In 1913, the inventory was written down to the lowest value that could reasonably be anticipated. If the market fell below the 1913 book value, the inventory would be written down further to market. Warshow, an officer of the National Lead Company, wrote two articles about his company’s adoption and use of the base stock method.12 The articles provide many insights into the base stock method and the following paragraphs draw heavily from them. Historically, LIFO can be viewed as an outgrowth of the base stock method.2 Therefore, a brief history of the base stock method in England and in America is presented before the history of LIFO.
32 With the U.S. economy arguably in the midst of the worst economic crisis since the Great Depression, LIFO repeal could only exacerbate an already bad economic situation. With the SEC and FASB both committed to convergence, there can be little doubt lifo conformity rule that in the not-too-distant future there will be a single set of international financial reporting standards. Unlike the international standards adoption process in most other countries, FASB is negotiating with the IASB on an issue-by-issue basis.
Early LIFO was envisioned as a flow assumption applicable only to homogeneous inventory. A study was made by qualified experts to determine the normal quantity of each of the different kinds of inventories necessary for continued op-eration. The study took into account other factors, such as the in-ventory in transit and minimum inventories necessary to insure a delay-free flow of goods through the manufacturing process. The normal quantity was about 80 percent of the total inventories at the National Lead Company.
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Obviously, his cost of goods sold is the replacement value of the goods he borrowed. retained earnings Thus, when a merchant liquidates his inventory, he is temporarily borrowing from it.
Profits were smoother than they would have been if National Lead had used the more conventional FIFO. Taxpayer in turn is wholly owned a foreign corporation, which is a lower-tier subsidiary of Foreign Parent. Subsidiary, also a U.S. corporation, is a wholly-owned subsidiary of taxpayer and is a member of taxpayer’s consolidated group. Subsidiary uses the LIFO method to account for its inventory for U.S. federal income tax purposes. Foreign Parent is a corporation organized under the laws of a foreign country. Under the Accounting Periods and Methods, a taxpayer that uses LIFO for tax purposes must use a LIFO method in computing book income. Accordingly, financial statements issued to shareholders, creditors, or other parties must reflect income based on inventory computed under a LIFO method.
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In early 1974, the taxpayer, pursuant to a loan application, forwarded various financial materials to the First National Bank of Cincinnati , including certain accountants’ worksheets that were to be used in preparing the taxpayer’s financial statements for the year ending December 31, 1973. In considering the fate of LIFO, it is important to remember that the objectives of the Code and the objectives of financial reporting are not. More importantly, GAAP does not have authority over U.S. income tax law.
As previously discussed, a taxpayer using LIFO for taxes must use LIFO for financial reports. A problem arose if market declined below the book value of the inventory. If no write down was permitted on the balance sheet, the inventory was overstated. If auditors refuse to certify the financial statements of a company that uses LIFO inappropriately, the company would have to use FIFO for financial statements and would not be able to use LIFO for tax purposes. Congress believed it was thus ensuring that LIFO would be used only where appropriate. It should, however, be pointed out that, in 1953, the above passage was eliminated from Accounting Research Bulletin Number 29. This omission means that the accounting profession rejected the premise that LIFO should be used only under appropriate conditions.
GAAP with iGAAP has made a great deal of progress to date, there are still many issues yet to be addressed, including the fate of the LIFO method. For over a decade, FASB and the IASB have had an ongoing agenda of projects, the objective of which is to move the process of convergence forward. For the period 2006– 2008, numerous convergence-related issues were identified as either being on an active agenda or on a research agenda prior to being added to an active agenda. However, the issues of LIFO and inventory valuation in general are not included on the active or the research agenda of either board. One of the biggest challenges in using LIFO is the need to measure changes in inventory costs. If you currently use LIFO, you may be able to enjoy additional savings by electing to use the inventory price index computation method.
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In the period of rising inventory value, the company was under no pressure to increase dividends and wages. When inventory values fell, National Lead was able to continue paying its dividend since it had maintained its liquidity when inventory values rose.17 The company was thus satisfied that the base stock method stabilized earnings. However, what is the accounting treatment when ending inventory, due to unforeseen shortages or other factors, is less than base stock? If base stock is depleted, the goods sold are regarded as being borrowed from the base stock. Since the goods returned to the base stock will have to be bought at current market price, the current market value of the deficiency is charged to cost of goods sold and subtracted from the inventory.
One significant instance in which such a link does exist is Sec. 472, the LIFO conformity requirement. This article examines whether the time has come for online bookkeeping Congress to sever that link between tax and financial reporting of inventory. Did National Lead Company benefit from the use of the base stock method?
In summary, if Congress had intended that the Certified Public Accountant make sure that LIFO was only used appropriately, the intention was thwarted. Many people complained that the Act was poorly drafted.34 The inclusion of only certain industries was considered especially unfair.
As prices rise, companies prefer to apply LIFO for tax purposes because this assumption reduces reported income and, hence, required cash payments to the government. In the United States, LIFO has come to be universally equated with the saving of tax dollars. When LIFO was first proposed as a tax method in the 1930s, the United States Treasury Department appointed a panel of three experts to consider its validity. They eventually agreed to recommend that LIFO be allowed for income tax purposes but only if the company was also willing to use LIFO for financial reporting. A taxpayer may be required to reconcile differences between the value of inventories maintained for credit or financial reporting purposes and for Federal income tax purposes in order to show that the taxpayer has satisfied the requirements of this paragraph.
- Why did Congress, when it made the LIFO method available to all taxpayers, include a subsection requiring conformity of method?
- This does not result in an emasculation of the statute, particularly in light of its past interpretation, supra.
- With its 1973 federal income tax return, plaintiff filed a Form 970, Application to Use LIFO Inventory Method.
- Since for all other taxpayers write-downs to market are fully tax deductible, why should the LIFO taxpayer be discriminated against?
Later in September, Powell issued revised reports which included a balance sheet and a statement of earnings and retained earnings in LIFO. At this time, the taxpayer asked its shareholders to return the original 1973 annual report. Ultimately, seventeen of the original thirty-nine reports distributed were returned. Switching to LIFO may reduce your tax bill, but it could also depress your current earnings and reduce the value of inventories on your balance sheet, thus giving the appearance of a weaker financial position. With respect to such inventories treated a business combination for credit or financial reporting purposes in a manner different from the treatment of the business combination for Federal income tax purposes. The IRS recently examined a case where the LIFO conformity rules and IFRS standards came into conflict. This issue will become more relevant as IFRS and generally accepted accounting principles convergence becomes a reality in the next few years.
Any method relating to the classification of an item as inventory or a capital asset. Accounting Today is a leading provider of online business news for the accounting community, offering breaking news, in-depth features, and a host of resources and services. The Big Four firm issued its 2021 audit quality report Monday, pointing to progress on auditor independence, along with issues such as diversity and inclusion. Obviously, the early proponents of LIFO did not envision a LIFO-Retail.
Taxpayers With Rising Inventory Costs May Benefit From Lifo
The disallowance of the use of LIFO for tax purposes would result in a large current tax bill for many of the companies that use the method. One popular technique — the last-in, first-out method — assumes that merchandise is sold in the reverse order it was acquired or produced. Although this method is often preferred for tax purposes, internal accounting personnel may be hesitant to use it for various reasons.
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The taxpayer shall file an application to use such method specifying with particularity the goods to which it is to be applied. BDO USA LLP reported revenue of $2,000,300,000 for the fiscal year ending April 30, 2021, a year-over-year increase of 10.9%. The key to more useful information about inventory is getting Congress out of the accounting standard-setting arena. A realized holding gain or loss for the difference between the FIFO and LIFO cost of goods sold .
Method Lessons Learned
Obviously, a company will not publicize its use of an accounting method that has doubtful tax validity and favorable tax conse-quences. The avoidance of publicity explains the difficulty of pinpointing the exact beginnings of the base stock method. The benefit of a LIFO election in 2010 can be illustrated with a simple example. Assume a company with an inventory of synthetic rubber products elects the LIFO method and chooses to use a simplified method of determining the LIFO adjustments under the Bureau of Labor Statistics inflation index for synthetic rubber products.