CPA Firm LIFO Opportunities & Training Guide

CPA Firm LIFO Opportunities & Training Guide

CPA Firm LIFO Opportunities Training Guide

Text Version

  • LIFO Opportunities Abound

    LIFO represents a valuable planning opportunity to companies for the following reasons:

    1. Increased cost of goods sold from using the LIFO method reduces net income & lowers amount of federal income taxes paid
    2. Reduced federal tax payments improves cash flow
    3. Considered to be annuity that annually accrues
    4. Can also be thought of as an interest-free loan that doesn’t have to be repaid unless a company liquidates their inventories or terminates LIFO election

    LIFO represents a valuable planning opportunity to CPA firms for the following reasons:

    1. Current clients who have been rewarded with the benefits of LIFO based on their firm’s recommendation will be more loyal to their CPA than those not provided such opportunities
    2. Prospective client proposals that present the tax savings & cash flow benefits of LIFO will be perceived as more attractive than competitor’s proposals that fail to provide such opportunities
    3. Offering both current & prospective clients turnkey LIFO calculation outsourcing solutions allows firm’s clientele to enjoy the benefits of LIFO while avoiding all the hassle of making the calculations

    There are tens of thousands of companies that are not on LIFO that should be. Reasons why this number is not as high as it should include:

    1. IRS Regs. are written by tax lawyers, are difficult to understand and LIFO reference materials are generally poor
    2. Many accountants consider the LIFO method to be a nuisance
    3. Companies & CPA firms lack the resources to easily determine the potential benefits of LIFO for clients or prospects that don’t currently use LIFO
    4. Companies & CPA firms find it difficult to complete LIFO calculations

    CPA firms are considered to be financial reporting and tax compliance gatekeepers to the clients they serve. Furthermore, they possess the potential to be the biggest advocates of LIFO to their clientele because accountants at most companies know little or nothing about LIFO. CPA firms exercising due diligence should consider LIFO analysis to be mandatory rather than an optional exercise as the lowered tax payments and improved cash flows from LIFO can play a key role in the growth and improved cash flow of their clients. Ideally, CPA firms should perform a preliminary LIFO analysis for all clients that have inventory.

  • Opportunities for CPA Firms to Improve Their Clients’ LIFO Situation
    1. Partial LIFO election where inflationary goods are excluded- LIFO should be used for all goods for which there is inflation.
    2. Using LIFO for goods with consistent deflation– Partial LIFO terminations can solve this problem for some companies.
    3. Using of the Double Extension rather than the Link-Chain method– The use of this method often produces LIFO inflation volatility and unexpected results; learn more by reading LIFO-PRO’s whitepaper Why the Double-extension LIFO Index Calculation Method is Unreliable.
    4. Use of Internal indexes instead of the IPIC method– The IPIC method is a better choice for almost all companies. Refer to the next section for further information.
    5. Use of Unit LIFO – Doing this almost always guarantees lower LIFO benefits for a company because LIFO is applied on an item-by-item basis. LIFO layer erosions (causing reduction of previous years’ LIFO benefits) occur for every item each year there are fewer units on hand compared to the prior year because there is essentially a LIFO pool for each item. With dollar-value LIFO, pools are established for broad types of goods so increases and decreases in items on hand are netted together which results in fewer LIFO layer erosions.
    6. Too many LIFO pools are used- The fewer the pools, the better to maximize tax savings and simplify the LIFO computations.
    7. Using pre-2002 IRS Regs. LIFO methodology- This may not only be a compliance problem but could prevent maximum tax savings.
    8. Using CPI indexes when PPI indexes produce higher inflation– This is an increasingly popular idea which has helped some retailers maximize their tax savings. Learn more on this subject at our LIFO blog: Use of PPI by Supermarkets to Increase Tax Deferral
    9. Using discontinued PPI categories– The categories for which the Bureau of Labor Statistics compiles indexes changes three times a year, and use of discontinued categories can cause LIFO calculation accuracy & consistency issues.
    10. IPIC pool index calculation errors– These errors are very common for companies who use more than a few PPI or CPI categories. Just obtaining these indexes can be an adventure.
    11. LIFO layer erosion calculation errors– The longer a company is on LIFO, the more likely these errors will occur usually as a result of incorrect layer erosion computations (i.e. decrement pricing).
    12. Using an incomplete “layers remaining only” LIFO layer history format-Carryforward schedules that don’t show the original current-year cost balances, indexes & LIFO layer for years for which those layers have been subsequently eroded is a common problem.
    13. Incorrect Sec. 263A costs capitalized- Proper integration of this computation with the LIFO layer history is required & the more years a company is on LIFO, the less likely errors are avoided (LIFO-PRO recently discovered a $5 million UNICAP cost overstatement in a company’s prior year LIFO calculation causing the net income reported on their tax return to be overstated by $5 million).
  • Why LIFO Methods are Seldom Optimized & Errors are So Common

    Although the new IPIC method LIFO Regulations issued in 2002 simplified LIFO computations for many taxpayers, the LIFO Regs. are not simpler to understand. This is because: 1) the number of new rules and calculation methods increased in the new Regs. and 2) the Regs. are written by Washington IRS Accounting Methods lawyers for whom plain speaking seems to be a foreign language. Aside from confusing IRS LIFO rules, one of the reasons LIFO errors are so common (we seldom review error free LIFO calculations) is that no one ever does enough LIFO calculations and IRS filings often enough to develop expertise in this area sufficient to ensure full advantage is taken of the tax saving benefits of LIFO and to provide assurance that the calculations are correct. Even the “LIFO experts” at the large CPA firms have limited hands-on experience because they concentrate mostly on accounting methods and compliance.

  • Common LIFO Errors

    General LIFO calculation errors

    • Incorrect decrement calculations – These are very common in spreadsheet LIFO schedules.
    • Incorrect calculation of Sec. 263A costs – For taxpayers for which these are an add-on costs to the calculation of Sec. 471 LIFO balances, errors are common for years in which there are decrements.
    • LIFO reserve balances don’t tie to detail – The current and prior year inventory at base and LIFO inventory balances should tie to the LIFO layer history carryforward schedule.

    Internal index calculation errors

    • Exclusion of new items in inventory – IRS LIFO Regs. specifically prohibit exclusion of items not in inventory the prior year(link-chain) or base year(double-extension) because doing so tends to overstate inflation. The Regs. allows the prior year or base year index to be set equal to the current year price, but this method understates inflation.
    • Using current year prices for prior periods – The easiest way to handle new items is to set the prior period item price equal to the current year item price. This method is allowable by the IRS but this method will understate LIFO inflation and the understatement can be significant especially for double-extension method taxpayers.
    • Improper representative sampling – The potential for errors of this nature are great and the likelihood of this type of error increases for taxpayers that have a diversity of inventory types and locations.

    IPIC Method pool index calculation errors

    • Wrong indexes or BLS weights looked up – The typical supermarket chain’s IPIC calculation, when performed correctly, will make use of approximately 60 (30 current year & 30 prior year) CPI indexes and 20 BLS Weights. This is a total of 80 numbers to be looked up, and there is almost always at least one error when these indexes are looked up manually.
    • Changes in makeup of CPI or PPI categories – There are frequent changes to the PPI Table 6 categories with numerous new categories added and deleted every year. Many taxpayers use the same categories year after year without determining whether indexes are still compiled for the categories used or whether they have inventories in categories added since the prior year end.
    • Inconsistent use of PPI Preliminary or Final Indexes – The IRS Regs. allow use of either preliminary or final PPI Table 6 indexes, however taxpayers are to consistently use either preliminary or final indexes. Most taxpayers use preliminary indexes, but accessing preliminary indexes on the Web is tricky since only final indexes are included in the BLS database available on the Web starting the fifth month after indexes are published.
    • Wrong indexes or BLS weights categories used – An example of this error is the use of the SAF116 Alcoholic beverages CPI category. This category includes SEFX Alcoholic beverages away from home as well as SEFW Alcoholic beverages at home . SEFX is not a commodity-only price index and should not be used. SEFW is the appropriate category to use in the LIFO calculation.
    • Incorrect 10% method rollups – Spreadsheets cannot handle the logic necessary to deal with situations where category indexes are to be calculated based on the 10% threshold being met when this level changes in subsequent years because of inventory mix changes. As a result, category indexes are often calculated at the wrong level.
    • Incomplete accounting of items actually present in inventory – A good example of this error is often seen for supermarket chains in their APPAREL commodities inventory. Because the APPAREL dollars are substantially less than 10% of total inventory, only the total APPAREL commodity dollars need be gathered. Most large supermarket chains carry only a few of the APPAREL commodity categories in inventory, so only the CPI indexes and BLS weights for those categories should be used for the APPAREL commodities index category index calculation. The shortcut commonly used, in error, is to use the overall APPAREL commodities index rather than the correct weighted average using the indexes and BLS Weights for the categories actually present in inventory.
    • Weighted average indexes – Various spreadsheet formula errors are common for both category indexes (using BLS Weights for the 10% method) and for the dollars weighted average pool index calculations.
  • Common LIFO Misconceptions
    1. LIFO complicates tracking inventory costs, purchases & sales within a company’s inventory accounting information system (AIS) – A company’s inventory AIS will track inventory costs, purchases & sales the exact same way even if they’re on LIFO as long as the dollar-value LIFO method is used (other option is “Unit LIFO”; vast majority of companies use dollar-value LIFO). This is because the IRS Dollar-value LIFO Regs. require the following:
      • Inventory costs are tracked throughout the course of the year using company’s costing method of choice (i.e. FIFO, weighted-average i.e. average cost)
      • Annual calculation completed after the close of the year end
      • LIFO Calculation occurs outside of the Accounting information system & manual adjustment made to general ledger to adjust cost of goods sold & ending inventory balances
    2. LIFO benefits will be minimal for companies with fast inventory turnover– Inventory turnover rate is irrelevant as the only amounts that impact the amount of LIFO benefit are the amount of inflation and year end inventory balances.
    3. Perpetual inventory systems & RFID tracking eliminate the benefits of LIFO – This myth is similar to the argument that LIFO benefits will be minimal for companies with fast turnover. The type of inventory and/or tracking system(s) used has no effect on dollar-value LIFO calculations because they’re performed at the end of the year.
    4. Companies inventory levels have to constantly increase for LIFO to be beneficial- Unless inventory values decrease significantly, the amount of inflation is a far more important determinant of LIFO expense (tax benefit) inventory balances; significant LIFO reserve increases are possible even with sizable inventory decreases. This fact holds true knowing that there are thousands of companies using LIFO with inventory balances that stay the same over long periods of time whom also retain significant tax savings from the use of the LIFO method.
    5. Low inflation rates will not produce significant LIFO benefits-Consistent positive inflation can produce sizable LIFO benefits for companies with significant inventories. Sizable LIFO benefits are also possible for companies with small inventories for which there is consistently high inflation.
    6. Book and Tax LIFO methods need to be consistent-This was true until the late 1970s but the IRS Regs. LIFO “conformity rule” was changed at that time to require only the conformity of the LIFO election scope (goods on LIFO). The Regs. specifically permit different book and tax LIFO methods.
    7. Valuation (Lower-of-Cost-or-Market) reserves provide as much or more benefit than LIFO-If this seems to be true for a company, the reserving method would not likely pass muster with the IRS. Furthermore, LIFO reserves will grow with continued inflation regardless of inventory value increases and this is not true of LCM reserves. LCM reserves must be taken into income when LIFO is adopted as a Section 481(a) adjustment but this is spread over 3 years. If the IPIC LIFO method is adopted, this provides taxpayers a “safe harbor” which prevents the IRS from challenging bad tax methods used in prior periods.
  • Who Should Use the LIFO Method

    Who Should Use LIFO

    LIFO-PRO uses the following criteria to determine if a company is a good candidate to use LIFO:

    1. Historical average annual inflation rate greater than or equal to 1% – Inflation is the most important aspect in determining a company’s potential LIFO tax savings.
    2. Consistent inflation – LIFO-PRO’s criteria used to measure consistency is to determine if a company would have had inflation in 11 or more of the past 20 years. LIFO-PRO’s method of determining this is using the following data to measure the inflation that would have resulted in each of the prior 20 years:
      1. Current period inventory balances & product mix
      2. Bureau of Labor Statistics (BLS) Producer Price Index (PPI) inflation categories
    3. At least $1 – 5 million of inventory – A company with $1 million in inventory & 5% historical average annual inflation would accumulate a LIFO reserve of approximately $1 million over a 20-year period, meaning their income tax reduction would be somewhere in the range of $200,000 – $350,000. The same could be said of a company with $5 million of inventory and 1% average inflation.

    Choosing the Right Time to Elect LIFO

    Timing is key when making a LIFO election because it will affect the amount of current & future period’s tax savings achieved. The point of emphasis is to understand the working parts that goes into determining the potential LIFO benefits. Although meeting the three criteria listed above would likely indicate that a company is a good LIFO candidate at some point in time, both the three criteria above along with the following criteria below should be met to make a LIFO election in the current period:

    • Current year inflation rate is expected to be greater than or equal to 1%
    • Current year profit is expected to be reported
    • Significant inventory level drop not expected in the next period

    Based on the above-listed criteria for choosing the right time to elect LIFO, it would be unwise to make a LIFO election in the current period if any of the following are true:

    • Current period inflation rate is expected to be less than 1%
    • Current period net operating loss is expected to be reported
    • Significant inventory level drop expected in the next period

    To recap, the following criteria should be met to make a LIFO election for your company’s upcoming year end:

    1. Historical average annual inflation rate is greater than or equal to 1%
    2. Consistent inflation (11 or more of the past 20 years)
    3. At least $1-5 million in inventory
    4. Estimated year-to-date inflation is greater than or equal to historical average annual inflation rate

    For companies with inflationary inventories, LIFO acts like an annuity that provides annual returns, and the long-term benefits can be substantial. Choosing the right time to start using LIFO will allow your client or prospective client to maximize the tax benefits that it provides.

  • Would LIFO Benefit my Client or Prospective Client?

    We recommend using the following one or both of the following to determine the potential benefits of LIFO for your client or prospective client

    • Use our lists in the sections below that show the best LIFO candidates by industry, primary business activity or product type as well as historical inflation averages
    • LIFO CalculatorContains our calculator tools to compute estimated income tax savings & inflation rates
    • LIFO Election Benefit Analysis – See if LIFO makes sense for your company or client, determine how much the potential benefit may be, and find out the most ideal timing for making a LIFO election by requesting a complimentary LIFO Election Benefit Analysis

    Quick Analysis LIFO Tax Savings Formula

    Use the following formulas to calculate the estimated LIFO tax savings that a company could achieve from using the LIFO method:

    • Current year taxable income reduction = estimated y/e inventory balance * estimated c/y inflation
    • Current year income tax reduction = current year taxable income reduction * tax rate

    Example: To illustrate the use of the Quick Analysis LIFO Tax Savings Formula, assume the following:
    Estimated year end inventory balance: $15,000,000
    Estimated current year inflation: 2%
    Tax rate: 30%
    Current year taxable income reduction: $15,000,000 * 2% = $300,000
    Current year income tax reduction: $300,000 * 30% = $90,000A long-term LIFO benefit analysis could be achieved by using the same formula shown above and multiplying the results by the desired number of years that you’re wishing to project (i.e. 3/5/10/20 year).

  • Best LIFO Candidates by Bureau of Labor Statistics Producer Price Index Commodity
    BLS PPI CodeBLS PPI Commodity Description9M Ended Sep. '22 (YTD)12M Ended Sep. '2212M Ended Dec. '2112M Ended Dec. '203 Year Annual Avg.5 Year Annual Avg.10 Year Annual Avg.20 Year Annual Avg.Inflation Freq-uencyInfl-ation Freq. RateYTD vs. 20Y Average Multiplier
    02Processed foods & feeds10.2%9.7%10.4%2.0%4.9%3.2%1.7%2.8%17 of 2085%3.6
    021Cereal & bakery products12.9%15.6%9.2%0.1%3.2%2.7%1.5%2.8%16 of 2080%4.6
    022Meats, poultry & fish3.8%-2.3%20.0%2.7%9.2%4.8%2.7%3.3%14 of 2070%1.2
    023Dairy products13.2%18.0%7.6%-3.0%4.0%1.9%1.0%2.2%11 of 2055%6.0
    024Processed fruits & vegetables14.3%16.3%4.5%3.8%2.4%2.4%1.7%2.7%17 of 2085%5.2
    025Sugar & confectionery8.6%9.4%3.1%-1.4%1.7%1.2%0.5%2.6%16 of 2080%3.3
    026Beverages & beverage materials8.6%10.4%3.3%2.1%2.3%1.9%1.4%2.1%20 of 20100%4.1
    027Fats & oils10.5%11.8%42.5%10.8%14.7%8.3%1.9%6.3%11 of 2055%1.7
    028Miscellaneous processed foods14.6%16.9%5.9%1.2%2.0%2.4%1.6%2.2%16 of 2080%6.7
    029Prepared animal feeds17.1%15.9%8.0%9.6%5.9%3.9%1.4%3.9%15 of 2075%4.4
    03Textile products & apparel8.7%12.9%15.4%-0.2%4.7%3.8%1.9%1.8%13 of 2065%4.8
    032Processed yarns & threads17.9%27.1%29.3%-2.0%6.7%5.8%1.8%2.7%13 of 2065%6.5
    033Greige fabrics11.7%15.3%13.3%-1.1%3.2%2.6%0.3%1.6%11 of 2055%7.1
    034Finished fabrics9.1%12.1%14.5%1.8%5.7%4.1%2.3%2.2%14 of 2070%4.1
    038Apparel & other fabricated textile prods4.2%7.3%7.0%-0.1%2.7%2.2%1.8%1.4%16 of 2080%3.1
    039Miscellaneous textile products/services26.1%37.5%25.7%2.2%5.2%3.7%1.7%1.8%12 of 2060%14.5
    043Footwear6.6%10.0%6.0%-0.2%3.0%2.3%2.7%2.1%18 of 2090%3.1
    044Other leather & related products4.0%5.0%3.0%1.1%1.8%1.7%2.1%1.6%19 of 2095%2.5
    05Fuels & related products & power33.8%36.6%38.3%-6.3%6.7%6.9%0.2%4.9%13 of 2065%6.8
    053Gas fuels72.8%93.5%108.2%9.1%1.3%7.8%0.5%4.6%11 of 2055%15.8
    055Utility natural gas8.7%33.7%40.5%14.5%9.0%9.3%4.5%4.4%13 of 2065%2.0
    056Crude petroleum (domestic production)33.0%31.1%48.6%-22.3%9.2%6.0%-3.9%7.7%13 of 2065%4.3
    057Petroleum products, refined39.5%40.6%57.4%-15.3%11.8%10.8%-1.0%7.7%13 of 2065%5.1
    058Asphalt & other petroleum & coal products19.4%44.1%48.7%11.9%8.7%15.2%-1.9%9.0%12 of 2060%2.2
    06Chemicals & allied products5.5%6.4%22.9%0.7%6.4%5.5%2.6%4.5%17 of 2085%1.2
    061Industrial chemicals5.7%4.1%44.5%-3.1%9.3%7.3%0.9%5.3%12 of 2060%1.1
    062Paints & allied products17.9%21.4%13.9%1.4%6.0%5.1%2.7%3.9%17 of 2085%4.6
    064Fats & oils, inedible16.0%8.0%49.7%15.2%21.3%8.3%0.5%7.4%12 of 2060%2.2
    065Agricultural chemicals & chemical products14.6%30.8%49.5%3.8%12.5%10.2%2.4%5.1%13 of 2065%2.9
    067Other chemicals & allied products9.7%13.4%8.7%0.3%3.3%2.8%1.9%2.4%19 of 2095%4.0
    07Rubber & plastic products9.2%14.3%21.1%0.6%6.4%5.1%2.5%3.2%17 of 2085%2.9
    071Rubber & rubber products11.3%12.7%11.0%0.3%3.5%2.8%0.6%2.7%14 of 2070%4.2
    072Plastic products8.6%14.8%24.1%0.7%7.2%5.7%3.1%3.3%16 of 2080%2.6
    082Millwork10.9%14.9%17.7%7.9%8.6%6.8%4.8%3.2%19 of 2095%3.4
    084Other wood products9.9%7.7%17.1%2.9%7.2%6.0%3.9%2.5%15 of 2075%3.9
    085Logs, bolts, timber, pulpwood & wood chips4.8%3.0%7.8%3.2%2.1%1.9%1.2%2.0%15 of 2075%2.4
    086Prefabricated wood buildings & components8.5%13.8%25.6%6.2%10.6%8.0%5.3%3.7%17 of 2085%2.3
    087Treated wood & contract wood preserving10.5%22.1%6.1%12.4%7.1%4.8%4.3%2.7%14 of 2070%3.9
    09Pulp, paper & allied products9.4%12.8%16.0%3.0%5.3%4.1%2.3%2.6%16 of 2080%3.6
    091Pulp, paper & prod., ex. bldg. paper9.2%12.5%18.6%1.6%4.9%4.2%2.3%2.8%15 of 2075%3.3
    094Publications, printed matter & printing material12.6%17.4%9.5%1.5%4.5%3.2%1.7%11 of 2092%7.4
    103Metal containers19.1%27.0%21.6%0.7%6.9%6.4%2.7%3.2%14 of 2070%6.0
    104Hardware4.4%11.7%17.5%1.8%6.6%5.0%2.9%2.8%17 of 2085%1.5
    105Plumbing fixtures & fittings8.7%11.1%5.4%1.9%3.5%3.4%2.5%2.7%20 of 20100%3.5
    106Heating equipment7.1%14.5%21.3%0.4%8.3%6.4%4.1%4.0%20 of 20100%1.7
    107Fabricated structural metal products7.7%14.2%41.6%2.2%13.0%9.7%4.9%4.5%17 of 2085%1.6
    108Miscellaneous metal products6.6%10.9%14.0%0.7%5.1%4.3%2.1%2.4%17 of 2085%3.2
    11Machinery & equipment7.8%10.1%7.1%1.0%3.2%2.6%1.5%1.2%15 of 2075%5.0
    111Agricultural machinery & equipment10.1%16.2%14.6%1.0%5.8%4.3%2.8%2.9%20 of 20100%3.7
    112Construction machinery & equipment8.5%13.4%10.1%1.2%4.4%3.5%2.6%2.8%20 of 20100%3.2
    113Metalworking machinery & equipment6.7%9.5%7.3%0.7%3.1%2.7%1.9%1.8%18 of 2090%3.6
    114General purpose machinery & equipment12.2%15.3%10.1%1.8%4.6%4.0%2.8%3.0%20 of 20100%4.3
    1141Pumps, compressors, and equipment14.6%16.0%7.6%0.7%3.1%3.2%2.6%3.1%20 of 20100%4.8
    1142Elevators, escalators, and other lifts4.3%17.3%16.7%0.9%7.1%5.3%3.4%2.4%16 of 2080%1.8
    1143Fluid power equipment10.9%13.7%8.7%1.1%4.0%3.3%2.4%3.0%20 of 20100%3.6
    1144Industrial material handling equipment7.6%12.9%14.4%1.7%5.6%4.6%3.4%3.3%19 of 2095%2.3
    1145Mechanical power transmission equipment12.3%13.7%8.0%1.7%3.8%3.4%2.3%3.1%18 of 2090%4.0
    1146Scales and balances7.4%9.0%11.9%1.1%4.8%5.3%3.9%2.9%20 of 20100%2.5
    1147Air purif. equip. & indust./commerc. fans/blowers9.2%10.1%9.6%1.8%4.9%4.0%2.9%2.8%19 of 2095%3.2
    1148Air conditioning and refrigeration equip19.0%24.9%14.7%2.6%6.7%5.4%3.3%2.8%19 of 2095%6.8
    114902Metal valves, except fluid power12.3%14.2%4.9%2.8%3.2%3.6%3.2%4.1%20 of 20100%3.0
    114903Metal pipe fittings, flanges, and unions14.1%16.0%14.4%13.6%9.5%7.8%3.5%3.4%15 of 2075%4.1
    116Special industry machinery & equipment8.4%10.0%11.6%2.1%5.1%3.7%2.3%2.0%19 of 2095%3.6
    118Miscellaneous instruments7.6%9.2%3.5%1.3%2.3%2.1%1.8%1.8%20 of 20100%4.2
    119Miscellaneous machinery4.9%6.6%4.1%0.8%2.1%1.8%1.1%1.8%17 of 2085%4.5
    12Furniture & household durables7.1%9.3%10.9%1.6%4.7%3.9%2.4%2.1%20 of 20100%3.0
    121Household furniture7.1%10.0%13.3%0.9%5.4%4.3%2.7%2.5%19 of 2095%2.6
    122Commercial furniture10.0%12.0%12.5%1.9%5.5%4.8%2.9%2.7%18 of 2090%3.4
    124Household appliances8.5%10.5%8.3%1.9%4.4%3.7%1.9%1.3%12 of 2060%4.5
    126Other household durable goods5.0%6.6%9.8%2.6%4.5%3.2%2.1%1.8%20 of 20100%2.4
    13Nonmetallic mineral products12.2%13.8%7.8%2.1%3.8%3.5%3.0%3.3%19 of 2095%4.0
    131Glass6.6%8.9%6.5%3.3%3.7%3.0%2.8%1.5%15 of 2075%2.4
    132Concrete ingredients & related products11.9%11.9%4.1%3.8%3.7%3.7%3.6%3.8%19 of 2095%3.3
    133Concrete products12.5%15.4%8.4%2.7%4.6%4.0%3.6%3.5%17 of 2085%3.5
    134Clay construction products ex. refractories5.8%7.2%5.4%2.0%2.9%1.9%1.5%1.3%15 of 2075%3.8
    135Refractories10.3%11.1%7.2%0.5%4.3%3.8%2.7%3.5%18 of 2090%3.8
    136Asphalt felts & coatings16.4%14.9%11.7%2.3%4.2%5.1%1.9%4.8%11 of 2055%8.7
    137Gypsum products16.5%18.6%20.2%3.7%6.1%6.0%6.9%4.4%15 of 2075%2.4
    138Glass containers10.9%12.4%6.8%1.7%3.7%2.8%2.1%2.7%20 of 20100%5.2
    139Other nonmetallic minerals13.3%15.1%8.4%-0.5%2.6%2.5%1.9%3.3%16 of 2080%6.9
    14Transportation equipment3.7%5.1%3.9%0.9%1.7%1.5%1.3%1.4%19 of 2095%2.7
    141Motor vehicles & equipment3.7%5.3%4.6%0.7%1.7%1.4%1.3%1.0%16 of 2080%2.9
    142Aircraft & aircraft equipment3.7%4.3%1.6%1.3%1.4%1.3%1.4%2.2%19 of 2095%2.6
    143Ships & boats4.6%6.1%5.2%1.3%3.2%2.4%1.8%2.7%20 of 20100%2.6
    149Transportation equipment, n.e.c.5.7%9.9%10.2%0.5%3.7%3.3%2.0%1.7%16 of 2080%2.8
    15Miscellaneous products7.4%9.0%6.3%2.8%4.3%3.6%2.7%2.5%18 of 2090%2.8
    151Toys, sporting goods, small arms, etc.7.7%9.7%9.7%0.3%4.8%2.9%2.0%1.7%16 of 2080%3.8
    152Tobacco products, incl. stemmed & redried9.1%10.7%7.7%6.4%6.8%6.3%5.5%4.3%18 of 2090%1.7
    153Notions6.4%13.5%12.6%0.6%4.8%3.6%2.2%3.1%18 of 2090%2.9
    154Photographic equipment & supplies8.5%10.3%7.2%-0.1%4.7%3.4%2.0%1.5%12 of 2060%4.3
    155Mobile homes8.3%15.0%30.1%8.6%15.4%11.0%6.8%5.2%20 of 20100%1.2
    156Medical, surgical & personal aid devices3.3%3.8%1.3%1.1%1.3%1.2%1.0%1.1%20 of 20100%3.4
    157Other industrial safety equipment7.4%9.2%7.0%2.9%3.0%2.0%2.1%1.8%18 of 2090%3.5
    159Other miscellaneous products12.0%14.9%8.7%2.1%5.4%4.0%2.2%2.3%18 of 2090%5.4
  • Publicly Traded Companies on LIFO by Primary Business Activities or Product Types
    Business or Industry Type Count Business or Industry Type Count
    Machinery Manufacturing 40 Beverage and Tobacco Product Manufacturing 7
    Merchant Wholesalers, Durable Goods 29 Wood Product Manufacturing 7
    Chemical Manufacturing 27 Electrical Equip., Appliance & Component Mfg. 7
    Fabricated Metal Product Manufacturing 26 Textile & Textile Product Mills 7
    Petroleum and Coal Products Manufacturing 23 Plastics and Rubber Products Manufacturing 6
    Food Manufacturing 21 Printing and Related Support Activities 6
    Transportation Equipment Manufacturing 18 Clothing and Clothing Accessories Stores 6
    Merchant Wholesalers, Nondurable Goods 17 Publishing Industries (except Internet) 6
    Paper Manufacturing 16 Steel Pipe And Tubes 5
    Primary Metal Manufacturing 13 Leather and Allied Product Manufacturing 4
    Miscellaneous Retailers 13 Mining (except Oil and Gas) 4
    Food and Beverage Stores 12 Miscellaneous Manufacturing 4
    General Merchandise Stores 10 Apparel Manufacturing 4
    Motor Vehicle and Parts Dealers 9 Nonmetallic Mineral Product Manufacturing 3
    Furniture and Related Product Manufacturing 8 Furniture and Home Furnishings Stores 3
    Computer and Electronic Product Manufacturing 8 Health and Personal Care Stores 3
  • LIFO-PRO Clientele by Business Activity or Product Type
    Primary Business Activity or Product Primary Business Activity or Product
    Auto and Home Supply Stores Industrial Supplies
    Beer and Ale Industrial Trucks, Tractors, Trailers & Stackers
    Beverage and Tobacco Product Manufacturing Industrial Valves
    Bolts, Nuts, Screws, Rivets & Washers Laboratory Apparatus and Furniture
    Building Material and Garden Equipment and Supplies Dealers Lighting Equipment
    Chemical Manufacturing Lumber and Other Building Materials Dealers
    Department Stores Machinery Manufacturing
    Drugs, Drug Proprietaries & Druggists’ Sundries Metals Service Centers
    Durable and Non-Durable Goods Wholesalers Construction Machinery & Heavy Duty Equipment
    Electrical Machinery, Equipment & Supplies Navigation, Measuring, Medical & Control Instruments
    Electrical Machinery, Equipment, Appliance & Component Mfg. Nonmetallic Mineral Product Manufacturing
    Fabricated Metal Product Manufacturing Paper Manufacturing
    Fabricated Pipe and Pipe Fittings Petroleum and Coal Products Manufacturing
    Fabricated Plate Work (Boiler Shops) Plastics and Rubber Products Manufacturing
    Fabricated Structural Metal Plastics Foam Products
    Farm and Garden Machinery and Equipment Plastics Material Synthetic Resins & Nonvulcanizable Elastomers
    Farm Supplies Plastics Materials and Basic Forms and Shapes
    Food and Beverage Stores Plumbing and Heating Equipment and Supplies (Hydronics)
    Food Manufacturing Power, Distribution & Specialty Transformers
    Furniture and Home Furnishings Stores Primary Metal Manufacturing
    Furniture and Related Product Manufacturing Publishing Industries (except Internet)
    Gaskets, Packing & Sealing Devices Pumps and Pumping Equipment
    Gasoline Stations Recreational Vehicle Dealers
    General Industrial Machinery and Equipment Steel Works, Blast Furnaces (Inc. Coke Ovens) & Rolling Mills
    General Merchandise Stores Tobacco and Tobacco Products
    Hand and Edge Tools, Except Machine Tools and Handsaws Transportation Equipment Manufacturing
    Hardware Stores Variety Stores
    Health and Personal Care Stores Warm Air Heating and Air-Conditioning Equipment and Supplies
    Industrial & Commercial Fans & Blowers & Air Purification Equipment Wines, Brandy & Brandy Spirits
    Industrial Machinery and Equipment Wood Product Manufacturing
  • LIFO Election Requirements

    Financial Reporting


    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

  • IPIC LIFO Method Advantages
    1. Higher inflation indexes possible- Many companies have found Producer Price Index (PPI) or Consumer Price Index (CPI) inflation rates to be consistently higher than their internal index inflation (IPIC LIFO uses externally-calculated inflation indexes). An example of this is large supermarket chains for whom the CPI & PPI v. internal index difference has consistently been almost 2% for the past 10 years. See our Use of PPI by Supermarkets to Increase Tax Deferral blog for more information.
    2. Less volatility of LIFO inflation- Many companies find PPI or CPI inflation rates to be less volatile than internal indexes. Two reasons for this are:1) PPI and CPI reflect price changes for the entire U.S. and not a single company and 2) internal indexes are more reflective of raw materials prices and PPI or CPI indexes are more reflective of intermediate or finished goods prices and raw material prices are more volatile.
    3. Fewer pools possible– The IPIC Regs. provide for establishment of pools by PPI or CPI Major Groups. Since this pooling method is optional and taxpayers can use other methods provided for in the Regs., taxpayer using the IPIC method are assured that the number of pools they use will be no greater than and may be less than alternative methods.
    4. Index calculation simpler than internal indexes- Use of a published index precludes the need to calculate an internal index unless companies switch for tax LIFO only. Internal index calculations are usually a major undertaking and can be avoided if companies switch for book LIFO also. The IPIC LIFO weighted average index calculations can also be complicated if done manually but this problem goes away with automated LIFO software.
    5. Easy way to switch from Double Extension- The IRS has been reluctant to permit changes from this method to the Link-Chain method, especially for companies whose annual turnover of inventory items is not rapid. Taxpayers can make an automatic change to the Link-Chain method if changing to the IPIC method. Use of the Double Extension method invariably produces more volatile LIFO indexes than Link-Chain indexes, so it is important for most taxpayers using the Double Extension method to switch to the IPIC Link-Chain LIFO method
    6. Cutoff method accounting change- Prior year restatement of inventory balances is not required for Tax purposes.
    7. Reduced IRS audit exposure– Companies switching to the IPIC method are provided a “Safe Harbor” by the IRS with respect to methods used in years prior to the change. IRS audit exposure may be eliminated in these areas:
      • Statistical sampling – Many companies use internal index sampling methods not acceptable to the IRS. For example, a company’s sampling method may not give new items an equal chance for selection as the IRS requires.
      • Pooling – Many companies use pooling methods not authorized by the IRS. Taxpayers may elect the optional IPIC pooling rules thereby establishing an acceptable pooling method.
      • Other – Some manufacturers still use the components of cost method despite its prohibition by the IRS. Some manufacturers also incorrectly apply raw materials only indexes to total inventory dollars including labor and overhead.
  • Why CPA Firms Partner With LIFO-PRO
    • CPA firms partner with LIFO-PRO because:
      • Offer valuable inventory tax savings to clients & prospects without being LIFO experts Our firm’s automated LIFO software, extensive historical inflation database & 25 years of expertise makes us the best-suited LIFO partner for CPA firms. Companies not yet on LIFO are more likely to decide to use LIFO when their CPA firms partner with us because our complimentary analysis provides the most accurate, in-depth & straight-forward feedback & recommendations available. Companies already on LIFO are more likely to stay on LIFO when their CPA firms partner with us because we allow them enjoy the benefits while eliminating all the work.
      • Complimentary services only available from the leading LIFO experts – Our proprietary of LIFO Election Benefit Analysis & Best LIFO Practices Methods Review allows CPA firms to provide their clients valuable feedback, recommendations & resources free of cost! Give your firm the ability to determine if your clientele or prospects are good potential candidates to use LIFO. Get Best LIFO Practices Methods Reviews for clients & prospects already on LIFO.
      • Land more prospects – CPA firms that recommend LIFO to clients & prospects have a better chance of maintaining & gaining new clients compared to competitors whom are unable to do so.
      • LIFO-PRO does not compete with CPA Firms – CPA firms can rest assured that LIFO-PRO will only provide LIFO solutions and nothing more; furthermore, our incentive to provide complimentary services such as LIFO analysis for clients not on LIFO & reviews for clients on LIFO is that we may be able to provide LIFO calculation services, meaning the time saved from letting us do the work is a win-win for everyone
      • Software license provides powerful time saving & pro forma benefit analysis tools – Our software allows CPA firms to minimize the time spent managing their client’s LIFO calculations while maximizing the accuracy & reporting transparency. Plus, we build all of your client’s software database files so you can hit the ground running on completing their LIFO calculations! The icing on the cake is that CPA firms can make pro forma LIFO calculations for clients & prospects not already on LIFO using our software in a matter of minutes! CPA firms can rest assured that all their clients & prospects are afforded the opportunity of LIFO with the help of our software!
      • Services scaled to fit your client’s size and budget – We scale the level of services provided based on the exact specifications of the CPA firm and client at the lowest possible cost
      • Flexible billing arrangements – Whether it’s working exclusively with the CPA firm, a mix of both or dealing exclusively with the client, we’ll collaborate with firms for billing and communication to be arranged in a manner that best serves the needs of your firm & clientele!
      • Top-notch service and support quality – LIFO-PRO’s level of service and support are unmatched because we handle every aspect related to LIFO so CPA firms can focus on everything else
  • CPA Firm Offerings

    1. Complimentary Offerings – LIFO-PRO delivers the essentials when it comes to LIFO analysis & review, including the following complimentary offerings:

    a. LIFO Election Benefit Analysis – LIFO-PRO provides CPA firms this complimentary consulting service to quickly determine if a client/prospect is a good candidate for LIFO. All we need to initially get started is either the company’s primary business activity or URL. From there, LIFO-PRO utilizes our 25+ years of historical inflation data covering all industries to turn around a quick yes or no answer on if LIFO would make sense for any given client. Refer to the Sample LIFO Election Benefit Analysis Report in Appendix A of this guide for further information.

    b. Best LIFO Practices Methods Review – LIFO-PRO offers this complimentary consulting service to review a company’s LIFO calculation, documentation and methods to determine the following:

    i. LIFO calculation accuracy

    ii. LIFO methods conformity/compliance

    iii. LIFO policies & procedures optimization recommendations

    The finished product provided to CPA firms and their client is a Best LIFO Practices Methods Review Report. This valuable resource can ensure LIFO calculation accuracy, reduce IRS audit exposure risk and provide great planning opportunities. Refer to the Sample Best LIFO Practices Methods Review Report in the Appendix of this guide for further information.

    2. Software Licenses – Minimize time spent on LIFO, increase LIFO calculation accuracy & maximize reporting transparency with our software. CPA firms can also make quick work of identifying if a client or prospect is a good LIFO candidate using the software! CPA firms can use their software license as a powerful tool to generate more tax savings opportunities in less time!

    3. Turnkey LIFO Outsourcing Solutions – Regardless of it’s a client that’s making a first-time LIFO election or one that’s already on LIFO, we have a solution that allows both CPA firms and companies to pass 100% of their LIFO workload off to us. LIFO-PRO handles all aspects of the LIFO calculation and delivers a complete set of LIFO-PRO Reports to the CPA and client.

    4. LIFO Consulting Services – Aside from our complimentary consulting services (LIFO Election Benefit Analysis & Best LIFO Practices Methods Review), LIFO-PRO offers the following consulting services (can be bundled or stand-alone):

    a. Producer Price Index (PPI) category assignments

    b. IRS LIFO election form preparation (Form 970 & statement attachment)

    c. IRS accounting method change form preparation (Form 3115 & statement attachment)

    d. Accounting method changes –

    i. Changing from internal to externally calculated inflation indexes (IPIC)

    ii. Changing from double-extension to link-chain

    iii. Changing from CPI to PPI

    e. Restatements & retrospective adjustments

    f. Pool combinations/splits

    g. Rebasing LIFO layer history

  • LIFO-PRO’s Clients & CPA Firm Partnerships


    LIFO-PRO’s clientele has combined annual sales in excess of $1 trillion. The total inventory balances calculated by the LIFO-PRO software exceeds $100 billion & our client’s combined LIFO reserve exceeds $15 billion. The software is used by over 60% of all department and grocery store retailer’s that use LIFO. Notable clients include:

    • Wal-Mart
    • Kroger
    • Target
    • Dillard’s
    • Macy’s
    • Rite Aid
    • US Foods
    • Albertson’s
    • SpartanNash
    • Meijer, Inc.
    • SuperValu
    • General Mills
    • Eastman Chemical
    • Kimberly Clark
    • Case New Holland Industrial (CNH)
    • The Timken Company
    • Eli Lilly and Company
    • Steelcase
    • Valmont Industries
    • The Marmon Group

    CPA Firm Partnerships

    Over 75 CPA firms work with LIFO-PRO directly or indirectly to provide LIFO solutions to their clientele & prospects; notable CPA firm partnerships include:

    • RSM
    • CliftonLarsonAllen
    • Crowe Horwath
    • CohnReznick
    • Moss Adams
    • BKD
    • BakerTilly
    • Plante Moran
    • Marcum
    • EisnerAmper
    • Carr, Riggs & Ingram
    • Eide Bailly
    • More than 65 other firms
  • LIFO Success Stories
    1. A small CPA firm outsourced LIFO calculations for about 10 of their clients to a multinational company. Over the course of a couple of years, LIFO-PRO took over the calculations for all their clients. Furthermore, LIFO-PRO determined that two of the CPA firm’s clients had not adopted LIFO previously because the proposed costs from the other service provider were too high for the size of their companies. These two clients eventually adopted LIFO after determining that LIFO-PRO’s costs were significantly lower than the other service provider’s costs.
    2. A company contacted us to determine if LIFO would make sense for them based on a referral from their CPA firm (the CPA firm referred one of their clients to LIFO-PRO in the past and enjoyed the security of knowing that they weren’t forcing their client to seek the help of competing firms that could help them with LIFO). The company’s LIFO Election Benefit Analysis showed they would have had a $2.7 million LIFO reserve if they would have elected LIFO 20 years ago, and would have $350,000 of LIFO expense in they were to elect LIFO in the current year. LIFO-PRO offered a LIFO calculation outsourcing solution bundled with IRS LIFO Election forms preparation at a low-cost, and the company subsequently elected LIFO and continues to use our services annually.
    3. A CPA firm contacted us about a retail farm & home hardware retailer to determine if they were a good candidate for LIFO. The company’s LIFO Election Benefit Analysis Report indicated that they would have had 1.3% average annual inflation & LIFO reserve of nearly $4.5 million if they would have elected LIFO 20 years ago, and would have current year LIFO expense of nearly $600,000 if they decided to elect LIFO in the year of the analysis. We offered a low-cost LIFO calculation outsourcing solution bundled with IRS LIFO Election Forms preparation. The company subsequently utilized our services, adopted LIFO & continues to be a client today.
    4. A CPA firm contacted us about a set of related-party winery clients that were on LIFO that had been using questionable LIFO methods and procedures. LIFO-PRO completed a complimentary Best LIFO Practices Methods Review to determine that both companies were using multiple LIFO methods considered impermissible by the IRS. LIFO-PRO performed a pro forma IPIC LIFO calculation to estimate the average annual inflation and LIFO reserve for the prior 20 years. We bundled a low-cost LIFO calculation outsourcing solution bundled with the Change in Accounting Method IRS Forms preparation. The CPA firm jumped on this opportunity & elected to utilize our services in future years.
    5. A company on LIFO whose accounting department was short-staffed due to constant expansion was sold on outsourcing their LIFO calculation to a multinational LIFO services provider. It turned out that the service provider’s annual LIFO outsourcing costs were nearly three times higher than LIFO-PRO’s. Upon reviewing the company’s LIFO documentation and providing a LIFO outsourcing cost estimate, the company immediately decided to utilize LIFO-PRO’s outsourcing services. This company has been a client for over ten years now, and they believe that our service & support quality are far superior to their former service provider.
    6. A medical equipment manufacturer was using internal index LIFO. They didn’t elect the IPIC method several years ago despite their Big 4 CPAs’ recommendation because they believed the task of inventory sorting would be very time consuming. We visited their web site and saw that almost all of their inventory could be classified into a single PPI category. This allowed us to run pro forma IPIC calculations without any input from them other than their LIFO history schedule. The pro formas showed if they had used the IPIC Method they would have reduced their taxable income by an additional $1 million for the current year & an additional $5 million over the last ten years. They adopted the IPIC Method for tax & continue to enjoy the additional LIFO tax savings.
    7. A retail grocery chain used what we call “Simplified Simplified LIFO” for which a single index per pool is used & the pools are the standard grocery industry departments with a separate set of pools for each store. Some departments, amounting to about 15% of total inventory, were not on LIFO. We combined their pools into a single set of pools for each corporation and elected the IPIC pooling method. This resulted in using the minimum number of pools possible to maximize LIFO tax benefits (by minimizing LIFO layer erosions). We provided the client instructions to enable them to sort their FIFO inventory by the minimum number of CPI categories to comply with IRS Regs., expanded the LIFO election to include all goods, thereby increasing their LIFO tax savings.
    8. A retail grocery chain used eleven pools corresponding to standard grocery business departments. We reduced the number of pools used down to five & increased their tax savings by using the IPIC pooling method. We corrected numerous layer pricing errors in their layer history resulting from decrement calculation errors.
    9. A convenience store chain using the IPIC method had set up seven LIFO pools because they initially elected a non-IPIC pooling method. We showed them they could reduce this to three pools & increase their tax savings by using the IPIC pooling method. The client used Retail LIFO & had recently experienced a large LIFO reserve decrease because of cost complements being affected by increased margins. We recommended that they use Cost LIFO to eliminate their LIFO reserve being affected by margin changes. Not all goods were on LIFO. We expanded their LIFO election to include all goods thereby increasing their tax savings.
    10. A discount store chain switched to the IPIC method using PPI indexes two years ago. We performed a Best LIFO practices Methods Review and determined that the company had assigned incorrect PPI categories to their inventories. We performed pro forma calculations that showed the client would get a significantly larger LIFO expense for the most recent year if they sorted their drug inventories into the appropriate PPI categories.
    11. A foodservice distributor was not using LIFO. Food businesses are excellent candidates to use LIFO because almost all food categories have inflation over time. Using the current year inventory breakdown by PPI category, we performed a LIFO Election Benefit Analysis. As expected, the results showed an average annual inflation rate of about 2%. The client adopted LIFO and was able to significantly reduce their taxable income & improve cash flow.
    12. A manufacturing company using Double-Extension internal index LIFO would have had a 10% decrease in their pool index despite having some inflation in their raw material costs. This would have wiped out their $3 million LIFO reserve. Using a rough estimate of their most recent year end FIFO balances broken down by PPI category, we ran a pro forma Link-Chain IPIC LIFO calculation for the past 20 years. This showed the LIFO inflation in past years would have created a $1 & $5 million higher LIFO reserve in current and past years if Link-Chain IPIC LIFO was used. The company subsequently switched to Link-Chain IPIC LIFO and avoided unexpected material LIFO fluctuations in the future (this situation is quite common for companies using Double-Extension internal index LIFO).
    13. A home improvement products retailer used the IPIC method and CPI indexes. We advised them to switch to using PPI indexes because they were about 2% higher than CPI inflation and had been for several years. They did so and increase their tax savings considerably. They made this change for tax purposes only and now enjoy the best of both financial reporting and tax worlds, deflation for book LIFO and inflation for tax LIFO.
    14. A company that had lost a considerable amount of its accounting staff due to downsizing their accounting department, and the remaining employees were overburdened with the work of the staff that had been laid off, including an estimated 200 hours/year of work in completing their LIFO calculation. LIFO-PRO reviewed this company’s LIFO documentation and determined that they could complete the work in under 50 hours and subsequently provided a competitive LIFO calculation outsourcing cost estimate. The company decided to outsource their LIFO calculation and their accounting staff was utterly grateful to be able to hand off what they considered to be a big mess otherwise for them.
    15. A CPA firm acquired a new audit client by initially proposing to complete their LIFO calculation at a fraction of the cost of the company’s current LIFO service provider. The firm subsequently determined the work required to complete their new client’s LIFO calculation involved far more time and effort than they could afford. LIFO-PRO reviewed their client’s LIFO documentation, designed a procedure to complete the client’s LIFO calculation while staying within the budget they initially proposed.
  • Sample LIFO Election Benefit Analysis Report
  • Sample Best LIFO Practices Methods Review Report
  • How LIFO Works - Overview

    The Last-in, First-out method, also known as the LIFO method, is one of the four cost flow assumptions allowed by U.S. GAAP & the IRS (FIFO, average cost & specific identification are the three other acceptable methods). LIFO matches current inventory costs against current sales to provide a better measure of earnings. When there’s inflation, the effect of using LIFO is that the value of the most recently purchased, higher cost items are included in cost of goods sold while the older, lower cost goods remain in inventory. In other words, LIFO is designed to move some of the inflationary costs from the balance sheet (inventory) to the income statement (cost of goods sold).
    The IRS Tax Court made the following statement about LIFO, “The theory behind LIFO is that income may be more accurately determined by matching current costs against current revenues, thereby eliminating from earnings any artificial profits resulting from inflationary increases in inventory costs. At the heart of the LIFO method is the principle that income is more clearly reflected by matching current costs with current revenues.” The cumulative difference between inventory valued at LIFO vs. a non-LIFO method (i.e. FIFO, average cost) is known as the LIFO reserve and the annual change between the current & prior period LIFO reserve is known as LIFO expense (income if current vs. prior period LIFO reserve decreases). The infographic shown below further illustrates the concept of how LIFO works:

    Illustration 1. LIFO Process Flow Chart


  • How LIFO Works - History of LIFO

    In the 1930’s, inflation was causing increased replacement inventory costs, artificially high ending inventory balances, understated cost of goods sold & overstated earnings. The unintended consequence was having to pay additional taxes based on artificial income on inventory not yet sold. Because of this, a large number of companies & industry trade associations collaborated with the Special Committee on Inventories of the American Institute of Accountants (now known as the AICPA) to develop an alternative inventory method that matched current costs against sales, and thereby more clearly reflecting income. The Securities & Exchange Commission considered LIFO to be permissible for financial reporting purposes in 1936 & the AIA later advocated for LIFO to be allowed for both financial reporting & tax in 1938. The combined lobbying efforts of the AIA, corporations & trade associations eventually led to Congress accepting the use of the LIFO method for tax purposes when the Revenue Act of 1938 was passed.

  • How LIFO Works - Advantages & Disadvantages

    LIFO’s Advantages

    • Reduced tax liability in periods with inflation compared to non-LIFO methods (FIFO, average cost, earliest acquisitions, etc.)
    • Represents an annuity that will grow over time as opposed to a one-time deduction
    • Usually provides more long-term tax savings than other valuation reserves since it continues to grow (unlike LCM & obsolescence reserves that are reversed after the related items are sold/disposed of)
    • Increases cash flow & ability to grow/reinvest
    • One of the few prospective financial reporting accounting method changes (also treated prospectively for tax)

    LIFO’s Disadvantages

    • Making calculation manually is often complex, error-prone & often difficult to forecast
    • Difficult to provide transparent reports to financial statement users when done manually
    • LCM & other inventory reserves must be taken into income over a three-year period for tax purposes
    • Deflation and/or significant inventory liquidations can cause increased taxable income (LIFO income)
  • How LIFO Works - Contrasting Inventory Costing & Dollar-Value LIFO

  • How LIFO Works - How LIFO's Accounted For

    For dollar-value LIFO method users, a company will continue tracking inventory costs within their accounting database using the same method that was used prior to adopting LIFO. This means that beginning inventory, purchases, sales & cost of goods sold recorded during the reporting period continues to be valued any of the available non-LIFO methods (i.e. FIFO, average cost, earliest acquisitions etc.). Illustration 2 below provides an example of common inventory activity occurring during the course of a reporting period using FIFO or average cost:

    Illustration 2. Accounting for Inventory Activity Under LIFO – Year 1 on LIFO

    Illustration 3. LIFO Calculation & General Ledger Adjusting Journal Entry – Year 1 on LIFO

    As shown in the calculation summary above, the LIFO inventory balance is between $2 – $3 million less than the current period end inventory balance at cost. This difference represents the LIFO expense (current – prior period LIFO reserve) & LIFO reserve balances (inventory at cost – LIFO inventory). It also represents how LIFO transfers inflationary inventory costs from the balance sheet (inventory) to the income statement (cost of goods sold). The debits and credits in the journal entry shown above represent increases to both cost of goods sold and the LIFO reserve contra inventory account. Since the LIFO reserve account is a contra inventory account, ending inventory gross of LIFO reserve represents inventory at cost & while ending inventory net of LIFO reserve represents inventory at LIFO. The cost of goods sold account is essentially the vehicle that allows for LIFO taxpayers to reduce their taxable income. Using the data from the illustrations above, the example below shows the 2017 year end balances after the LIFO general ledger adjusting journal entry has been made:

    Illustration 4. Post LIFO Calculation Inventory Balances – Year 1 on LIFO

    As shown above, the cost of goods sold account is now $2 – $3 million higher after the LIFO calculation. Aside from any other adjusting entries required after the LIFO calculation, this will be the amount used for financial reporting and tax purposes. Although the cost of goods sold account balance will be closed out after recording the closing entries, the LIFO reserve contra inventory account is a permanent account that will be carried forward into the next reporting period.

    Using the data from the illustrations above, the examples shown below illustrate how inventory costs will be tracked when going from the first to the second reporting period on LIFO:

    Illustration 5. Accounting for Inventory Activity Under LIFO – Year 2 on LIFO

    As shown above, beginning inventory, purchases, sales & cost of goods sold continue being valued at cost throughout the course of the second period on LIFO (will remain the case for all subsequent periods on LIFO). As explained earlier, the LIFO reserve contra inventory account remains in place because the beginning inventory balance net of LIFO reserve represents inventory at LIFO cost. The example below illustrates the year 2 LIFO calculation results along with the adjusting journal entries and post-LIFO calculation general ledger inventory balances:

    Illustration 6. LIFO Calculation, General Ledger Adjusting Journal Entry & Account Balances – Year 2

    As shown above, the current period LIFO calculation resulted in 17% & 13% inflation for each of the two calculations that resulted in approximately $5 million & $3.7 million of LIFO expense (increase to cost of goods sold). Although the LIFO inventory balance is the difference between ending inventory gross and net of the current period LIFO reserve, the LIFO expense is the difference between the current & prior period LIFO reserve and represents the current period increase to cost of goods sold. Using the data from the illustrations above, the example below shows the 2018 year end balances after the LIFO general ledger adjusting journal entry has been made:

    Illustration 7. Post LIFO Calculation Inventory Balances Year 2 on LIFO

  • How LIFO Works - How LIFO Reduces Taxable Income & Tax Liability

    As illustrated above, the cost of goods sold account was increased in each of the two years shown and represents the vehicle for companies on LIFO to reduce their taxable income & tax liability. Using the 2018 year end (year 2) data from the illustrations above, the example below compare the differences in cost of goods sold, taxable income & federal income tax liability between LIFO, FIFO and average cost:

    Illustration 8. Cost of Goods Sold, Taxable Income & Income Tax Liability Comparison

    As shown above, there’s a $5 million & $1.5 million reduction in taxable income & federal income tax liability when comparing a LIFO vs. non-LIFO taxpayer that uses FIFO as their current-year cost method. Similarly, there’s a $3.5 million & $1.1 million reduction in taxable income & federal income tax liability when comparing a LIFO vs. non-LIFO taxpayer that uses average cost as their current-year cost method. It should be noted that this difference would also have been recognized in the first year on LIFO (prior period LIFO reserve amounts), and will recognition will continue in subsequent periods as long as there’s inflation. Another important concept is the fact that current period LIFO reserve grew despite the current vs. prior period ending inventory balance at cost decreasing. A common misconception exists that inventory balances must increase for the LIFO reserve to grow, but this is not the case. The LIFO reserve will continue to grow when the current vs. prior period end inventory balance is lower as long as the amount of inflation outpaces the amount of the inventory balance decrease.

    LIFO Election Requirements


    Financial Reporting


    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

  • How LIFO Works - LIFO Methods & Submethods
    • LIFO Index Computation 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 inventory 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 pools
    • 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)
      • Other method that clearly reflects income
    • 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)
      • 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
        • Appropriate month selection:
          • Annually select appropriate month (annual selection)
          • One-time binding selection of representative appropriate month
  • LIFO-PRO Software Reports Table of Contents
    Sample LIFO-PRO Reports

    Standard Reports (for all LIFO methods)

     Current & Prior Period

     Actual Year End LIFO Summary Report (Report 18) – Shows summary information for each pool and in total for the current and previous year ends (separate reports for each of these years). This report shows the balances necessary to make the LIFO accounting entries. Balances shown include the inventory current year cost (FIFO or average cost), current and cumulative indexes, LIFO inventory, reserve and expense and Sec. 263A costs (if applicable) for each pool.

    LIFO Reserve Calculation Report (Report 18a) – This is a more detailed version of Report 18 that shows all the steps necessary to calculate all years’ LIFO reserves and shows the details of decrement calculations where applicable. This report shows these calculations for all pools and in total for a given year. The bottom section of this report (except where retail LIFO is used) shows the breakdown of the LIFO expense or income components between the inflation index effect and the layer erosion effect. The latter is the pre-tax amount that is required by GAAP to be disclosed in the notes to the financial statements (if material) for financial reporting purposes.

    LIFO Expense Components Report (Report 19) – This report shows the breakdown of the LIFO expense or income components between the inflation index effect and the layer erosion effect. The latter is the pre-tax amount that is required by GAAP to be disclosed in the notes to the financial statements (if material) for financial reporting purposes. Available in current-period only or all periods format.

    All Periods

    LIFO Inventory History Summary Report (Report 16) – This is a one page per pool LIFO history carryforward schedule for all years, which includes all data fields involved in the calculation of LIFO balances once the current year index and current year cost (FIFO or average cost) total by pool has been determined. This format shows the amount of the original increment or decrement and the amount of all layers remaining as of the latest year closed. The cumulative inflator indexes for years in which there are decrements is the weighted average index of the layers eroded and is equal to the Priced Increase (Decrease) or decrease in LIFO cost divided by the decrease at base prices. The detail of which years’ layers are eroded for decrements is shown in Reports 16a and 18a.

    LIFO Layer History Proof Report (Report 16a) – This is a one page per pool schedule showing the detail by layer of all decrements and the detail by layer of all layers remaining. This report is a proof of the Report 16 decrement calculations.

    LIFO Inventory History Detail Report (Report 17) – This is a one page per pool LIFO history for all years which includes all data contained in Report 16 & also shows the remaining balance of all layers for all years.

    LIFO Reserve by Layer Report (Report 15) – This report shows which years’ layers the most recent year end LIFO reserve is attributable to and in what amounts along with the FIFO balance required to erode each layer. The FIFO balance shown for each year is the balance at which that layer begins to be eroded; that layer will be completely eroded (and the LIFO reserve associated with it will be removed) when the next year (following the most recently closed year end) FIFO balance is reduced to the next earliest layer remaining FIFO balance shown in the rightmost column.

    Internal Index Reports

    Internal Index Data Input Report (Report 3) – This report is primarily used for companies using internal indexes as it serves as the data input screen (Screen 3) for entering the front-end software input values required to complete the LIFO calculation. The blue-shaded fields are the front-end input values are entered by software users and serves as a source document for the variables used to complete the back-end of the LIFO calculation. This report automatically updates the LIFO expense, reserve, inventory & expense/income component fields shown to the right of the current period index columns after the blue-shaded input value fields have been entered. This report & screen is also used for external index users wishing to perform interim estimates using current period inventory balances, a user-defined BLS index period range & the product mix used for the last period closed (prior period).

    External Index Reports (IPIC LIFO CPI/PPI)

     IPIC LIFO Calculation Summary Report (Report 23S) – This is a summary report by pool and in total showing the IPIC method pool indexes for the current year as well as the prior and current year cumulative indexes, FIFO and LIFO inventory balances, LIFO reserve, and LIFO expense.

    IPIC LIFO Index Calculation Report (Report 23) – This shows the details of the pool index calculations using Harmonic Mean Weighting specified in the IRS Regulations.

     IPIC LIFO Index by PPI Code Report (Report 24) – This report shows the current and prior year inflation indexes and calculation of current year inflation index for all PPI categories.

    Replaced & Discontinued PPI Codes Report (Report 25) – This report shows the PPI categories assigned to inventory balances on the Excel input schedule which have been discontinued or recoded. Separate sections are printed for: 1) Categories that replacements were automatically made by the LIFO-PRO software 2) Categories that replacements will be made for future periods based on when the categories were discontinued.

    IPIC 5% Method Proof Report (Report 26) – Shows which of the 8 CPI or 15 PPI BLS Major Category or Commodity Groups are to be LIFO pools based on inclusion of 5% or more of total inventory per IRS Reg. Sec. 1.472-8(c)(2) for establishing pools.

    IPIC Data Input Sheet Report – This report is the source document for external index calculations as it shows the Excel file imported into the software containing BLS categories & inventory balances.

    Other Reports

    Consolidated Reports for Multiple/Separate Entities, Locations or for Differing Book & Tax LIFO Methods – Used for the following:

    • Companies needing to combine the results of separate LIFO calculations made for multiple entities or locations for financial statement or tax purposes
    • Companies needing to combine the results of separate financial reporting (book) & tax LIFO calculations in order to compute deferred tax asset/liability balances and/or schedule M items

    LIFO Projections Report (Report 1) – This shows the next year LIFO expense (income) amounts that would result from the range of year end inventory current year cost (FIFO or average cost) balances shown in the leftmost column and the range of inflation indexes shown on the sixth row.

    UNICAP Reports – Shows balances before & including §263A UNICAP costs with user-inputted absorption ratios. UNICAP costs are included in Reports 16, 16a, 17, 18 & 18a.

  • Sample LIFO-PRO Software Reports - Actual Year End LIFO Summary (Report 18)

  • Sample LIFO-PRO Software Reports - LIFO Expense Components (Report 19)

  • Sample LIFO-PRO Software Reports - LIFO Inventory History Summary (Report 16)

  • Sample LIFO-PRO Software Reports - LIFO Layer History Proof (Report 16a)

  • Sample LIFO-PRO Software Reports - LIFO Inventory History Detail (Report 17)

  • Sample LIFO-PRO Software Reports - LIFO Reserve by Layer (Report 15)

  • Sample LIFO-PRO Software Reports - Internal Index Calculation Reports

  • Sample LIFO-PRO Software Reports - External Index Calculation Reports (IPIC CPI/PPI)

  • Sample LIFO-PRO Software Reports - Consolidated Reports for Multiple/Separate Entities, Locations or for Differing Book & Tax LIFO Methods

  • Sample LIFO-PRO Software Reports - LIFO Projections (Report 1)

  • Sample LIFO-PRO Software Reports - UNICAP Reports


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