Will Congress Sink LIFO?

Tax-cutters on the prowl for other ways to raise federal revenue may well view last-in, first-out inventory accounting as ripe for repeal.

Looking for ways to garner more tax revenue and bridge an apparent gap between financial and tax accounting, the Senate Finance Committee has its sights set on the corporate tax benefits enjoyed by many users of the last-in, first-out method of accounting for inventory costs. To judge by the first stirrings of the committee, repeal of LIFO might not be out of the question.

Indeed, Congress could view a repeal of the accounting method as one way to receive increased corporate taxes, says George Plesko, an accounting professor at the University of Connecticut School of Business, who testified on the method at a Finance Committee hearing on corporate tax issues. LIFO, which gauges the cost of goods sold in terms of a company’s most recent inventory purchases, generally results in a lower tax bill than other inventory cost-accounting methods do. During a period of increasing prices, LIFO produces a higher cost of goods sold—thereby shrinking gross profit and the taxes based on it.

Tax-cutters on the hunt for other forms of federal revenue may well view LIFO as ripe for the plucking. “Whenever you have an eye toward a discussion about fundamental tax reform, which would imply trying to broaden the base in order to lower the rates, LIFO is one of many provisions in the tax code that has to be discussed,” Plesko told CFO.com in a phone interview. “Broadening the [tax] base frees up revenue to allow you to lower the rates.”

Basing his estimate on public-company data culled from 1975 to 2004 by the American Institute of Certified Public Accountants, Plesko testified at the hearing that LIFO repeal could spawn a federal revenue gain of about $18 billion before tax credits.

In May, the Senate leadership suggested a plan to generate a $100 gas-tax rebate for every American family that would be funded by repealing LIFO for every oil company, recalled Plesko. Although the Senate withdrew the plan quickly, a promise by senior-ranking Senators to hold hearings on the accounting method resulted in the June 13 Finance Committee hearing. At the hearing, Sen. Chuck Grassley, the committee’s chairman, said he hopes to explore corporate tax reform in greater detail this fall. Companies that use LIFO and the National Association of Manufacturers and other trade associations have written to Congress to express support for the status quo.

The current Senate review of inventory accounting isn’t an attempt to repeal LIFO, however, notes Plesko. Rather, it reveals a desire by Congress to think about the issue of overall tax reform going forward. After all, the professor says, just bringing up the topic brings House and Senate members perilously close to a political “third rail” with some powerful constituents, he says. While the number of users is relatively small, they’re heavily concentrated in oil, chemicals, and other manufacturing industries.

But LIFO’s critics make the case that its use adds little transparency to corporate financials and is merely a way for companies to shrink their tax bills. “It is an open question as to whether any company would use LIFO if it were not for the tax benefits,” said Plesko, who doesn’t have a stance on whether the method is positive or negative overall. He believes, however, that the quality of information yielded under LIFO is better than the first-in, first-out (FIFO) method because it reflects current costs.

Analysts agree. “I like to see LIFO [if] only because it matches your inventory at the current cost” on the income statement, says Jerry Hirschberg, director of corporate ratings at Standard & Poor’s. “I think it is a little more realistic valuation of what you are trying to sell” because it smoothes profits and makes them more predictable, he said.

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