This question may be blatantly obvious and simple to some people. However, I'm curious to know what the difference between LIFO (w/ LIFO reserve essentially standardizing it to FIFO) and FIFO would be?
Given the use of LIFO reserves, why would firms still choose to use LIFO? It seems to me like they would be the same...
Any comments would be appreciated..thanks in advance!
I'm assuming you're asking why firms would still choose to use FIFO? There are no GAAP restrictions on the use of FIFO to report inventory. IFRS, however, prohibits the use of LIFO. Because of this, U.S.-based companies that use LIFO have to report a footnote that essentially "converts" the statements to FIFO thanks to the LIFO reserve.
The case for using LIFO is that it would require a corporation to pay less taxes. Because of inflation, one can assume that inventory prices are constantly rising in the long-term. LIFO would lead to a higher COGS figure, lower net income, and, effectively, lower taxes. You can see why this would raise a ton of regulatory concern.
Right, I get what you're saying. But my question is: why would firms even use LIFO in the first place when you have to essentially "convert" it back to FIFO? Why not just use FIFO to begin with?
Also, when you adjust for LIFO reserve, you also have to make appropriate changes in COGS and taxes, which makes the use of LIFO pointless isn't it?
bump for the working professionals
I think you are confused. Firms usually use LIFO for reporting/tax purposes only (their fundamental business process is usually FIFO). They use LIFO because as described above, it will reduce taxes.
Here is how LIFO reserve is used. First, firms don't use LIFO reserve to convert LIFO inventory amount to FIFO amount. Rather, the firm's accounting system will report FIFO balance (asset so debit account) and LIFO reserve (contra asset so credit account), and the net of the two will be reported on the financial statements and tax reports as LIFO.
Same thing happens with COGS. Firms internal accounting will report COGS on a FIFO basis and then will add to the COGS the change in LIFO reserve to get to the LIFO COGS, which will be reported on the financial statements/tax reports.
So to answer your questions, yes, companies actually use FIFO for internal purposes (because it reflects the business process). But by using LIFO and adding to the COGS (for reporting and tax purposes), you end up inflating costs and thus reducing taxes. The LIFO reserve accounts and the adjustments to FIFO COGS is just basically a hassle to get that extra tax deduction and a regulatory requirement such that investors, if they want, convert back to FIFO to align financial information with the underlying business process.
Thank you so much for the response.
I get all that. I'm still confused as to why there would be a benefit though? Because on paper, the "LIFO" is basically FIFO with the LIFO Reserve and its associated affects (i.e. COGS and tax adjustments etc.) The only tax benefit I can think of is deferred tax assets (taxes payable > tax expense). Then it wouldn't be a true tax benefit. Is this what you were referring too?
Interested in knowing how often folks adjust their public comps for LIFO / FIFO normalization across the group? This can be tedious
I'll leave it to you to answer whether LIFO election will result in a deferred tax asset or just a lower tax compared to FIFO.
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