LIFO Inventory Accounting Solutions
Creating cash from idle inventory
Inventory is one of the largest line items on a balance sheet and often a company’s most important asset. Since 1936, the U.S. tax code has provided an accounting method that allows companies to leverage inventory to create cash. The last-in-first-out, or LIFO, method of inventory accounting removes inflation from inventory, reducing its value and lowering taxable income. The resulting increase in cash, referred to as a LIFO reserve, enables companies to invest in things like new equipment, research and development, process improvement, specialized staff, additional inventory, or even fund payroll.
While inflation is the biggest driver of the LIFO benefit, even in periods of low inflation, LIFO provides an annual benefit, creating a deduction each year. At its core, LIFO is an interest-free loan that helps stimulate business growth by providing much needed cash flow.
Multitudes of narrowly focused special interest deductions, most incorporated after 1986, are under review as Congress begins the arduous task of addressing tax reform. While LIFO is among those under consideration, its broad acceptance and adoption by thousands of U.S. companies for nearly 80 years – both large and small across numerous industries -- make it an unlikely candidate for significant reform. And, adoption of the international financial reporting standards (IFRS), which ban the use of LIFO, has all but completely lost momentum in the U.S., even among its staunchest supporters.
The SourceHOV | Tax approach to LIFO
SourceHOV | Tax helps companies of all sizes across a wide range of industries adopt one of three LIFO methods or convert from one method to another:
- Internal LIFO calculation method – Using an internal calculation based on actual inventory items purchased, a company can measure inflation by comparing the cost of items purchased at the beginning of the year to similar items purchased at the end of the year. Companies with astute purchasing strategies may be able to drive down costs among specific categories that might not be reflected using an aggregated method.
- Inventory price index computation (IPIC) method – IPIC is an IRS-preferred method that uses monthly indices published by the Bureau of Labor Statistics (BLS). The BLS categories are a domestic measure of inflation and do not take into account offshore manufacturing or low-cost overseas purchasing. While aggregated categories may not be an exact representation of actual inventory mix, the BLS indices nearly always show higher inflation, resulting in a greater LIFO benefit. In addition, companies that convert from an internal calculation method to IPIC, are given audit protection for the previous LIFO method.
- Automotive LIFO – Due to the nature of its inventory, the automotive industry has a specific LIFO method of its own. This method compares the base model cost of vehicles year over year by manufacturer and brand for both new and used vehicles. Auto dealers will also benefit from adoption of the safe harbors under UNICAP §263A.
SourceHOV|Tax has been providing LIFO calculations to clients for more than 30 years. Our in-house, dedicated LIFO team [open to LIFO team page] is intimately familiar with the nuances of the tax code and regulations surrounding the LIFO method. Our investment in internal processes and a proprietary software platform allows us to analyze all available options and submethods such as vehicle pooling, grouping and weighting or index options. While there are a handful of common submethods, our approach enables us to create numerous, highly specific methods that with careful analysis and application can provide more lucrative options for our clients.
Any company that experiences even modest inflation should evaluate the LIFO inventory method as a way to mitigate the effects of inflation. There is no comparable opportunity to attain an annual tax benefit from day one with a reserve that continues to grow year after year.