Taxpayers with rising inventory costs may benefit from LIFO

In detail

The specific identification method tracks each individual item in inventory from the time the item is acquired or produced until the item is sold.  The FIFO method assumes that the earliest obtained or produced goods are the earliest sold goods, and the associated costs are included first in cost of goods sold.  Under LIFO, goods sold during the year are deemed to come first from goods purchased or produced during the year and then from beginning inventory. As a result, inflation on items in ending inventory is included in cost of goods sold, which could reduce taxable income.

Observation:  Products that have experienced substantial inflation (25% to over 200%) over the last twelve months include leather, natural gas, propane, crude oil and petroleum products, organic chemicals, lumber and wood products, and metals and metal products.

Taxpayers adopting the LIFO method may measure inflation using indexes based on changes in internal inventory costs or external inventory prices as allowed under the inventory price index computation method, which uses indexes published by the Bureau of Labor Statistics.

A taxpayer must value all LIFO inventory, including beginning inventory, at cost.  The taxpayer must take into account adjustments resulting from valuing beginning inventory at cost ratably over a three-year period, beginning with the tax year of adoption.

Under the LIFO conformity rule, a taxpayer that uses LIFO for tax purposes must use a LIFO method in computing book income.  Accordingly, financial statements issued to shareholders, creditors, or other parties must reflect income based on inventory computed under a LIFO method. 

A taxpayer adopts LIFO by attaching Form 970, Application to Use LIFO Inventory Method, to its federal income tax return.