Bob Richardson

About once every couple of years, we encounter a situation for which a taxpayer is making their LIFO calculation using the Specific Goods LIFO method (Unit LIFO is another name for this method). Using this method virtually guarantees lower LIFO benefits for a company. This is because when this method is used, LIFO is applied on an item-by-item basis. Using this LIFO method will result in substantially less LIFO tax deferral because LIFO layer erosions (causing reduction of previous years’ LIFO benefits) under this method occur for every item each year in which there are fewer units on hand at year end than at the prior year end because there is essentially a LIFO pool for each item. Any time that the year end quantity on hand of any item goes to zero, the LIFO reserve applicable for that item also goes to zero.

The Specific Goods LIFO method also becomes less practical to use the longer the method is used because the inventory accounting system must keep track of an ever increasing number of items and item cost values for many years but the most important disadvantage is the Specific Goods LIFO method LIFO reserve amounts are always far smaller than if dollar-value LIFO is used.

With the alternative Dollar-Value LIFO method, LIFO pools are established for broad types of goods (and often just one or two pools for manufacturers) so that increases and decreases in items on hand are netted together which results in far fewer LIFO layer erosions. Shown below is a table that shows the amount of LIFO reserve after 5, 10, 15, etc. of using LIFO that would remain when the Specific Goods LIFO method is used as a percentage of what the LIFO reserve would be using the dollar-value method assuming 2% inflation per year and inventory item turnover assumptions of 10% (10% of all items each year were not in inventory the prior year), 20% and 30% per year.

This table shows that the LIFO reserve for a 20% per year inventory item turnover ratio using the Specific Goods LIFO method LIFO reserve for 20 years is only 28% of what it would be had the dollar-value LIFO method been used and only 15% after 50 years. This table illustrates what a disaster the use of the Specific Goods LIFO method is and this method should be avoided at all costs.

Comparison of Specific Goods Method LIFO Reserve as a Percentage to the Dollar-Value Method

Years on LIFO10% New Item Turnover Rate20% New Item Turnover Rate30% New Item Turnover Rate

CPAs should be aware of situations for which their clients are using the LIFO inventory valuation option in an inventory accounting software application because this is a Specific Goods method.

The dollar-value method is utilized by the vast majority of LIFO taxpayers because the after-tax cash savings achieved when compared to the specific goods LIFO method is far greater. Furthermore, the LIFOPro software automates dollar-value LIFO calculations, meaning there’s a clear alternative available to other accounting software that only makes specific goods LIFO calculations. LIFOPro also provides turnkey outsourcing solutions that eliminates the hassle of dollar-value LIFO calculations altogether.

The fact that any inventory accounting software would offer a Specific Goods LIFO method cost flow option is hard to imagine but there are some that still do. The QuickBooks inventory accounting module had this capability 10 or more years ago but they wised up and no longer offer a LIFO cost flow option.