Avoiding missteps in the LIFO conformity rule: how to properly present U.S. GAAP-to-IFRS reconciliations.

Author:Adams, Mollie T.
Position::Last-in/first-out, generally accepted accounting principles, international financial reporting standards
 
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EXECUTIVE SUMMARY

* The last-in, first-out (LIFO) inventory method is an effective way to reduce taxes.

* Using LIFO, however, requires taxpayers to be consistent. The LIFO conformity rule requires taxpayers that elect to use LIFO for tax purposes to use no method other than LIFO to ascertain the income, profit, or loss for the purpose of a report or statement to shareholders, partners, or other proprietors, or to beneficiaries, or for credit purposes.

* IFRS does not recognize LIFO, yet taxpayers with business operations outside the United States are often required to provide restated financial information that complies with IFRS.

* Providing this information may violate the LIFO conformity rule. This article discusses ways to avoid this problem and provides illustrations of alternative reporting statements.

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During inflationary times, companies can reduce their taxable income by using the last-in, first-out (LIFO) cost flow assumption for inventories. However, the tax savings from using LIFO come at a cost. Under the LIFO conformity rule in Sec. 472(c), if LIFO is used on a taxpayer's tax return, no other method can be used to value inventory to calculate income, profit, or loss in any report or statement covering the same tax year that is provided to shareholders and other owners, or to creditors. The IRS strictly enforces this rule.

The increase in multinational companies and the disparity in financial reporting standards among countries add to the complexity of satisfying the LIFO conformity rule. While LIFO is allowed under U.S. GAAP, it is not allowed under IFRS. Violating the LIFO conformity rule would certainly be a concern if the United States adopts IFRS for financial reporting rules; however, even if the United States does not adopt IFRS, these standards are increasingly being used globally. Financial statement preparers for U.S. entities that are members of larger consolidated groups with foreign operations or ownership need to be aware of what is and is not allowable to avoid violating the conformity rule.

In a recent legal advice memorandum (FAA 20114702F), the IRS determined that a U.S. taxpayer had violated the LIFO conformity rule by providing a bank with financial statements prepared under both U.S. GAAP and IFRS. In this case, the taxpayer, which had been using LIFO for both financial statement and tax reporting purposes, was bought by a foreign entity that used IFRS for financial reporting purposes. The taxpayer continued to use LIFO for tax and financial reporting purposes but re ported to its foreign parent on an IFRS (non-LIFO) basis. To meet the bank requirements for a letter of credit, the taxpayer provided a nonconsolidated IFRS-only balance sheet and income statement, and a balance sheet and income statement in a three-column tabular format showing the reconciliation between IFRS and U.S. GAAP The U.S. GAAP column was calculated using LIFO to value inventories. Analyzing the mistakes made by this company that led to the decision in FAA 20114702F can help both domestic and multinational companies better understand what is allowable under the conformity rule.

The first mistake the taxpayer made was to provide the non-LIFO financial statements for credit purposes. Even though the statements were provided as required by an already existing letter of credit rather than to obtain new credit, the IRS considered maintaining a current credit relationship to fall under the definition of "credit purposes." Taxpayers that use LIFO for tax reporting purposes are allowed to...

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