Not on LIFO? 2021 May be Your Year

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.

About the Author(s)

Jim is a Principal of HBK CPAs & Consultants and the National Director of HBK Manufacturing Solutions, a group of specialists focused on manufacturing clients and their unique needs.

After joining the firm in 1988, Jim has spent his career working in a variety of industries, including manufacturing and distribution. As the National Director of HBK Manufacturing Solutions, Jim advises manufacturing clients on issues including tax planning, finance, succession planning, mergers and acquisitions, and ESOP transitions. In addition, he shares his knowledge and experiences with manufacturing specialists throughout the firm as well as local and regional organizations and trade associations focused on the manufacturing industry. To recognize his accomplishments, Jim was named Business Professional of the Year in August 2019 by the Youngstown Warren Regional Chamber of Commerce.

In addition to his HBK role, Jim is Chairman of the Board of the Youngstown Business Incubator, an internationally recognized incubator focused on programs including the use of additive manufacturing and advanced manufacturing technologies in the Mahoning Valley and Northeast Ohio.

Jim’s accomplishments include:

  • Evaluating and implementing strategies including the LIFO (last-in, first-out) inventory accounting method, cash basis accounting method, research & development tax credits, Interest Charge Domestic International Sales Corporations (IC-DISC), and cost segregation studies with manufacturing clients in a variety of sub-industries.
  • Supporting clients with cash flow projections and financial statement projections, including companies with annual revenues in excess of $100 million dollars.
  • Assisting a company in securing an asset-based line of credit with a financial institution for $30 million dollars.
  • Helping companies analyze state income and sales tax filings requirements in order to minimize liability and maximize compliance.
  • Aiding a manufacturing client in obtaining state tax credits based on their investment in expanding their manufacturing capabilities.
  • Representing clients before the Internal Revenue Service and state and local taxing authorities.
  • Developing a training program for the HBK Manufacturing Solutions team, to improve internal capabilities and overall manufacturing expertise.
  • Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.