Insights
The manufacturing sector of the economy has begun to show indications of increases in production, as well as slight price increases. According to the U.S. Bureau of Labor Statistics, the consumer price index has increased 2.7 % before seasonal adjustment over the last 12 months. In addition, the Producer Price Index for Finished Goods advanced 4.4 % in 2009, after falling 0.9 % in 2008. These recent price increases at both the consumer and producer levels provide opportunities to either adopt the last-in, first-out (LIFO) method of inventory valuation or change the existing LIFO method.
The adoption of LIFO inventory valuation method allows taxpayers to value their inventory based on the purchase price of the oldest items in inventory. The most recently purchased items are the first items to be removed from inventory when sold, thereby allowing the inventory value to remain at a lower level. Over time, the LIFO method of inventory valuation normally results in a significant deferral of income.
Many businesses calculate their price indexes for the various LIFO pools based on their internal price changes from year to year. In recent years when prices have been either flat or declining, these internal calculations have resulted in businesses recognizing income. By changing to an inventory valuation method, such as the Inventory Price Index Computation (IPIC), many businesses can yield results that are more beneficial than their existing methods. In addition, the use of indexes that are published by the Bureau of Labor Statistics provides administrative advantages, especially in situations where items within the pool no longer exist, making it difficult to find similar items to calculate the current year price index.
Recently, we have seen taxpayers in the manufacturing sector save in excess of $2,000,000 in current tax benefits (cash savings) simply by changing from an existing LIFO method to the IPIC method. This additional cash flow can be used to fund current operations or additional capital expansion.
There is no cost to evaluate the potential benefits that may exist by either adopting the LIFO inventory valuation method or changing to the IPIC LIFO method. However, be aware that some industries provide greater benefits than others, depending on the makeup of their inventory. Consult your Schneider Downs advisor to determine if an evaluation of the benefits of adopting LIFO or changing to the IPIC LIFO method is warranted for your business.
Schneider Downs provides accounting, tax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA, and Columbus, OH.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.
Comments
- George Adams
- February 16, 2010
- I'm not sure I completely understand the question. If the question is what is the tax effect of switching from LIFO to FIFO inventory, there answer is for a C corporation the total amount of the reserve is recorded as taxable income in the year of the change, but only 25% of the tax related to the recapture of the LIFO reserve is due in the year of change. The remaining 75% of the tax is due in three equal installments (25% per year) each of the three succeeding years. A passthrough entity recognizes 25% of the income related to the recapture of the LIFO reserve as taxable income beginning with the year of the election to switch to FIFO. The remaining 75% of the LIFO reserve is picked up as taxable income for tax purposes 25% per year for each of the successive three years. Hopefully that answers your question. If not, please post or email me directly.
- D NOORLAG
- February 12, 2010
- WHAT IS THE TAX EFFECT TO DESELCT-RECAPTURE OF DEFERRED TAX? PAYABLE IN FIRST YEAR OPTION?
Manufacturing
Should You Adopt the LIFO Inventory Valuation Method?
By George Adams
February 12, 2010