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Best LIFO Practices

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Best LIFO Practices

  • Best LIFO Practices
  • LIFO Election Requirements
  • LIFO Methods Alternatives & Pros/Cons

Best LIFO Practices

  • Accounting Methods & Calculation Approach Alternatives

    There are a variety of LIFO “submethod” alternatives available, and in some cases, there are material differences in the recurring administrative burden & long-term tax benefits amongst the various submethod options. Listed below are the most notable submethod alternatives & LIFOPro’s best practices feedback.

    • LIFO value pricing method
      • Specific goods (“unit LIFO”): LIFO value of inventory is accounted for at the item level. Unit costs & the physical flow of goods are tracked on a LIFO basis within accounting system
      • Dollar-value: Under this method, the LIFO value is accounted for as a top-side adjustment rather than at the item level. Unit costs & the physical flow of goods are tracked at actual cost (FIFO, average cost or specific ID) or standard cost. Side computation made outside of accounting system to calculate inflation, layers (decrements), inventory @ LIFO, LIFO reserve & LIFO expense (income)
      • Best practice: Use dollar-value LIFO because it avoids many undesirable characteristics of LIFO & offers materially higher long-term tax benefits when compared to unit LIFO
    • LIFO index computation timeframe selection
      • Link-chain: Current quantities are extended against current & prior period item/unit costs to calculate current year inflation index (one year measurement period)
      • Double-extension: Current quantities are extended against current & base period unit costs to calculate current year cumulative index (all years on LIFO measurement period)
      • Best practice: Use Link-chain LIFO because it’s absent of the inherent flaws built into double-extension method & link-chain precludes the need to reconstruct base year costs for new items
    • Inflation measurement source
      • Internal indexes: Current year inflation index measured using actual costs paid/incurred to acquire/procure the goods
      • External indexes: aka Inventory Price Index Computation or IPIC method. Bureau of Labor Statistics Consumer/Producer Price Indexes assigned to goods to calculate current year inflation index.
      • Best practice: Common to use the method that’ll provide the most inflation & favorable tax position, but many companies also consider the difference in overall calculation complexity/administrative burden & IRS audit risk when selecting their inflation measurement source (IPIC method is an IRS safe harbor method; internal index is not).
    • Pooling method
      • Resellers (retailers & wholesalers/distributors)
        • By line or class of goods
        • Natural business unit can be used in certain cases
        • IPIC pooling method
      • Manufacturers/producers
        • Natural business units (separate pool required for manufactured vs. purchased for resale goods)
        • Raw materials content
        • Multiple pools
        • IPIC pooling method
      • IPIC LIFO method users
        • IPIC Pooling method: pools established for each BLS major group with 5% or more of the total inventory balance at cost
        • Any non-IPIC pooling method listed above that matches your industry type ( i.e., manufacturers using IPIC method could use natural business unit pooling method)
      • Best practices
        • Utilize the method expected to create/require the least amount of LIFO pools to minimize likelihood of LIFO recapture caused by inventory liquidations
        • When possible, use of a single LIFO pool also greatly simplifies performing interim estimates
    • Current-year cost method
      • The required starting point used for all dollar-value LIFO calculations is the current year ending inventory value at cost. Accordingly, companies must use a cost flow method in their accounting system that approximates cost. The IRS term for this amount is called the Current-year Cost.
      • The determination of the Current-year cost is a critical step in determining the LIFO inventory value because it is needed to convert or deflate the current year end cost value of inventory to its base year cost, and subsequently inflate the base year cost to the LIFO inventory value.
      • Most companies using LIFO use the dollar-value method because it allows them to continue valuing their inventories within their accounting information system using the same cost flow method they’ve historically used (FIFO, average cost, standard cost, specific identification etc.).
      • The following cost flow methods can be used to determine the Current-year Cost:
        • Latest acquisitions cost (FIFO)
        • Average cost (aka moving/rolling/weighted average cost)
        • Earliest acquisitions cost (“EAC”)
        • Specific identification cost (“Specific ID”)
        • Standard cost (year end adjustment required to adjust to actual cost i.e. average cost or FIFO)
      • Best practices
        • First-time elections: Use the same method employed by accounting system to track item costs prior to electing LIFO to prevent wholesale changes to accounting system or IT burden associated with measuring multiple methods
        • Existing LIFO elections
          • Companies using all methods other than EAC: Continue using existing method
          • Companies currently using EAC
            • Most companies using EAC cost are doing so for LIFO purposes (because EAC creates a bigger LIFO tax benefit than other methods when an increment occurs)
            • Many companies are also using a shortcut to approximate EAC as opposed to maintaining costs at EAC within their accounting system for the following reasons:
              • Maintaining true earliest acquisitions costs within existing accounting information system is difficult or not possible
              • Accounting system uses average EAC is only being used for LIFO purposes
            • Many companies using EAC are actually tracking costs on a FIFO, average cost or standard cost basis in their accounting systems for the following reasons:
              • These methods are compatible with all accounting information systems
              • FIFO, average cost or standard cost provides more accurate information for internal management functions such as purchase/sales forecasts/planning
            • Companies using IPIC method: Change to FIFO, average cost or standard cost because IRS prohibits the use of EAC when using the IPIC method
            • Companies using non-IPIC method: Consider changing to FIFO, average cost or standard cost because it reduces the administrative burden & eliminates IRS audit risk associated with using shortcut to approximate EAC (See Technical Advice Memorandum 9853003 that concludes using an approximation of EAC is impermissible)
  • New Item Inflation Treatment Approach When Using Internal Indexes

    Using the costs of the goods paid to suppliers and vendors to measure inflation for LIFO calculation purposes is known as internal indexes. Inflation is measured by double extending current quantities against the current & prior period’s unit costs, and the sum of the current & prior period’s extensions are divided to calculate a current year inflation index. Since prior year unit costs don’t exist for new items, it’s critically important to understand the new item inflation treatment alternatives. This is especially important when new items represent a material value. A background & best practices are described below.

    New Item Inflation Treatment Background

    • New items are generally considered to be any good entering the accounting information system for the first time beginning with the current year end (was never carried in a prior period)
    • IRS Regs. requires all goods valued under the LIFO method to be included in the inflation calculation regardless of if the item is preexisting or new. Furthermore, the IRS has provided formal guidance in many past instances concluding that excluding new items from the inflation calculation is impermissible (although it’s not uncommon to use a sample population to calculate inflation where less than 100% of the goods are included in the inflation calculation, the IRS has taken the position that it’s impermissible to use a judgmental sampling method that defines sample population for the inflation calculation as preexisting items only).
    • IRS Regs. provides the following options for establishing a prior year unit cost for new items:
      • Zero inflation: New item’s prior year unit cost is set equal to the current year unit cost, which results in a current year inflation index of 1.0 (zero inflation)
      • Reconstruct prior year unit cost using a “reasonable method” (See §1.472-8(e)(2)(iii))
    • Using the zero inflation approach can materially reduce the inflation & resulting LIFO tax benefit when there’s a high percentage of new items. For example, assume there’s $20M of inventory at FIFO cost, 10% preexisting item inflation & 25% of the total inventory balance are new items. If the zero inflation approach was used, the weighted average inflation rate would be 7.3% & would result in roughly $730K of LIFO expense, which is about $270K less than the $1M of LIFO expense that would’ve occurred if all goods had a 10% inflation rate (LIFO expense = CY vs. PY LIFO reserve increase; represents current period’s taxable income reduction from LIFO).

    New Item Inflation Treatment Best Practices

    • Determine if the prior year unit cost may be available in your accounting – In many cases, companies reference the prior period’s inventory listing to lookup the prior year cost to the current period’s inventory report. When this is the case, any preexisting item that was not in stock at the end of the prior year may not have been included in the prior year’s inventory report. If this is the case, a new prior year inventory report should be generated that lists all items and their unit costs regardless of quantity on hand.
    • Reconstruct new item cost using a reasonable method: A common approach is using the current year inflation index of preexisting similar items to deflate the current period’s unit cost to its prior year unit cost, which can be done as follows:
      • If accounting information system has preexisting inventory classifications or groupings – Determine if the items within these classes/groups have similar cost characteristics (modifications should be made the accounting system classes/groups if items with materially different cost behaviors exist amongst a single class/group)
      • If accounting information does not have preexisting inventory classifications or groupings – Create a product classification or grouping system where items with similar cost characteristics are placed into their own classes (It’s important for the items placed into classes/groups have reasonably or sufficiently similar cost behaviors)
      • Create a preexisting item inflation by class/group schedule – Within this schedule, generate the sum of the current & prior period’s extensions for the preexisting items only for each class/grouping, and calculate the current year index of each class/grouping by dividing the current & prior year extension for each class/grouping
      • Map preexisting item current year index to all new items by class/group – Map the current year index for each new item calculated in the preexisting item inflation by class list using the new item’s class as the lookup value and calculate each new item’s prior year unit cost by dividing the current year’s unit cost by the preexisting current year index calculated for the new item’s class
    • Use zero inflation approach for remaining items after employing the approaches described above
  • Auto Dealer Best LIFO Practices

    As an industry, auto dealers are one of the most predominant LIFO users. This is much in thanks to the consistent historical inflation that exists in the automobile industry. Most dealerships are eager to maximize tax deferral & minimize taxable income by using LIFO because of the profitable nature of the industry. There are a wide range of method alternatives & calculation options, so it’s critical to understand the various options available, and the best practices to employ, which are listed below.

    LIFO Election Scope – Background

    • Most auto dealers usually only include new vehicles in their LIFO election. This is often because the dealers carry lower of cost or market (LCM) reserves for their used vehicles and parts (aka write-downs or mark-downs).
    • During the COVID pandemic, most auto dealers recaptured most or all of their used vehicle LCM reserves/write-downs as a result of the supply chain disruptions. During this time, the supply shortages also created record high used vehicle inflation, and many auto dealers expanded their LIFO election scopes to include used vehicles to offset their used vehicle LCM reserve/write-down recapture, and to also establish a consistent long-term means of growing their LIFO tax benefits (more goods on LIFO = higher LIFO tax benefits).

    The long-term LIFO tax benefits will outpace the long-term LCM reserve tax benefits because the LIFO tax benefits will grow in perpetuity when there is inflation (even if the inventory balance doesn’t increase). Contrarily, the LCM reserve tax benefits only increase when inventory levels grow and/or more vehicles are reserved or written down, and they actually decrease or are recaptured every time that a vehicle with a reserve is sold (LCM reserve is directly tied to each vehicle) . Conversely, the LIFO reserve remains intact when vehicles are sold as long as additional vehicles replace the sold vehicles by the end of the year. Said another way, the LIFO reserve is not tied directly to each vehicle, but instead based on the total dollar-value, which is why most companies use the dollar-value method, and not the specific goods or unit LIFO method which ties a LIFO value to each item.

    Note: a common misconception is that companies are using  specific goods or unit LIFO when they are in fact using the dollar-value LIFO method, and are using the “specific identification” or specific ID method to determine their year end inventory balance at cost i.e. Current-year Cost. Nearly all companies use dollar-value LIFO because the tax benefits are materially higher than the unit LIFO method.

    LIFO Election Scope – Best Practices

    The recommendations for the scope of the goods to be valued using LIFO is dependent on the inflation measurement source used by auto dealers because there are differences in the way that inflation can be measured amongst the alternatives. The best practices are broken out by the two available inflation measurement sources:

    • Auto dealers using the IPIC method: The best practice is to include all goods in the LIFO election scope if Producer Price Indexes are used because PPIs are calculated from surveys collected by the vehicle OEMs, meaning they only represent new vehicle price changes, and exclude used vehicles from the inflation calculation. Since new vehicles have historically had higher inflation frequency than used vehicles, the same LIFO tax benefits available for the new vehicles using PPI will be created if the used vehicle are included in the LIFO election scope. Also, there is a single BLS PPI for parts, making it extremely easy to include parts in the LIFO election scope & maximize LIFO tax benefits.
    • Auto dealers using alternative LIFO method (ALM): Most will likely be better off with a selective LIFO election scope because although tax benefits can be obtained from including the used vehicles in the LIFO election scope, the used vehicle ALM inflation has been much more volatile historically, and is much more representative of the used car market since the prices are measured from the used vehicle price books (black book or KBB).

    Inflation Measurement Source Alternatives – Background

    Historically speaking, the alternative LIFO method (ALM) has been the most predominantly utilized auto dealer LIFO inflation measurement source because from the time of its inception in the early 1990s up until COVID, it created materially higher inflation & long-term LIFO tax benefits than the IPIC method. With that being said, the IPIC method was occasionally used during this time because it reduced the administrative burden & tight reporting deadlines associated with the ALM (IPIC only requires inventory balances by cars, trucks and parts to calculate inflation. ALM requires invoices for all vehicles on hand at year end along with a source for obtaining the prior period base vehicle cost to measure inflation, which can be extremely burdensome).

    Beginning with the COVID pandemic, the IPIC method inflation became initially comparable with the ALM. In 2021 and 2022, the IPIC method inflation became materially higher than the ALM, and because of this, sizably higher LIFO tax benefits were there for the taking by willing participants. As a result, a huge influx of accounting method changes were made by auto dealers to switch from the ALM to the IPIC method in 2021 & 2022. Additionally, many auto dealers who were making the change from the ALM to the IPIC method were also expanding their LIFO election scope to include used vehicles to take advantage of unprecedented inflation & LIFO tax benefits (and also to offset or eliminate LIFO recapture that had been or was occurring due to the material vehicle liquidations caused by the supply chain disruptions). The switch to the IPIC method was essentially a slam dunk for many auto dealers when the additional tax benefits were paired with the promise of significantly reduced administrative burden, expedited LIFO reporting and lower outsourcing costs.

    As of today, there is wide-spread usage of both the alternative LIFO method and the IPIC method. As of 2024, the inflation differential & LIFO tax benefits for the upcoming year end is sometimes comparable or better for the IPIC method, but just as often can be more beneficial when using the ALM (BLS PPI inflation is 2%; ALM new vehicle inflation is wide ranging from flat to 1% – 2% inflation). With that being said, the alternative LIFO method will always carry higher administrative burdens, outsourcing costs, and longer LIFO reporting turnaround times compared to the IPIC method, so the best practices regarding the inflation measurement source will be dependent on the specific wants and needs of each dealer. An overview of the two alternatives are provided below.

    • Alternative LIFO method (ALM): Measures inflation based on comparing current & prior period’s invoice costs for all vehicles on hand at year end; Item definition are the model codes.
      • Pros
        • Historically created more inflation & LIFO tax benefit than IPIC method until 2020
        • IRS safe harbor method & used by many auto dealers since its inception
      • Cons
        • Delays booking annual year end LIFO adjustment & integrating into P12 financial statements compared to IPIC method because the calculation requires for invoices of all vehicles on hand at year end to be available to complete calculation
        • Higher outsourcing costs than IPIC method
        • Interim estimates take more time than IPIC method since inflation is measured by invoice cost
        • Not eligible for heavy duty trucks with GVWR > 14K lbs. (only light duty trucks are eligible; unlike IPIC method which is eligible to be used for all vehicles)
        • Year end calculations require more turnaround time since inflation data typically isn’t available until after year end
      • IPIC method: Measures inflation by using Bureau of Labor Statistics Consumer/Producer Price Index (BLS CPI/PPI); Item definition is the BLS categories (1. Cars 2. Trucks, SUVs & minivans 3. Parts)
        • Pros
          • Expedites booking annual year end LIFO adjustment & integrating into P12 financial statements because invoice-level detail is not required (all that is required to complete calculation is summarized balances by type i.e. cars, trucks & parts)
          • Annual year end LIFO adjustment can be further expedited by using an inflation measurement period that’s 1 – 2 months prior to the year end. For example, a company with a December year end could perform their year end calculation on January 1st by using November BLS CPI/PPI
          • Interim estimates can be easily performed on demand since they can be made using the most recent BLS index release
          • Can be used for all vehicles, including heavy-duty trucks with GVWR > 14K lbs. (unlike ALM which is only eligible to be used for light-duty trucks)
          • Lower outsourcing costs than ALM
          • Year end calculations can be completed more quickly than ALM calculations since an appropriate month other than the year end month can be used to complete inflation calculation (i.e. November PPI can be used for December year end)
          • IRS safe harbor method & has grown exponentially in popularity over the last three years
        • Con: Prior to pandemic, created less inflation & tax deferral than ALM

    Inflation Measurement Source: Best practices

    • Dealers not on LIFO:
      • Electing LIFO in 2024 will likely create meaningful tax benefits this year
      • Based on the 1.6% year to date BLS PPI inflation using the IPIC method, LIFOPro expects the 2024 year end tax benefits to be higher if using the IPIC method, but comparative analysis should be performed
      • Dealers who elect using IPIC method can switch to the ALM immediately using automatic change procedures. For example, if ALM inflation & LIFO tax benefits are materially higher in the second year on LIFO, dealer can change from IPIC to ALM using automatic change procedures and apply the new method changes prospectively, which will keep pre-change LIFO reserve locked in place & start accumulating new method LIFO tax benefits beginning in year of change.
    • Dealers on LIFO:
      • Continue using ALM if only new vehicles and/or parts are included in the LIFO election scope unless the desire to minimize administrative burden, expedite LIFO closing process & minimizing outsourcing costs is greater than the desire to maximize LIFO tax deferral
      • Switch to IPIC method from ALM could create materially higher tax benefits than ALM by expanding LIFO election scope to include used vehicles and/or parts
    • All Dealers
      • LIFO tax benefits will likely be maximized by electing IPIC method if used vehicles included in election scope
      • Long-term LIFO tax benefits will likely be maximized by using alternative LIFO method if LIFO election scope is limited to new vehicles or new vehicles and parts (used vehicles excluded from LIFO election scope)
      • IPIC method reduces admin. burden, expedites booking LIFO journal entry & minimizes outsourcing costs
      • Change to/from IPIC method is automatic approval & is applied prospectively beginning of year of change (deadline for making the change is the extended return filing deadline)
      • Dealers on already LIFO changing from ALM to IPIC & vice versa after their 2nd year must remain on the new method for 5 years prior to switching back to the old method. For example, a dealer who has been on LIFO using ALM since 2012 switched to the IPIC method in 2021. This dealer must use the IPIC method from ‘21 – ‘25 & can’t switch to the ALM under automatic change procedures until the 2026 year end.
      • Auto dealers using the IPIC method can use CPI OR PPI (not just CPI like many believe!). Because of this,
      • Many dealers using IPIC CPI have switched to PPI in 2023, and even more will do so in 2024 because PPI inflation & LIFO tax benefits have been materially higher than CPI used vehicles inflation

     

    Bureau of Labor Statistics Auto Dealer Producer/Consumer Price Index Inflation History

  • Accounting for LIFO Errors

    When an error or series of errors occur in the LIFO calculation, the corrective actions available and/or required to be made are dependent on the frequency of the error (if the error occurred once or in multiple consecutive periods). Separate GAAP or financial reporting and tax rules also apply when accounting for LIFO errors, which are outlined below.

    • Financial reporting LIFO error treatment
      • All LIFO errors should be corrected regardless of if it only occurred once or if it occurred in multiple prior periods
      • Retrospective accounting is required for LIFO errors resulting in a material change
      • Extent of restatement and/or adjustment will likely be dependent on the extent/materiality of the error & the practicability of correcting the error
      • May require for separate book/tax LIFO calculations since error can be corrected for book, but not for tax
      • Best practices:
        • If issuing audited or reviewed GAAP financial reports: If practicable, correct error beginning in the first period that the error is made & apply prior period adjustments to next financial report
        • If not issuing audited or reviewed GAAP financial reports: Follow tax treatment of error
      • Tax LIFO error treatment
        • Errors made on two or more consecutive year end tax returns
          • Considered a change in accounting methods: Although permission was not requested by the taxpayer nor granted by the IRS, any LIFO error reported on two or more consecutive period’s tax return is the equivalent of adopting a new LIFO calculation method
          • Error can not be corrected by filing an amended return
            • All LIFO method changes are applied on a cutoff basis (prospective change), meaning the new or proposed method is used beginning in the year of the change
            • Since all LIFO method changes are applied on a cutoff basis, no prior period adjustments to account for the pre vs. post change tax liability is required (§481(a) adjustment not permitted)
          • Automatic consent procedures do not exist to correct LIFO-related errors
            • Most of the automatic LIFO-related accounting method changes relate to changes to or within the IPIC method (external index; using Bureau of Labor Statistics Consumer/Producer Price Index)
            • The LIFO error will remain locked in place even if a LIFO-related accounting method change is made because all LIFO accounting method changes are applied on a cutoff basis
          • Best Practices
            • Internal index: Switch to the IPIC method if an internal index is presently used
              • IPIC method is an IRS safe harbor method. This means upon changing to the IPIC method, taxpayers receive audit protection from all prior period LIFO errors, LIFO-related taxable income overstatement/understatements
              • Ideal when error(s) resulted in a LIFO reserve overstatement & tax liability understatement since audit protection precludes IRS from proposing unfavorable adjustment
              • Automatic approval to switch to the IPIC method & requires no IRS users fee (only requires an IRS Form 3115/970 to be filed)
              • Change can be made after the close of the year end and the Form 3115/970 filing deadline is the same as the extended return filing date
              • Change to the IPIC method is made on a cutoff basis i.e. prospective change applied beginning in the year of change, so no prior period adjustments are required nor permitted (IRS requires layer rebasing, but this does not affect the LIFO reserve)
            • Make a change within the IPIC method if the IPIC
            • Automatic change procedures apply for change to the IPIC method
              • Change can be made after the close of the year end and the filing deadline is the same as the extended return filing date
              • Change to the IPIC method is made on a cutoff basis (prospective change applied beginning in the year of change), so no prior period adjustments are permitted
              • Ideal when error(s) resulted in a LIFO reserve overstatement & tax liability understatement since audit protection precludes IRS from proposing unfavorable adjustment
            • One-time errors
              • Are NOT considered a change in accounting method
              • Some companies choose to correct the error immediately upon discovery by applying the correction to the LIFO calculation for the next period to be closed & running the error through the next tax return to be filed
              • Best practice: Can & should be corrected by filing an amended tax return if the error is discovered by or before the later of 1. Within three years from the original filing date of the return that included the error 2. Two years from the date the tax liability for that return that included the error was paid.

LIFO Election Requirements

  • LIFO Election Requirements
    • Financial reporting & tax
      • Inventories must be valued on both the financial statements & tax return using LIFO beginning in the year of adoption & in subsequent periods – For example, if inventories were valued using LIFO on the 12/31/2021 tax return, then the 12/31/2021 financial statements must also report inventories at LIFO. This remains true in perpetuity until the LIFO election were to be terminated. This is the first of two requirements related to the LIFO conformity rule.
      • Scope of goods valued under LIFO for tax purposes can not be greater than the financial reporting scope –  This is the second requirement of the LIFO conformity rule. The LIFO election scope is the term used to describe which goods are included in the LIFO election. Selective elections can be made where portions of inventories are valued using LIFO & the remaining inventories are valued using methods other than LIFO. Although companies are allowed to make selective elections, the goods valued under LIFO for tax purposes must be equal to or less than the goods valued under LIFO on the financial statements. For example, if a chemicals manufacturer valued its raw materials & finished goods under LIFO on the tax return, it could not value the finished goods under LIFO & raw materials under FIFO on the financial statements.
    • Tax only
      • Beginning & ending inventories must be valued at cost in the year of LIFO election & subsequent to adoption – For financial reporting purposes, LIFO inventories can be valued at the lower of cost or market aka LCM (inventories valued under all other non-LIFO methods must be valued at the lower of cost or net realizable value). For tax purposes, LIFO inventories must be valued at cost, and can not be valued at the lower of cost or market. This is important to understand because many companies maintain inventory reserves other than a LIFO reserve such as LCM excess, obsolete (E&O) & slow-moving inventory reserves. Although these reserves are allowed to be maintained for financial reporting even after LIFO is elected, for tax purposes, no inventory-related reserves are allowed to be maintained for goods valued under LIFO.
      • Write-downs & the preexisting inventory reserves must be restored into income over a three year period via a §481(A) adjustment – For financial reporting purposes, companies can continue to maintain any non-LIFO related inventory reserve subsequent to adoption. For tax purposes, companies must restore those reserves into income over a three year period & can no longer apply write-downs to inventories valued under LIFO.
      • Must remain on LIFO for at least five tax year ends in order to terminate LIFO under automatic consent procedures – Although a LIFO taxpayer could terminate its LIFO election beginning in it’s second year on LIFO, it would be required to file an advanced approval Form 3115 by or prior to their tax year end & pay an $11,800 IRS user’s fee. The same would be true until a company’s sixth year on LIFO as this accounting method change falls under the IRS five-year change rule.
      • Must wait five years to reelect LIFO after terminating LIFO election – A LIFO taxpayer seeking to do the opposite of the above bullet would be prevented from reelecting LIFO in less than six years under the same IRS five-year change rule.
    Requirement

    Financial Reporting

    Tax
    IRS Form 970 Application to Use LIFO Inventory Method & statement attachment must be filed with federal tax return in year of adoption

    Opening (beginning) inventories must be valued at cost for a company’s first year on LIFO

    Ending inventories must be valued using FIFO, earliest acquisitions or average cost

    Must be used for financial reporting & tax purposes for all periods beginning in year of election

    Financial reporting LIFO election scope must be equal to or greater than Tax scope (i.e. goods on LIFO for tax purposes can not be greater than what is on LIFO for financial reporting)

    Prior lower of cost or market writedowns must be restored through income over a three-year period

LIFO Methods Alternatives & Pros/Cons

  • LIFO Method Alternatives
    • LIFO Value Pricing Method:
      • Dollar value method– A shortcut cost flow method which measures inventory layers in terms of dollars rather than physical units. Inventory items are grouped by pools and are priced in terms of each pool’s aggregate base year cost. The result is compared to each pool’s aggregate base year cost at of the end of the prior year to determine whether the inventory levels have increased or decreased.
      • Specific Goods Method (Unit LIFO)– An approach to applying LIFO in which changes in the quantity of individual types of inventories are the basis for determining whether the inventory levels have increased or whether a portion of the existing inventory has been liquidated.
    • LIFO Election Scope: can be selective (by stage of production, product groups, departments, business segment, parent on LIFO but subsidiary is not, etc.) with these exceptions:
      • Manufacturers using Natural Business Unit Pools (NBU)
      • If IRS Technical Advice Memorandum would prevent selective elections within IPIC pooling method
    • Item Definition Method:
      • Individual items
      • Fungible commodities measured in gallons, pounds, board feet, etc.
    • Inflation Comparison Period:
      • Link-Chain Method-Compare current year-end prices to prior year-end prices
      • Double-Extension Method-Compare current year-end prices to base-year prices
    • Current Year Cost & Layer Valuation Method:
      • Latest acquisitions (FIFO)
      • Earliest acquisitions
      • 12-month moving average or rolling-average (i.e. weighted-average or average cost)
    • LIFO Pooling Method:
      • Resellers (retailers & wholesalers)-By line, type or class of goods
      • Manufacturers:
        • Natural Business Unit pools (separate pool required for parts purchased for resale)
        • Raw materials content pools
        • Multiple pools
      • IPIC pooling method using Consumer/Producer Price Index major groups (for IPIC method taxpayers)
    • Inflation Measurement Source:
      • Internal indexes:
        • All inventory items used
        • Representative sampling (index method)
      • External indexes – IPIC method:
        • BLS Index Selection:
          • Consumer Price Indexes (CPI)
          • Producer Price Indexes (PPI)
        • Index timeframe selection:
          • Final Indexes
          • Preliminary Indexes
        • Discontinued categories treatment:
          • Compound inflation method
          • Substitute index method
        • Weighted-Average pool index calculation method:
          • 10% method
          • Most detailed category method
  • LIFO Submethod Pros & Cons

     

    Submethods Best Practices

    • Inflation index computation method
      • Specific goods (“unit LIFO”): LIFO value of inventory is accounted for at the item level. Unit costs & the physical flow of goods are tracked on a LIFO basis within accounting system
      • Dollar-value: Under this method, the LIFO value is accounted for as a top-side adjustment rather than at the item level. Unit costs & the physical flow of goods are tracked at actual cost (FIFO, average cost or specific ID) or standard cost. Side computation made outside of accounting system to calculate inflation, layers (decrements), inventory @ LIFO, LIFO reserve & LIFO expense (income)
      • Best practice: Use dollar-value LIFO because it avoids many undesirable characteristics of LIFO & offers materially higher long-term tax benefits when compared to unit LIFO
    • Inflation index computation timeframe selection
      • Link-chain: Current quantities are extended against current & prior period item/unit costs to calculate current year inflation index (one year measurement period)
      • Double-extension: Current quantities are extended against current & base period unit costs to calculate current year cumulative index (all years on LIFO measurement period)
      • Best practice: Use Link-chain LIFO because it’s absent of the inherent flaws built into double-extension method & link-chain precludes the need to reconstruct base year costs for new items
    • Inflation index computation source
      • Internal indexes: Current year inflation index measured using actual costs paid/incurred to acquire/procure the goods
      • External indexes: aka Inventory Price Index Computation or IPIC method. Bureau of Labor Statistics Consumer/Producer Price Indexes assigned to goods to calculate current year inflation index
      • Best practice: Common to use the method that’ll provide the most favorable tax position (inflation), but ultimately varies by industry, product mix & many other company-specific considerations
    • Current-year cost & layer valuation method
      • Latest acquisitions (FIFO), 12-month moving average or rolling-average cost (aka weighted average cost), Earliest acquisitions, specific ID or other method that’s clearly reflective of income
      • Best practice: For first-time elections, use the same method employed by accounting system to track item costs prior to electing LIFO to prevent wholesale changes to accounting system or IT burden associated with establishing a new method or employing multiple methods purely for the purpose of LIFO
    • Pooling method
      • Resellers (retailers & wholesalers/distributors): Line, type or class of goods
      • Manufacturers/producers
        • Natural business units (separate pool required for manufactured vs. purchased for resale goods)
        • Raw materials content
        • Multiple pools
      • IPIC LIFO method users
        • IPIC Pooling method: pools established for each BLS major group assigned 5% or more of the total inventory balance at cost
        • Any non-IPIC pooling method listed above that matches your industry type ( i.e., manufacturers using IPIC method could use natural business unit pooling method)
      • Best practice: Utilize the method expected to create/require the least amount of LIFO pools to minimize likelihood of LIFO recapture caused by inventory liquidations

      Learn more here: LIFO Methods, Rules & Regulations

Resources

2025 Tariffs & LIFO Tax Benefits Guide
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LIFO Election

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Best LIFO Practices

Your comprehensive resource for best LIFO practices, LIFO election requirements, and LIFO calculation approach alternatives!

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If the IPIC method is good enough for the IRS, it should be good enough for GAAP
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Using Bargain Inventory Purchases to Create Sizable LIFO Election Tax Benefits
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Use of External Inflation Indexes for Financial Reporting
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Financial Reporting & Tax Treatment of Change to LIFO Method
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CPA Firm Partnership Playbook
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Sec. 473 Relief Estimate Request Form
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Auto Dealer IPIC LIFO Case Study
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2025 LIFO Opportunities & Strategies Guide
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How LIFO Works: A Beginner’s Guide to LIFO
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How to Identify Clients that are Good LIFO Election Candidates
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Complimentary Interim LIFO Estimate Request Form
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Best LIFO Practices & Review
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Auto Dealer LIFO Case Study
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LIFO Election Benefit Analysis
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Downloads

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IPIC LIFO Guide

Get educated on the Inventory Price Index Computation (IPIC) method, including the origins, advantages & disadvantages, calculation procedures, options & much more!

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Service Organization Control Report

Learn how LIFO-PRO receives an annual review of our policies & procedures to provide required assurances to our clients.

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Secure File Upload Portal

Here you can send us all files needed for us to seamlessly give you the best LIFO results possible. We look forward to working with you!

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CPA Firm LIFO Opportunities & Training Guide

Learn about LIFO opportunities abound for CPA firms, how to increase the scope of your LIFO offerings & learn how to easily identify good LIFO candidates!

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Interim Estimate Options

Learn how to obtain interim LIFO estimates within our software or LIFO outsourcing solutions!

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Non-disclosure Agreement Request Form

Get a NDA generated electronically in less than a minute using LIFO-PRO’s online request form page & avoid having to print, sign & scan a paper NDA!

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IPIC LIFO Resources

Learn how the IPIC LIFO Method works, find valuable Bureau of Labor Statistics (BLS) links and stay up to date on all changes related to the IPIC Method!

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LIFO Success Stories

Learn about LIFOPro’s past roles in partnering with companies & CPA firms to deliver great value by finding solutions to the most challenging LIFO issues!

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IPIC LIFO Overview

The Inventory Price Index Computation (IPIC) method allows taxpayers to use published external indexes to calculate inflation for the purpose of valuing LIFO inventories.

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LIFO Authoritative Guidance

Your comprehensive resource for authoritative LIFO guidance, LIFO election requirements, and method alternatives!

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Supermarket Physical Count Procedures

Find helpful information on how IRS regulations effect grocery LIFO Count Procedures for CPI & PPI taxpayers on our Supermarket Count Procedures page.

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Special Challenges for Supermarkets

Supermarkets face LIFO calculation issues unique to the industry. Find out why & answers to how they are dealt with Special Challenges for Supermarkets page.

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Why the Double-extension LIFO Index Calculation Method is Unreliable

Facts describing why the double-extension LIFO index calculation method is unreliable and examples proving how this method creates unpredictable results.

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LIFO Training & Audit Guide

The LIFO Inventory Training Basics & Audit Guide provides detailed LIFO calculation steps, LIFO documentation procedures, internal controls & audit best practices.

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Addition of Services Table 9 Codes

Find recent important changes & BLS addition of Table 9 Wherever-provided Services & Construction PPI Indexes & Important Change in PPI Code Structure page.

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CPI Category Updates

Find information on CPI Category Changes & Bureau of Labor Statistics Consumer Price Index update information such as new medical commodity codes here!

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PPI Category Updates

Learn IRS Regulations Requirements for missing PPI Indexes, procedures for reassigning discontinued PPI Categories at LIFO-PRO’s PPI Category Changes page.

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Producer Price Index Usage by Supermarkets to Increase Tax Deferral

Learn how drugs, non-foods & food/beverage indexes cause increase LIFO tax benefits at our PPI Index Usage by Supermarkets to Increase Tax Deferral page.

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Consumer/Producer Price Index Inflation History

Get the most up to date Bureau of Labor Statistics Consumer & Producer Price Index inflation data from LIFOPro!

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IPIC LIFO Advantages

Switching from the double-extension to link-chain method? Want to achieve higher possible inflation indexes? Learn more at the IPIC LIFO Advantages page.

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LIFO Repeal Updates

Get the latest LIFO repeal updates including the latest news on corporate tax reform at LIFO-PRO’s LIFO Repeal Updates page.

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Videos

LIFO-PRO Company Overview – Quick 1 minute video explaining LIFO-PRO’s service and software offerings.

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Request Forms Page

Request a software trial, LIFO Election Benefit Analysis, Best LIFO Practices Methods Review or cost estimate. All of our requests are complimentary & free of obligation!

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FAQ’s

View some of our frequently asked questions to learn more about LIFO

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LIFO Glossary

Accounting and financial professionals who work with LIFO need to understand the jargon associated with LIFO. Below are a number of LIFO-related terms.

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