2024 LIFO Opportunities & Strategies Guide

2024 LIFO Tax Savings Opportunities Abound

Although inflation has returned to a more normalized level, there are many industries with inflation at or above the historical levels & will be good LIFO election candidates for the 2024 year end. The best opportunities will be in the following areas:

• Food and beverages
• Paper & paper products
• Machinery & equipment
• Nonmetallic materials & products
• Transportation equipment (including auto dealers)
• Miscellaneous products, including toys, sporting goods, tobacco, photographic equipment, mobile homes, medical/surgical/personal aid devices & safety equipment

LIFOPro’s list of 2024 top LIFO election candidates are shown further below, and instructions for quickly identifying , and the Top LIFO election candidates tables are shown below the instructions. Alternatively, view/download LIFOPro’s 2024 Top LIFO Election Candidate List Excel file by clicking this link: LIFOPro’s 2024 Top LIFO Election Candidates List Excel File

The actual flow or physical movement of goods does not need to match the inventory costing method used to value inventory (aka cost flow assumption). The most two most predominant inventory valuation methods can be simplified as follows:

• LIFO:
  • Matches current costs with current revenues, thereby reducing income & providing a better measure of current earnings
  • Commonly called the income statement approach as it provides the clearest reflection of income & costs of goods sold (removes inflation component from income)
• FIFO (first-in, first out):
  • Ending inventory most closely matches the current costs since it consists of most recent purchases
  • Commonly called the balance sheet approach because it most closely matches physical flow of goods
  • Charges oldest costs against more current revenue, and creates artificial inventory profits

Because of the advantages of the dollar-value method & disadvantages of the unit LIFO method, almost all companies using LIFO track and value inventories in their accounting system on a FIFO, average cost or standard cost basis for the following reasons:

• They use the dollar-value method which requires for unit costs to be tracked and valued on a non-LIFO basis
• Most accounting systems are designed to track and value inventories using FIFO, average cost or standard cost
• Companies often base their pricing decisions on a FIFO, average cost or standard cost assumption
• Recordkeeping on a non-LIFO basis is easier since LIFO does usually not approximate the physical flow of goods
• Profit-sharing & other bonus arrangements often depend on a non-LIFO cost flow assumption

One of the biggest misconceptions is item/unit costs must be tracked and valued on a last-in, first out basis once LIFO is adopted. Although this is not true, it’s a misnomer that causes many companies to not to use LIFO. The reality is there are two methods or options how goods are to be tracked and valued on a LIFO basis, which are as follows:

• Dollar-value method: The dollar-value method measures inflation in terms of the total dollar value of the inventories at a FIFO, average cost or standard cost basis, not by the physical quantity & unit cost on a LIFO basis. Under this method, inventories continue being tracked and valued on a non-LIFO basis in perpetuity even incident & subsequent to adopting LIFO. When the dollar-value method is used, a top-side adjustment is recorded to account for the difference between the inventory value at cost (FIFO, average cost etc.) & the LIFO inventory value. When using the dollar-value LIFO method, item/unit costs are never “LIFO-ized”. What instead occurs is that goods continue to be tracked and valued under a company’s existing method, and at the end of the year, an inventory report showing the quantities and item/unit costs on a non-LIFO basis is generated and exported out of the accounting system in order to calculate inflation & perform the total LIFO inventory value. Once this occurs, inflation is calculated outside of the accounting system, layer at base year cost and LIFO cost are determined, the total LIFO inventory value is determined, the change between the current & prior period’s LIFO reserve is computed, and a top-side journal entry is recorded to adjust cost of goods sold and LIFO reserve (many companies outsource this work to LIFOPro or license our software to automate their in-house dollar-value LIFO calculation). Simply put, the dollar-value method avoids LIFO’s most undesirable characteristics by allowing companies to maintain their existing accounting systems on a non-LIFO basis, and only requiring for a top-side journal entry to be made annually. Because of this, the vast majority of companies on LIFO use the dollar-value method.
• Specific goods method (aka unit LIFO): The unit LIFO method is most often illustrated in tutorials and taught in college accounting courses because the underlying concept is simpler to illustrate than the dollar-value LIFO method. In reality, integrating the unit LIFO method in a perpetual accounting information system is extremely burdensome & sometimes to costly to implement. Under this method, item costs are tracked on a LIFO basis, and the accounting system must be set up in a manner to assume a last-in, first out basis cost flow assumption, meaning the sales of goods must be set up in a manner where the newest goods are sold first and the oldest items remain in stock. Said another way, each item’s unit cost must be LIFO-ized & the total inventory value on a LIFO basis is determined by taking the sum of the extended LIFO cost of all items. Under this method, companies often maintain two separate cost flow assumptions within their accounting information system: 1. Costing method used in the existing accounting system 2. unit LIFO method. One additional shortfall of the unit LIFO method is that it creates a materially lower tax benefit over a long period of time when compared to the dollar-value LIFO method. This is due to the fact that when new items enter into inventory and other items are no longer stocked (due to being discontinued or new items replacing them), the LIFO reserve associated with the items no longer stocked is recaptured under the unit LIFO method, but is retained under the dollar-value LIFO method as long as the total dollar value of the new or replacement goods is greater than or equal to the total value of the goods no longer carried. Because of this, very few companies use the unit LIFO method.

• Misconception #1: The following burdens & costs outweigh the benefits of LIFO:
  • Wholesale changes must be made to accounting system since item costs & the physical flow of goods must be tracked on a LIFO basis
  • Management, cost accounting & purchasing/sales functions & responsibilities will be complicated by using LIFO
  • Clarifications
    • When the dollar-value method is used, the LIFO value of inventory is determined outside of the accounting system & a top-side accounting entry is recorded to adjust ending inventory from cost to LIFO & accrue the change in the LIFO reserve
    • When the dollar-value method is used, internal management and reporting functions are unimpeded by LIFO because unit costs must continue being tracked at cost (as opposed to the specific goods or unit LIFO method which tracks unit costs on a LIFO basis)
• Misconception #2: Employee compensation & bonuses will be complicated from using LIFO
  • Clarification: Internal management reports can be presented on a non-LIFO basis as long as they’re only being used internally
• Misconception #3: Tax savings from LIFO will be minimal because of high inventory turnover or new item rates
  • Clarifications
    • Under the dollar-value method, the inflation rate used to calculate the LIFO reserve change is based on a 12 month comparison of current vs. prior year’s item/unit costs extended by quantities on hand in ending inventory regardless of the turnover ratio
    • External indexes reconstruct inflation on new items, which ensures the same amount of inflation is applied to new & preexisting items
    • Manufacturers will always have raw materials & WIP; wholesalers/distributors & retailers still must maintain adequate base stock
• Misconception #4: Internal costs must be used to measure LIFO inflation
  • Clarification: External indexes such as the BLS CPI/PPI can be used to measure inflation, thereby minimizing reliance on accounting information systems
• Misconception #5: LIFO reserve change misconceptions:
  • This year’s LIFO reserve can’t grow unless this year’s ending inventory balance is as much or higher than last year’s ending inventory balance
  • This year’s LIFO reserve will decrease if this vs. last year’s inventory balance decreases
  • Material LIFO recapture will occur if there’s a significant decrease in inventory
  • Clarifications
    • In most cases, material LIFO recapture only occurs when there is either substantial deflation and/or substantial inventory liquidations
    • When there’s inflation, LIFO reserve can increase even when current vs. prior year inventory balances decrease
    • Any LIFO recapture (LIFO income) caused by inventory decreases can be partially or fully offset by the LIFO expense created from inflation

IRS Regs. §1.472-2(e) requires income to be reported and inventories to be valued on a LIFO basis on the face of the income statement and balance sheet beginning in the same year that LIFO is adopted for tax purposes. This is commonly referred to as the LIFO conformity rule. An overview of the LIFO financial reporting disclosure rules and alternatives are listed below.

• LIFO Disclosures
  • Face of the annual or year end income statement must present income, profit or loss using the LIFO method beginning no later than the year that LIFO is adopted for tax purposes
  • Once LIFO has been elected for tax purposes, income, profit or loss must be computed using LIFO on the face of all subsequent annual financial statements (unless LIFO is terminated for tax purposes)
• Non-LIFO Disclosures: The following non-LIFO disclosures and information are allowed within financial statements while also maintaining LIFO conformity compliance (see IRS Regs. §1.472-2(e)):
  • Supplemental and explanatory information using a non-LIFO method – Includes anything other than the primary presentation of the income statement, which includes the following:
    • Notes to the income statement
    • Appendices & supplements to the income statement
  • Other reports included in the financial reports, such as:
    • Management’s discussion and analysis
    • Statement of changes in financial position
    • Letters to shareholders, partners or other stakeholders
    • Summary of key figures
  • Inventory asset value disclosures
• Internal Management & Interim Reports
  • Internal Management Reports – The use of a non-LIFO method is allowed on all portions of internal management reports as long as the reports will not be issued or released to parties outside of the organization. Examples include earnings projections, budgets, and sales forecasts.
  • Interim reports – If issued in accordance with GAAP, same LIFO disclosure rules described above apply. If not issued in accordance with GAAP, then interim reports are not required to be presented on a LIFO basis (exception – series of interim reports that can be used to ascertain income, profit & loss by combining those reports)

Some or all goods can be valued using LIFO. A selective election scope infers that less than 100% of inventories are valued using the LIFO method. Although a general rule of thumb is to place all goods on LIFO to maximize the tax benefit, thorough analysis is highly recommended prior to electing LIFO. This is because including deflationary goods in the election scope could materially reduce LIFO’s long-term tax benefits. LIFOPro’s best practices regarding determining the LIFO election scope is described below.

• Perform analysis prior to election to determine if some or all goods have historically been inflationary: Prior to electing LIFO, thorough analysis should be performed where historical pro forma LIFO calculations are made to measure past inflation levels, inflation frequency and the resulting LIFO tax benefits. If there is a diverse product mix or material amounts of goods with differing cost characteristics, further analysis should be performed at a more granular level to determine the historical inflation by group or product type. If all goods have historically been inflationary, the long-term strategy should be to value 100% of the goods using LIFO, but if any material portion of goods have a history of deflation, the short & long-term strategy should be to exclude the deflationary goods from the LIFO election scope.
• Year of LIFO election: When there is a diverse product mix, additional analysis should be performed to determine if all goods have inflation in the year of the LIFO election, or if there are any material portions of goods with deflation. If there is significant deflation in a material portion of goods in the LIFO election year, a best practice is to make a selective LIFO election for the inflationary goods to prevent the deflationary goods from reducing the election year LIFO tax benefit.
• Year proceeding LIFO election: If goods were excluded from the LIFO election scope in the year of adoption but have an inflationary history, a best practice is to expand the election scope to include those goods in the first subsequent period where there is sufficient inflation & LIFO tax benefit to merit doing so (IRS Form 970 must be filed; change is applied prospectively beginning in year of change).
• The following are other examples of why certain goods may be excluded from the LIFO election scope
  • Existing entity using LIFO acquires a business not using LIFO & chooses to keep them off LIFO because the additional tax benefits would be minimal
  • Tax benefits of including certain inventories in the election scope is less than the cost and administrative burden

LIFOPro uses proprietary inflation metrics and a standard grading system to establish whether or not LIFO is a preferable method for a company or given industry. From this grading system, a determination can be made regarding if a company is a good LIFO candidate, and subsequent recommendations are also provided regarding the proper timing of when to elect LIFO. Our grading system & scoring criteria is organized as follows:

• Good LIFO candidate (LIFO preferability criteria): These criteria use past pricing metrics sourced from the Bureau of Labor Statistics Consumer/Producer Price Indexes (BLS CPI/PPI) to establish preferability as of the time of exploring a LIFO election, which are as follows:
  • Inflation level – How much inflation has there been historically?
    • The inflation level is the most fundamental metric used to establish LIFO as a preferable method because higher the historical inflation level, the higher the likelihood that LIFO will create a material tax benefit and be more clearly reflective of income than other non-LIFO methods in the future.
    • LIFOPro’s inflation level requirement is to have a long-term average annual inflation rate of 1% or more. Auto dealers and supermarkets (predominant users of LIFO) have 20 year average annual inflation rates of around 1% – 2%, which is more than sufficient to establish preferability because over a 20 year period, there will have been 20% – 40% cumulative inflation, and in most cases, inflation at this level will yield material long-term LIFO tax benefits.
  • Inflation frequency – How often has inflation occurred historically?
    • Inflation frequency is another key metric used to establish LIFO as a preferable method because the more often there has been inflation in the past, the higher the likelihood that LIFO will be most clearly reflective of income & create a tax benefit in the future
    • Inflation frequency is also an important LIFO risk assessment metric because there is an inverse relationship between the amount of LIFO risk and inflation frequency rate. More specifically, the lower the inflation frequency rate, the higher amount of LIFO risk. Conversely, the higher inflation frequency rate, the lower the risk. Certain industries have 20 year inflation frequency rates of 100% (inflation measured in all of the last 20 years), meaning there is little or no LIFO risk in these areas.
    • LIFOPro’s inflation frequency requirement is to have a rate of greater than or equal to 50% over the last 20 years (inflation measured in 10 or more of the last 20 years)
  • Both of the aforementioned criteria must be met for LIFO to be a preferable method and for a company/industry to be a good LIFO candidate. LIFO is not a preferable method and a company/industry is not a good LIFO candidate if neither or only one of the two historical preferability criteria is met.
• 2024 Top LIFO election candidate (Current year LIFO election recommendation criteria): These criteria provide the basis of the recommended LIFO election timing, which are as follows:
  • Both Good LIFO candidate criteria met (LIFO preferability criteria)
  • Current year vs. 20 year average inflation rate multiplier (2024 Election Inflation Multiplier) of ≥ 1 – This criteria exists to ensure the election year inflation rate is as much or more than the historical average
    • 2024 Election Inflation multiplier is calculated by taking the quotient of the Current year inflation rate and the 20 year average annual inflation rate
    • Current year inflation rate uses one of the following two options which assumes a December year end:
      • Year to date inflation: The year to date inflation rate at the time of this publication is 11 months ended November 2024 PPI (Nov. ’24 ÷ Dec. ’23) (to be updated w/ Dec. ’24 PPI in mid Jan.)
      • 12 Months or 1 Year ended November 2024 PPI (Nov. ’24 ÷ Nov. ’23)
    • The 20 year average annual inflation rate computed using the BLS PPI 20 year average annual inflation rate as of November 2024 (if available; 3/5/10 year average annual inflation rates used for BLS PPIs that have existed for less than 20 years)
  • LIFOPro’s 2024 Election Inflation Multiplier criteria is to have a multiplier of greater than or equal to 1. For example, if there’s 5% inflation in 2024 & a 20 year average annual inflation rate of 2%, the inflation multiplier would be 2.5 & a current year LIFO election would be recommended since the multiplier is greater than 1.
  • A company/industry must meet all good LIFO candidate (preferability) criteria & have a 2024 Election Inflation Multiplier of 1 or greater for a 2024 LIFO election to be recommended. If a company/industry is a good LIFO candidate but has a 2024 Election Inflation Multiplier of less than 1, LIFOPro recommends deferring a LIFO election until a later period
  • Note: Certain BLS PPIs will be 2024 Top LIFO candidates despite having Election Year Inflation Multipliers of < 1 because they have a current year inflation rate of ≥ 2% & an inflation frequency rate of ≥ 75%.

LIFOPro’s grading system & scoring criteria are integrated into LIFOPro’s 2024 Top LIFO Election Candidates Tables shown below. They’re also integrated in our complimentary LIFO election benefit analysis reports prepared for companies who aren’t on LIFO but are considering adoption.

• Step 1:
  • Go to Pages 9 – 13, locate a single BLS group/subgroup/product class that most closely matches your company/client’s product mix or industry & proceed to Step 3
  • If multiple BLS PPIs were identified that matches your company/client’s product mix/industry, proceed to step 2
• Step 2: If multiple PPIs match your company’s or client’s industry or product mix, take one the following steps:
  • Use one of the less-detailed BLS tables – For example, if multiple product classes were found that include a portion of but not all of your company or client’s product mix or industry (but no product class was found that included 100% of your goods), review the subgroup table to determine if there is a single subgroup that contains all goods & excludes most or all goods not carried. If no such subgroup can be found, review the major commodity group table and perform the same steps.
  • Use the most predominant group/subgroup/product class in your company/client’s industry or product mix – For example, if your product mix includes 70% of one product class, 20% of another product class & 10% of third product class, select the product class that represents the largest proportion of the total inventory balance.
• Step 3: Locate the Good LIFO Candidate field entry for the selected PPI & take the following steps:
  • If the Good LIFO Candidate entry is “Yes” – Your company is a goods LIFO candidate. Proceed to Step 4 and/or contact LIFOPro to obtain a free LIFO election benefit analysis.
  • If the Good LIFO Candidate entry is “No” – Your client or company is not a good LIFO candidate & LIFOPro recommends not using LIFO (or contact LIFOPro to obtain confirmation of this)
• Step 4: Locate the Top 2024 Election Candidate field entry for the selected PPI & take the following steps:
  • If the Top 2024 Election Candidate entry is “Yes” – LIFOPro recommends exploring a 2024 LIFO election and obtaining a complimentary benefit analysis from LIFOPro ASAP. Proceed to Step 5.
  • If the Top 2024 Election Candidate entry is “No” – Although your company/client is a good LIFO candidate, it is likely that current year LIFO election should be deferred to a future period in time. Consider obtaining a free election benefit analysis from LIFOPro this year, or defer doing so until next year.
• Step 5: Take any of the following steps to further explore electing LIFO:
  • Estimate 2024 LIFO tax benefit:
    • 2024 taxable income reduction from LIFO (2024 LIFO expense/reserve): Multiply the higher of the two inflation rates shown in the 2024 inflation rate fields by last year’s inventory balance
    • 2024 LIFO tax benefit (2024 LIFO after-tax savings): Multiply the 2024 LIFO expense by your combined federal & state tax rate
  • Contact your client & inform them of the following:
    • High likelihood that LIFO will create meaningful tax benefit for the upcoming year end
    • They can attend a free LIFO discovery call to learn more about LIFO, how to get a free benefit analysis & learn about our turnkey outsourcing solutions which makes being on LIFO as simple as possible
    • They can obtain a free, comprehensive benefit analysis to obtain a more accurate estimate and essential information on how LIFO works, election requirements and method alternatives
  • Schedule a free LIFO discovery call to learn more about LIFO, how to obtain a free election benefit analysis & LIFOPro’s outsourcing solutions:
    • Email or call Jamie Pentagulio at jamie@lifopro.com or 531-999-3147
    • Use our online scheduling tool: https://live.vcita.com/site/smleud97dkmgnkd9/online-scheduling

Table 1. Top 2024 LIFO Election Candidates by BLS PPI Major Commodity Group

Notes

• BLS PPIs with a Yes value in the Good LIFO Candidate field (Column D) indicates the historic inflation metrics were sufficient to meet our LIFO preferability criteria. Those with a No value indicates LIFO is not preferable & should not be used for that BLS PPI.
• BLS PPIs with a Yes Both, Yes YTD or Yes 12M value in the 2024 Top Election Candidate field (Column E) indicates the current inflation metrics were sufficient to meet our criteria to recommend exploring or making a 2024 LIFO election. Those with a No value indicates that it is probable that a LIFO election should be deferred to a later period for that BLS PPI.
• BLS PPIs with a Yes Both Value value in the 2024 Top Election Candidate field (Column E) indicates both the year to date (Column F) & 12M ended Nov. ’24 (Column G) inflation rates were sufficient to meet the 2024 LIFO election recommendation criteria. Those with Yes YTD or Yes 12M values indicate one of the two 2024 inflation rates were sufficient to meet the 2024 LIFO election recommendation criteria.
• Asterisk (*) In 2024 Top Election Candidate Field (Column E) denotes a BLS PPI determined to be a 2024 Top LIFO Election Candidate despite the Election Year Multiplier being less than 1 because the PPI had a 2024 inflation rate of 2% or more & an inflation frequency rate of 75% or more, which satisfy both of LIFOPro’s Good LIFO Candidate (preferability) criteria.
• Source: Bureau of Labor Statistics – Table 9. Preliminary Producer Price Indexes, first release. Rates shown in this file were derived from the November PPIs released by the BLS on 12/11/2024.
• Year to date & 12M ended November 2024 inflation rates shown in the absence of a full 12 months of inflation as of the December 2024 year end being available.
• This list will be updated with December 2024 BLS PPIs within 1-3 days of those indexes being released on 1/14/2025.
• 3/5/10/20 year average annual inflation rates are as of November 2024 (for example; 3 year average uses the compound average inflation rate between November ’21 – November ’24).

Table 3.1 Top 2024 LIFO Election Candidates by BLS PPI Product Class

Table 3.2 Top 2024 LIFO Election Candidates by BLS PPI Product Class

Table 3.3 Top 2024 LIFO Election Candidates by BLS PPI Product Class

Notes

• BLS PPIs with a Yes value in the Good LIFO Candidate field (Column D) indicates the historic inflation metrics were sufficient to meet our LIFO preferability criteria. Those with a No value indicates LIFO is not preferable & should not be used for that BLS PPI.
• BLS PPIs with a Yes Both, Yes YTD or Yes 12M value in the 2024 Top Election Candidate field (Column E) indicates the current inflation metrics were sufficient to meet our criteria to recommend exploring or making a 2024 LIFO election. Those with a No value indicates that it is probable that a LIFO election should be deferred to a later period for that BLS PPI.
• BLS PPIs with a Yes Both Value value in the 2024 Top Election Candidate field (Column E) indicates both the year to date (Column F) & 12M ended Nov. ’24 (Column G) inflation rates were sufficient to meet the 2024 LIFO election recommendation criteria. Those with Yes YTD or Yes 12M values indicate one of the two 2024 inflation rates were sufficient to meet the 2024 LIFO election recommendation criteria.
• Asterisk (*) In 2024 Top Election Candidate Field (Column E) denotes a BLS PPI determined to be a 2024 Top LIFO Election Candidate despite the Election Year Multiplier being less than 1 because the PPI had a 2024 inflation rate of 2% or more & an inflation frequency rate of 75% or more, which satisfy both of LIFOPro’s Good LIFO Candidate (preferability) criteria.
• Source: Bureau of Labor Statistics – Table 9. Preliminary Producer Price Indexes, first release. Rates shown in this file were derived from the November PPIs released by the BLS on 12/11/2024.
• Year to date & 12M ended November 2024 inflation rates shown in the absence of a full 12 months of inflation as of the December 2024 year end being available.
• This list will be updated with December 2024 BLS PPIs within 1-3 days of those indexes being released on 1/14/2025.
• 3/5/10/20 year average annual inflation rates are as of November 2024 (for example; 3 year average uses the compound average inflation rate between November ’21 – November ’24).

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)

Companies have the option to use one of the two following inflation measurement sources to calculate inflation:

• Internal index
  • Uses current quantities double extended against current & prior unit or standard costs
  • Items are defined as the most-detailed record/stockkeeping unit maintained in accounting system
  • Places heavy reliance on accounting information system to maintain detailed inventory listings with reliable, up to date quantities and unit costs
• External index
  • Also known as the IPIC method (Inventory Price Index Computation)
  • Inflation calculated using Bureau of Labor Statistics Consumer/Price Indexes (BLS CPI/PPI)
  • Items are defined as the BLS CPI/PPIs that include the goods on hand
  • Much less reliance placed on accounting system

Why many companies use the IPIC method

• Often creates more inflation & LIFO tax benefits than an internal index inflation for the following reasons:
  • BLS inflation will be greater than internal index inflation on goods that were imported or purchased for resale products sourced from abroad because BLS PPI only measures U.S. or domestic production & domestically produced goods inflation rates have historically been materially higher than imported goods
  • When the IPIC method is used, new items are given preexisting item inflation since BLS only measures price changes on preexisting items (or they reconstruct the cost on any newly-introduced item). With internal indexes, new items’ prior year costs are often set to equal to its current year cost since reconstruction is often burdensome/subjective & IRS Regs. prohibit new items from being excluded from the inflation calculation. As a result, during periods of inflation, new items will reduce the overall current year inflation rate when internal indexes are used. This becomes more pronounced when there’s high item turnover and/or high inflation.
• Can be a quicker, simpler means of performing interim estimates than internal indexes
  • When internal indexes are used, the equivalent of a full year end calculation is required to perform an interim estimate because the current period’s inflation is required to perform interim estimates
  • When external indexes are used, the majority of companies will use last year’s product mix paired against the year to date BLS CPI/PPI inflation rates (or 12 months ended current period) to perform interim estimates
  • Key takeaway: Interim estimates can be performed more quickly when using the IPIC method because it precludes the need to generate a current period inventory report
• Reduce IRS audit risk
  • IPIC method is IRS safe harbor method, which affords taxpayers less scrutiny from IRS upon audit compared to taxpayers using internal indexes since inflation calculation relies on external government indexes & internal indexes rely on the taxpayer’s accounting records/systems
  • Switch to IPIC method from internal indexes to IPIC method provides audit protection from prior period calculation errors
  • Affords audit protection from LIFO reserve overstatements since change is applied beginning in year of change & built from pre-change LIFO reserve
• Simplify LIFO calculation & reduce volatility
  • IPIC method can simplify inflation calculation for manufacturers because:
    • Reduces reliance on accounting information systems & appropriate allocation of item cost components such as materials, labor & overhead since inflation is measured using BLS PPI, not current & prior/base period item/unit costs
    • Inflation for work-in-process inventories are calculated by assigning the applicable finished goods PPI code to the WIP items
  • IPIC method can reduce volatility because BLS surveys thousands of producers & eliminates extreme cost fluctuations that could occur within any single company
• Automatic approval to change to IPIC method & is applied on a cutoff basis
  • Tax deadline for making the change is the extended return filing deadline, meaning change can be made after the year end has closed
  • Change is applied prospectively beginning in the year of change, meaning pre vs. post change LIFO reserve remains the same and no prior period adjustments are made

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.

• 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.
• 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

Get top-notch complimentary analysis & review from the LIFO experts. LIFOPro offers Best LIFO Practices & Methods Reviews for companies on LIFO. We also provide LIFO Election Benefit Analysis for companies considering adopting LIFO. Companies seeking an automated LIFO solution or replacement to their current LIFO system can get a free software trial.

LIFO Election Benefit Analysis

• Companies receive a comprehensive report that establishes whether or not LIFO is preferable, estimates the historical & election year LIFO tax benefit, includes election timing & submethods recommendations, provides the amount to record a LIFO journal entry & prepare financial reports/statements on a LIFO basis & includes a How LIFO Works Guide
• Also included is LIFOPro’s outsourcing solutions fee quote

Best LIFO Practices & Review

• Companies receive a comprehensive report that confirms LIFO calculation accuracy (or identifies errors & provides comparisons between as filed vs. as corrected), identifies LIFO tax benefit maximization strategies (and provides comparisons between the proposed vs. present methods) & offers recommendations regarding potential changes, error corrections, how to eliminate IRS audit risk & how to simplify calculation procedures
• Companies receive a LIFOPro report package that ties to their most recently calculated LIFO reserve
• Also included is LIFOPro’s outsourcing solutions fee quote

Document Requirements

• LIFO election benefit analysis (for clients not on LIFO)
  • Non auto dealers:
    • Current & prior period’s item detail reports
    • Completed LIFO election benefit analysis questionnaire
  • Auto dealers
    • Invoices for all vehicles on hand as of current period & as of prior year end
    • Completed auto dealer LIFO election benefit analysis questionnaire
  • Best practice & review (for clients already using LIFO): Prior two period’s LIFO calculation documentation

Sample Best Practices & Review Report Excerpt #1

Sample Best Practices & Review Report Excerpt #2

Sample Best Practices & Review Report Excerpt #3

Sample Best Practices & Review Report Excerpt #4

LIFOPro makes being on LIFO as simple as possible. We act as a third party LIFO service provider & subject matter expert to both CPA firms & companies. We design customized solutions that fit your firm & client’s LIFO needs, not a one-size fits all solution that offers more or less than what is needed. Our powerful in-house developed/maintained software allows us to automate most aspects of the work, spend a fraction of the time required by anyone else making manual LIFO calculations & deliver high-quality solutions at the most reasonable costs. We work with companies of all sizes and situations, including companies already on LIFO or those that aren’t but are considering a LIFO election.

LIFOPro Outsourcing Engagement Overview

LIFOPro’s Responsibilities

• Preparing all aspects of the LIFO calculation & supporting documentation free of errors and in accordance with IRS Regs., including
  • Inflation calculation (including BLS category assignments for companies using the IPIC method)
  • Layer calculations
  • LIFO inventory value, LIFO reserve & LIFO reserve change calculations
• Prepare documentation (LIFOPro reports) that provide adequate books & records of the LIFO inventory value & all supporting computations
• Deliver LIFOPro report package that includes all amounts required for the client to complete the following:
  • Record this year’s LIFO journal entry which will adjust the year end inventory balance to its LIFO value
  • Prepare the year end annual financial report/statement on a LIFO basis
  • Prepare year end tax return on a LIFO basis
  • Net inventory method adjustments (if applicable; for auto dealers using net inventory method)
• Interim LIFO estimate preparation & delivery (if applicable)
• Preparing the book vs. tax LIFO Schedule M tax return entry value (if applicable)
• Preparing the §263A UNICAP cost Schedule M entry value (if applicable; using the client-provided absorption ratio)
• Preparing IRS forms & statements related to LIFO elections or accounting method changes (if applicable)
• Preparing supporting documentation related to any pro forma LIFO calculations, reviews or accounting method changes (if applicable)
• Up to 40 hours of audit support related to the services provided by LIFOPro

 CPA Firm or Client Responsibilities

• Prepare & furnish the documents required by LIFOPro to complete our services
• Review LIFOPro report package and confirm all applicable amounts match the client’s books and records
• Record the annual LIFO adjusting journal entry
• Prepare the tax return on a LIFO basis
• Prepare annual financial reports/statements on a LIFO basis
• Notify LIFOPro of any LIFOPro report discrepancies discovered by the client or notify LIFOPro of adjustments made after LIFOPro report delivery that would affect the accuracy of the client’s LIFO inventory value (if applicable)
• Attach IRS forms & statements related to LIFO elections or LIFO accounting method changes to the tax return (if applicable)