FAQs & Resources

Why is lifo important?

Helps businesses determine income

The tax code requires taxpayers to use the best inventory accounting practice in the trade or business that most clearly reflects income.

Helps maintain the supply chain

LIFO ensures businesses have adequate cash flow to continue replenishing inventory to meet demand. LIFO requires inventory to be replaced and has a built in “toggle switch” to prevent gaming that triggers tax when inventory is not replaced or when prices go down.

Protects businesses & consumers from inflation

When prices are increasing, LIFO provides businesses with a tax deferral to help them manage rising costs. LIFO only benefits businesses when there is inflation.

LIFO IS DESIGNED TO REACT TO PRICE FLUCTUATIONS

LIFO has a built in “toggle switch” that triggers tax when prices go down.

LIFO and FIFO achieve the same purpose. They most closely match the cost of goods sold with the cost of replacement inventory the company must purchase in order to remain in business.

What would lifo Repeal mean to small businesses?

Of American Companies Use LIFO

Including manufacturers, distributors, and retailers across a wide variety of products and sizes including small and mid-sized businesses.

SMALL BUSINESSES RELY ON LIFO:

to maintain inventory levels. These businesses have tight profit margins, and repeal could push many of them into debt by forcing them to pay the recapture tax and replenish inventory – a backward spiral that will put them in a position of always trying to play catch-up.

MANY Companies

have built up their LIFO reserves over many decades and their LIFO reserve is a multiple of one year’s taxable income. A simple deferred payment scheme for the repayment of tax from LIFO repeal would not be sufficient to mitigate the harm that LIFO repeal would cause.

LIFO Math In Action

Assume that a company has an inventory of 6 widgets, A – F, purchased in alphabetical order. The cost of these widgets is as follows:

If the company then sold 4 widgets for $50 apiece (totaling $200), we can compare accounting methods to see how LIFO works. LIFO assumes that the last four items purchased (C – F), highlighted in blue, were the first 4 items sold, whereas FIFO assumes that the first 4 items purchased (A – D), highlighted in red, were the first 4 items sold.

Key Takeaways:

  • The LIFO accounting method results in $8 of deferred taxes ($22 – $14 = $8) to be reinvested in inventory at the higher replacement cost of $40.

  • The business is required to record the LIFO Reserve of $40, the difference between the FIFO remaining inventory and the LIFO remaining inventory ($75 - $35 = $40).

  • $8 of deferred taxes will eventually be paid when a recapture event occurs ($40 LIFO reserve taxed at 20%)

  • LIFO maximizes the cash flow for businesses with rising inventory costs. FIFO accomplishes the same thing for companies selling inventory that declines in price.