Simplified LIFO Can Ease Compliance, Boost Tax Savings

By choosing the inventory method that best meets their circumstances, manufacturers and distributors can increase the potential to realize significant tax savings. FIFO- and LIFO-based methods are the two options companies can choose to calculate inventory. Simply speaking, FIFO matches older expenses against current revenues, while LIFO matches more recent expenses against that same revenue.

In general, LIFO is the right choice if the price of inventory is going up. Because many companies experience some degree of inflation in inventory costs, LIFO is a common choice, but has a downside. The compliance effort is complicated; the calculations can be complex and time-consuming.

Complicated compliance is not the only problem. Companies that do a good job of controlling their costs may find some of the benefit of LIFO disappearing. This benefit comes from offsetting current revenue with higher current costs, which reduces taxes. If a company is holding those costs down, taxes would trend up.

Simplified LIFO

Simplified LIFO relies on indices published by the U.S. Department of Labor Bureau of Labor Statistics. Instead of using complex calculations to generate an actual inventory inflation index, companies select published indices to establish the LIFO value of inventory. For companies holding down their inventory costs through favorable purchasing and labor costs, simplified LIFO may be especially beneficial.

The costs of the published indices are sometimes higher than companies' actual inventory costs, allowing companies to offset more revenue than they could through regular LIFO. Relying on the published indices also greatly simplifies companies' future LIFO compliance efforts.

Choosing Simplified LIFO

Several conditions may indicate whether a company might benefit from a switch to simplified LIFO:

• Regularly experiencing computational errors in LIFO calculations;
• Not realizing adequate tax benefits from the current LIFO method;
• Considering abandoning the LIFO method for FIFO;
• Experiencing decreases in inventory costs; and
• Experiencing gross margin decreases between years.

Simplified LIFO may be a better alternative than LIFO (or FIFO) for companies facing one or more of these issues. Further, simplified LIFO also simplifies the LIFO accounting process and allows a company to control its inventory costs better than its competitors.

From Brian Lucas, Chicago, IL