Not on LIFO? 2021 May be Your Year

Date October 26, 2021
Article Authors

The Last-in, First-out method (LIFO) of accounting, is one of the four acceptable methods of accounting for inventory allowed by U.S. Generally Accepted Accounting Principles and the Internal Revenue Code. LIFO is not a new concept, as it has been in existence since the 1930s, but is often dismissed or overlooked by many companies. In periods of inventory growth or periods of economic inflation, LIFO can provide immediate tax benefits.

LIFO matches current costs against current revenue to provide a better measure of current profit margins. During periods of inflation, the effect of using LIFO is that the value of the most recently purchased items are included in the cost of goods sold, as current deductions, while older lower-cost items remain capitalized in inventory. In other words, LIFO transfers current costs from the balance sheet to the income statement, thereby reducing income and creating long-term tax savings. When prices are rising and/or inventory is growing, the increase in the LIFO reserves will create immediate tax savings by reducing the taxable margins. Many companies that have large inventories can benefit from LIFO, such as manufacturers, distributors, retailers, and automobile or equipment dealerships.

For companies considering a LIFO election, the Inventory Price Index Computation (IPIC) method can be chosen to utilize Consumer or Producer Price Indexes (CPI or PPI) to measure the inflation used to calculate the annual change in LIFO inventory. Many companies take advantage of this opportunity because it allows them to maximize their LIFO benefits and is far less arduous than calculating via an internal index and manually tracking LIFO layers or specific items of inventory. Internal index calculations are usually a major undertaking and can be avoided if companies switch their inventory accounting methods for both book and tax purposes. Companies already on LIFO may also choose to adopt IPIC for tax purposes while continuing to use internal indexes for internal LIFO calculations. This will result in annual tax differences that should be considered in planning. Higher LIFO expense for tax purposes may result without increasing the amount of the internal LIFO expense if the internal indexes used for financial reporting are less than the IPIC tax indexes. In many cases, since IPIC is on a national level, it will create better tax results than internally calculated indices.

The Bureau of Labor Statistics recently released the September 2021 Consumer Price Indexes. The “all items” index rose 0.3% in September and has increased 5.4% in the last twelve months. In the long-term the U.S. Inflation rate is projected to trend about 2.60 percent in 2022 and 1.90 percent in 2023, making 2021 a perfect time to elect LIFO. Some of the top candidates to elect LIFO in 2021 are in the following industries:

  • Metals and metal products
  • Chemicals and allied products
  • Rubber and plastic products
  • Processed foods and feeds
  • Lumber and wood products

This list is by no means all-inclusive. Many other industries can reap significant benefits by electing LIFO in 2021.

If you would like to discuss how LIFO can benefit your company, please contact a member of HBK Manufacturing Solutions.

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