BALTIMORE—
The road to a global economy can be rocky even in the best of times. But as far as the U.S. accounting profession is concerned, a little-known international committee just rolled a boulder into the middle of a crucial turn.
The London-based International Accounting Standard Committee, a group formed by 13 industrialized countries in 1975 to formulate accounting principles that could be used worldwide, voted recently to recommend that LIFO--short for “last in, first out”--be eliminated as a method for valuing inventory.
The idea makes sense outside of the United States. Many countries consider LIFO a bad accounting practice because it inflates the value of inventory on a company’s balance sheet.
But Americans bridle at the recommendation. Many U.S. companies prefer LIFO over its counterpart, FIFO, or “first in, first out,” because it results in a lower tax bill.
Also, federal tax laws require U.S. companies to use LIFO in certain circ*mstances. The laws have been on the Internal Revenue Service books since 1937, and eliminating LIFO in the United States would take an act of Congress, said Arthur Wyatt, a senior partner with the Chicago accounting firm of Arthur Andersen & Co. and one of two U.S. delegates to the IASC. Congress “might be persuaded to do it if it seemed to be in the national interest, but that would be a battle to be fought in Washington and nowhere else,” he said.
LIFO and FIFO are among the more arcane categories in accounting terminology, but the methods they describe are relatively simple.
In order to compute its earnings for the year, a company must put a value on the goods that remain in its inventory at year’s end. With LIFO, all goods remaining in inventory are valued at the price last paid for them. With FIFO, the goods are valued at the price originally paid for them.
The difference in the methods is most apparent in an inflationary economy.
Under LIFO, the value of the inventory, and thus the amount of earnings, is lower. With FIFO the two figures are higher. The higher its earnings, the more taxes a company has to pay--and vice versa. If a company uses LIFO in computing its taxes, the Internal Revenue Service requires it to use LIFO in financial statements it prepares for investors, auditors and such federal agencies as the Securities and Exchange Commission. A company that uses FIFO for taxes can use either method for financial statements.
Many U.S. companies routinely elect LIFO over FIFO. Of 600 companies surveyed by the American Institute of Certified Public Accountants, the leading trade association for the accounting profession in the United States, more than 400 use LIFO for both tax and financial reporting. Ninety percent of U.S. petroleum companies value their inventory with LIFO, as do 93% of the U.S. chemical companies, the survey reported.
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Also, as the U.S. economy has become increasingly inflationary, LIFO has become the method of choice.
FIFO, its counterpart, “gives you the most profit in the good times and the most loss in the bad times,” said Edward P. Brunner, vice president and chief financial officer of Baltimore Life Insurance Co.
In the past 20 years, the United States has “had several dips in the economy, and people who used FIFO got whipsawed. Companies changed to LIFO because they didn’t want to get hit again,” said Brunner.
As an accounting professional with extensive expertise in international accounting standards and methods, including LIFO (Last In, First Out) and FIFO (First In, First Out), I can provide an in-depth analysis of the concepts and implications discussed in the article.
The article delves into the global impact of the International Accounting Standard Committee's recommendation to eliminate LIFO as a method for valuing inventory. This recommendation poses a significant challenge for the U.S. accounting profession due to the prevalent use of LIFO in the country.
LIFO and FIFO are inventory valuation methods used by companies to determine the cost of goods sold and the value of remaining inventory. LIFO values the goods remaining in inventory at the most recent cost of acquisition, while FIFO values them at the earliest cost. The choice between these methods significantly affects a company's financial statements, particularly in an inflationary economy.
The article highlights that while many countries perceive LIFO as an accounting practice that inflates inventory values on a company's balance sheet, numerous U.S. companies prefer LIFO over FIFO. The preference for LIFO in the U.S. stems from its potential to result in a lower tax bill for companies due to its impact on reported earnings during inflationary periods.
However, the article emphasizes the conflict between the international recommendation and U.S. federal tax laws, which mandate LIFO usage in certain circ*mstances. Changing this practice in the U.S. would necessitate congressional action.
Moreover, it discusses the historical context, stating that companies often switched from FIFO to LIFO during economic downturns to avoid higher tax burdens, as FIFO tends to reflect higher profits in prosperous times but can cause more significant losses during economic downturns.
The survey mentioned in the article, conducted by the American Institute of Certified Public Accountants, showcases the widespread adoption of LIFO among U.S. companies, particularly in industries like petroleum and chemicals.
In summary, this article underscores the complexities surrounding inventory valuation methods, the divergent perspectives between international accounting standards and U.S. tax laws, and the practical implications for businesses in adopting different inventory valuation methods in varying economic conditions.
