By Jacob D. Favaro, CPA | Tax Partner
The movement to converge U.S. GAAP and IFRS has been affecting industries more and more every year. One reoccurring issue is the use of the LIFO (Last-in, First-out) method of accounting for inventory in U.S. GAAP and the method’s repeal. This repeal would require that any businesses using the LIFO method switch to the FIFO (First-in, First-out) method, or any other method that conforms to that particular business which clearly reflects their financial position. According to the Joint Committee on Taxation, the provision to repeal LIFO would increase revenues by $79.1 billion over the next ten years.
Most businesses use LIFO because it reflects the actual price of inventory as it is sold, as well as the price of replacing that inventory. In an inflationary environment, this creates higher cost of goods sold and a lower inventory account on the balance sheet than other inventory methods. This is reconciled with a LIFO reserve that represents the difference between inventory under LIFO and FIFO, and creates a deferred tax liability on the company’s books. In the provision, companies would have until 2019 to begin depleting their LIFO reserve and will then have to slowly pay it off: ten percent will be paid in the first year, fifteen percent in the second, twenty five in the third, and fifty percent of the liability will have to be paid in the final year, 2022.
When creating a deferred tax liability, a business recognizes that the tax will be paid at a later date, but could this be too soon for some? Many small businesses may struggle to create the cash flow to pay these taxes and it may be a better use of their cash to invest internally to grow. To address this issue, the provision proposes that a seven percent discount be provided for closely held businesses, which could greatly benefit those that are able to manage their cash flow in preparation for this possible change in inventory valuation.
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