From the July-August 2009 issue of Treasury & Risk magazine

Inventories Look Past LIFO

Has LIFO come to the end of its run? LIFO, which stands for Last In, First Out, lets businesses account for inventories as though the last item purchased was the first to be used or sold. The accounting method was already threatened by the U.S. move toward international financial reporting standards (IFRS), which do not allow its use. Now the Obama administration has proposed repealing LIFO to raise revenue. Previous attempts by Congress to eliminate LIFO have failed, notes Robert Kilinskis, a managing partner at Deloitte. But this time may be different, he says, in part because of the cost of economic stimulus and other administration proposals.

LIFO's repeal is expected to raise $61 billion over 10 years. "Because of that need to pay for some of those initiatives, looking at $61 billion, it's hard to pass that up," Kilinskis says. "There actually is a good chance this time we'll lose LIFO, either through legislation or IFRS."

LIFO tends to boost a company's inventories and reduce its earnings, thus lowering its tax bill. But when a company stops using LIFO, it must pay taxes on its LIFO reserve--the amount by which using LIFO reduced its taxable income. Companies usually have four years to pay up; the Obama proposal would give them eight years.

It's not clear how many companies would be affected; while a 2006 study found just 12% of publicly traded companies use LIFO, there are no good statistics on private companies. But a repeal could be costly for those that do use LIFO. Charles Mulford, professor of accounting and Invesco Chair at Georgia Tech, found in his research that 30 companies with big LIFO reserves would face a total tax bill of $15.6 billion, with energy companies hit hardest. Exxon Mobil would owe $8.8 billion and Marathon Oil $1.4 billion, according to Mulford.

Jade West, senior vice president of government relations for the National Association of Wholesaler-Distributors, argues the tax bills would bankrupt some companies, especially smaller ones. "We have companies who tell us they would not survive," she says.

Even if companies were no longer permitted to use LIFO for financial reporting, they could continue to use it to calculate taxes if either the Treasury or Congress eliminated the LIFO conformity rule that requires companies to use the same inventory accounting method for tax returns as for their financial reports. But Kilinskis doubts that will happen. "If you take away conformity, more companies would adopt LIFO and it could cost the government money," he says. "Given the concern about the national debt, it's hard to imagine Congress would pass something that would cost more money."