it didn’t take long before the funny-sounding acronym was back in
the taxman’s sights. The 2011 federal budget proposed by the Obama Administration
again includes a provision to repeal LIFO accounting. The government estimates that the
move would boost federal coffers by $59 billion over 10 years.

Even if LIFO somehow survives another year of federal budgeting, it still faces the long-
term threat of being wiped out if the United States adopts international financial reporting
standards (IFRS), which do not allow LIFO. That would stop companies from using LIFO
entirely, because companies that use the method to reduce taxable income reported to