THE ELIMINATION OF LIFO:

A REQUIREMENT FOR THE ADOPTION OF IFRS IN THE UNITED STATES

Peggy Ann Hughes, Fairleigh Dickenson University, Teaneck, New Jersey, USA
Nancy Stempin, Fairleigh Dickenson University, Madison, New Jersey, USA
Matthew D. Mandelbaum, Student, Montclair State University, Montclair, New Jersey, USA

ABSTRACT
The adoption of International Financial Reporting Standards (IFRS) in the United States is now a
foregone conclusion. The only question is not if, but when. One of the requirements for adopting IFRS is
the adoption of FIFO as an inventory valuation method. That adoption could cost US firms approximately
$27 billion in income tax payments. The petroleum industry would be significantly affected since 70% of
that amount belongs to it. No decision has been made as to the possibility of U.S. firms retaining LIFO for
tax purposes.

Keywords: Lifo; Fifo; Inventory Valuation; IFRS Conversion; Lifo Reserve

1. INTRODUCTION

Today, International Financial Reporting Standards (IFRS) are either used, or plan to be implemented in
most parts of the world, including the European Union, Hong Kong, Australia, Malaysia, Pakistan, India,
GCC countries, Russia, South Africa, Singapore and Turkey. As of August, 2008, more than 100
countries around the world, including all of Europe, currently require or permit IFRS reporting.
Approximately 85 of those countries require IFRS reporting for all domestic, listed companies (SEC). We
now function in a global economy. The US is not in a position to dictate the accounting rules used in the
rest of the world. The significant adoption of IFRS around the globe necessitates the US adoption as well.
To do otherwise leaves the US at a competitive disadvantage.

US companies registered with the United States Securities and Exchange Commission must file financial
statements prepared in accordance with US GAAP. Until 2007, foreign private issuers were required to
file financial statements prepared either (a) under US GAAP or (b) in accordance with local accounting
principles or IFRS with a footnote reconciling from local principles or IFRS to US GAAP. This
reconciliation imposed extra expense on companies which are listed on exchanges both in the US and
another country. From 2008, foreign private issuers are additionally permitted to file financial statements
in accordance with IFRS as issued by the IASB without reconciliation to US GAAP (SEC). There is wide
expectation among U.S. companies that the SEC will move to allow or require them to use IFRS in the
near future. In August 2008, the SEC announced a timetable that would allow some companies to report
under IFRS as soon as 2010 and require it of all companies by 2014 (SEC).

Based on the progress achieved by the Boards (FASB and IASB) through 2007 and other factors, the
SEC removed the reconciliation requirement for non-U.S. companies that are registered in the United
States and use IFRSs as issued by the IASB. The European Commission is proposing that the European
Union eliminate the possible need for U.S. companies with securities registered in European capital
markets and with financial information prepared in accordance with U.S. GAAP to reconcile their accounts
to IFRSs or provide other compensating disclosures. Additionally, a number of countries have adopted
IFRSs on the basis that companies using IFRSs would be able to access capital more efficiently in the
major economies throughout the world, which is now possible (FASB).

The economic turmoil that ripples through the world in 2008, and its major extension in 2009, caused the
SEC and the FASB to refocus their efforts toward remaking financial regulations to provide stronger
oversight to processes largely unregulated, such as credit default swaps, insurance companies with
features of financial firms, and hedge fund activities. How long the convergence path has been pushed
off is unknown. It is too late for it to go away. Views vary from eventual convergence, to parallel systems.

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 148
2. FASB AND IASB AGREEMENT

After their joint meeting in September 2002, the U.S. Financial Accounting Standards Board (FASB) and
the International Accounting Standards Board (IASB) issued the Norwalk Agreement, in which they “each
acknowledged their commitment to the development of high quality, compatible accounting standards that
could be used for both domestic and cross-border financial reporting.” At that meeting, the FASB and the
IASB pledged to use their best efforts (a) to make their existing financial reporting standards fully
compatible as soon as is practicable and (b) to co-ordinate their future work programs to ensure that once
achieved, compatibility is maintained (FASB).

One inconsistency between US GAAP and IFRS is the allowance of LIFO inventory valuation. US allows
it, IFRS does not. The change from LIFO to FIFO would be characterized as a change in accounting
principle—

“A change from one generally accepted accounting principle to another generally accepted accounting
principle when there are two or more generally accepted accounting principles that apply or when the
accounting principle formerly used is no longer generally accepted. A change in the method of applying
an accounting principle also is considered a change in accounting principle (FAS154, par.2).”

“If it is impracticable to determine the cumulative effect of applying a change in accounting principle to
any prior period, the new accounting principle shall be applied as if the change was made prospectively
as of the earliest date practicable. APB Opinion No. 20, Accounting Changes, illustrated that type of
change with a change from the first-in, first-out (FIFO) method of inventory valuation to the last-in, first-out
(LIFO) method. This Statement carries forward that example … for illustrative purposes without implying
that such a change would be considered preferable as required by paragraph 13 of this Statement.
(FAS154, par.9).”

The potential write up of balance sheet inventories and the accompanying income statement affect will
pose significant tax liability unless the US government makes special provision to handle the change.
This paper explores the potential taxation alternatives for companies having significant inventories, and
therefore significant tax liabilities caused by a change from LIFO to FIFO upon IFRS adoption.

2.1 United States and convergence with IFRS

In 2002 at a meeting at Norwalk, Connecticut, the IASB and the US Financial Accounting Standards
Board agreed to harmonize their agenda and work towards reducing differences between IFRS and US
GAAP (the Norwalk Agreement). In February 2006 FASB and IASB issued a “Memorandum of
Understanding” including a program of topics on which the two bodies will seek to achieve convergence
by 2008. No discussion on the acceptance of LIFO inventory valuation has been listed on the agenda.
Rather, a smaller point related to inventory valuation discrepancies between IFRS and ARB 43 was
addressed in the issuance of FAS 151.

2.2 FAS 151 Summary

This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “. . . under some circumstances,
items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so
abnormal as to require treatment as current period charges. . . .” This Statement requires that those items
be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.”
In addition, this Statement requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities.(FASB)

2.3 Reasons for Issuing this Statement

FAS 151 is the result of a broader effort by the FASB to improve the comparability of cross-border
financial reporting by working with the International Accounting Standards Board (IASB) toward
development of a single set of high-quality accounting standards. As part of that effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating certain narrow differences

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 149
between their existing accounting standards. The accounting for inventory costs, in particular, abnormal
amounts of idle facility expense, freight, handling costs, and spoilage, is one such narrow difference that
the FASB decided to address by issuing this Statement. As currently worded in ARB 43, Chapter 4, the
term so abnormal was not defined and its application could lead to unnecessary noncomparability of
financial reporting. This Statement eliminates that term (FASB).

3. IFRS ACCOUNTING RULES: INVENTORY VALUATION

Inventory is stated at the lower of cost and net realizable value (IAS2.9), which is similar in principal to
lower of cost or market (LOCOM) in US GAAP.
Cost comprises all costs of purchase, costs of conversion and other costs incurred in bringing items to
their present location and condition (IAS2.10). Where individual items are not identifiable, the "first in first
out" (FIFO) method is used, such that cost represents the most recent items acquired. "Last in first out"
(LIFO) is not acceptable (IAS2.25). Net realizable value is the estimated selling price less the costs to
complete and costs to sell (IAS2.6).
The US GAAP provisions differ somewhat from International Financial Reporting Standards, though SEC
Chairman Chris Cox set out a timetable for all U.S. companies to drop GAAP by 2016, with the largest
companies switching to IFRS as early as next year (IASB Framework…99-101).
In 2008, the Securities and Exchange Commission announced that the U.S. will abandon Generally
Accepted Accounting Principles, joining more than 100 countries around the world instead in using the
London-based International Financial Reporting Standards (IASB Framework…99-101).

3.1 US GAAP RULES: INVENTORY VALUATION

The amounts at which various current assets are carried do not always represent their present realizable
cash values. Accounts receivable net of allowances for uncollectible accounts, and for unearned
discounts where unearned discounts are considered, are effectively stated at the amount of cash
estimated as realizable. However, practice varies with respect to the carrying basis for current assets
such as inventories. The basis for carrying inventories is stated in ARB43, chapter 4. It is important that
the amounts at which current assets are stated be supplemented by information which reveals, for the
various classifications of inventory items, the basis upon which their amounts are stated and, where
practicable, indication of the method of determining the cost - e.g., average cost, first-in first-out, last-in
first-out, etc. (ARB43, Ch.3A, par.9).

3.2 Inventory Pricing

According to ARB43:
“The term inventory is used herein to designate the aggregate of those items of tangible personal
property which (1) are held for sale in the ordinary course of business, (2) are in process of production for
such sale, or (3) are to be currently consumed in the production of goods or services to be available for
sale. (ARB43, Ch.4, Par. 3).”

“An inventory has financial significance because revenues may be obtained from its sale, or from the sale
of the goods or services in whose production it is used. Normally such revenues arise in a continuous
repetitive process or cycle of operations by which goods are acquired and sold, and further goods are
acquired for additional sales. In accounting for the goods in the inventory at any point of time, the major
objective is the matching of appropriate costs against revenues in order that there may be a proper
determination of the realized income. Thus, the inventory at any given date is the balance of costs
applicable to goods on hand remaining after the matching of absorbed costs with concurrent revenues.
This balance is appropriately carried to future periods provided it does not exceed an amount properly
chargeable against the revenues expected to be obtained from ultimate disposition of the goods carried
forward. In practice, this balance is determined by the process of pricing the articles comprised in the
inventory (ARB43, Ch.4, Par. 4).”

In reading the above section from ARB43, one might think there is no difference in the inventory valuation
between IFRS and US GAAP. However, US GAAP does allow the use of LIFO, whereas IFRS does not.

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 150
“Cost for inventory purposes may be determined under any one of several assumptions as to the flow of
cost factors (such as first-in first-out, average, and last-in first-out); the major objective in selecting a
method should be to choose the one which, under the circumstances, most clearly reflects periodic
income. (ARB43, Ch.4, Par. 4).”

Although selection of the method should be made on the basis of the individual circumstances, it is
obvious that financial statements will be more useful if uniform methods of inventory pricing are adopted
by all companies within a given industry. (ARB43, Ch.4, Par. 7).”

When ARB43 was issued, one member of the committee, a Mr. Wellington, objected as relating to
companies using LIFO as an inventory valuation method. He believed that an exception should be made
for goods costed on the last-in first-out (LIFO) basis. In the case of goods costed on all bases other than
LIFO the reduced amount (market below cost) is cleared from the accounts through the regular
accounting entries of the subsequent period, and if the market price rises to or above the original cost
there will be an increased profit in the subsequent period. Accounts kept under the LIFO method should
also show a similar increased profit in the subsequent period, which will be shown if the LIFO inventory is
restored to its original cost. Mr. Wellington felt it incorrect to carry the LIFO inventory, not at the lower of
cost or current market, but at the lowest market ever known since the LIFO method was adopted by the
company (ARB54, Ch. 4).

3.3 LIFO Elimination

The real issue for U.S. companies with eliminating LIFO is not the financial reporting but the tax reporting.
If the LIFO is method eliminated, the estimated effect of the change in accounting practices is estimated
to be an inventory adjustment of $80.8 billion. The $80.8 billion added to the cost of goods sold will
produce an estimated tax obligation of $27 billion, with $56 billion of it coming from the petroleum refining
industry. Given the recent extraordinary earnings from that group, it is unlikely that claims from that
industry of non-affordability would gather much support. See Table 1. The FASB has recognized that the
issuance of any accounting policy “may not be borne evenly” across industries, as outlined below.
As the FASB expressed in its issuance of FAS 151:

“The mission of the FASB is to establish and improve standards of financial accounting and reporting for
the guidance and education of the public, including preparers, auditors, and users of financial information.
In fulfilling that mission, the Board endeavors to determine that a proposed standard will fill a significant
need and that the costs imposed to meet that standard, as compared with other alternatives, are justified
in relation to the overall benefits of the resulting information. Although the costs to implement a new
standard may not be borne evenly, investors and creditors—both present and potential—and other
users of financial information benefit from improvements in financial reporting, thereby facilitating the
functioning of markets for capital and credit and the efficient allocation of resources in the economy. The
Board believes the benefit of reducing the possibility for potential misinterpretation of the principles of
inventory pricing outweighs the cost of applying this Statement. (FAS151, par.A11).”

TABLE 1: LIFO RESERVES BY INDUSTRY GROUP

Industry LIFO Reserve

Petroleum Refining $ 56,722,243,000
Industrial and Farm Equipment $ 4,455,801,000
Chemical $ 3,541,879,000
Motor Vehicles and Parts $ 2,920,300,000
Metals $ 2,741,600,000
Food and Drug Stores $ 1,996,138,000
Utilities: Gas and Electric $ 934,000,000
Wholesalers: Diversified $ 893,125,000
Aerospace and Defense $ 782,900,000
Tobacco $ 751,000,000

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 151
 Diversified Financials $ 623,000,000
Insurance: Property and Casual (Stock) $ 482,000,000
Forest and Paper Products $ 459,000,000
Wholesalers: Food and Grocery $ 389,000,000
Food Consumer Products $ 344,538,000
Packaging, Containers $ 325,200,000
Energy $ 304,400,000
Oil and Gas Equipment, Service $ 299,159,000
Household and Personal Products $ 283,300,000
Computers, Office Equipment $ 237,000,000
Beverages $ 231,500,000
Wholesalers: Healthcare $ 212,400,000
Electronics, Electrical Equipment $ 175,200,000
Transportation Equipment $ 148,334,000
Pharmaceuticals $ 135,400,000
Mining, Crude Oil Products $ 102,000,000
General Merchandisers $ 90,800,000
Publishing, Printing $ 77,600,000
Home Equipment, Furnishing $ 61,700,000
Wholesalers: Electronics and Office Equip. $ 60,400,000
Scientific, Photographic, Control Equip. $ 18,000,000
Medical Products and Equipment $ 3,700,000
$ 80,802,617,000
Effective Availability October, 2008, per 10-K

TABLE 2: TOP 50 LIFO RESERVE BALANCES BY COMPANY

COMPANY Fortune 500 Rank LIFO RESERVE $ EFFECTIVE TAX RATE

Exxon Mobil 2 25,400,000,000 44.00%
Chevron 3 6,958,000,000 42.00%
ConocoPhillips 5 6,668,000,000 49.00%
Valero Energy 16 6,200,000,000 32.10%
Marathon Oil 36 4,034,000,000 42.40%
Sunoco 56 3,868,000,000 36.80%
Caterpillar 50 2,617,000,000 30.00%
Dow Chemical 42 1,511,000,000 29.40%
General Motors 4 1,423,000,000 17.00%
Tesoro 116 1,400,000,000 37.00%
Deere 102 1,233,000,000 33.00%
Ford Motor 7 1,100,000,000 31.00%
Alcoa 80 1,069,000,000 34.60%
Hess 77 1,029,000,000 50.50%
Walgreen 40 968,800,000 36.00%
Murphy Oil 134 709,743,000 38.00%
Altria Group 61 700,000,000 31.50%
DuPont 81 630,000,000 20.00%
General Electric 6 623,000,000 21.80%

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 152
 Kroger 26 604,000,000 35.40%
AK Steel Holding 351 539,000,000 34.40%
Nucor 151 518,500,000 34.68%
Eastman Chemical 337 510,000,000 32.00%
NiSource 319 481,000,000 35.60%
CHS 145 389,000,000 4.70%
Allegheny Technologies 441 374,600,000 34.90%
Berkshire Hathaway 11 331,000,000 32.70%
Genuine Parts 243 326,816,000 38.00%
Textron 202 307,000,000 29.60%
Integrys Energy Group 254 304,400,000 32.20%
DTE Energy 273 288,000,000 31.60%
W.W. Grainger 377 287,700,000 38.40%
Reliance Steel &
Aluminum 345 278,609,000 37.70%
Western Refining 342 256,100,000 29.90%
Weyerhaeuser 147 246,000,000 12.10%
Sherwin-Williams 316 241,579,000 32.60%
Commercial Metals 303 240,500,000 31.90%
Pitney Bowes 399 237,000,000 42.40%
Parker Hannifin 247 216,794,000 28.40%
Kimberly-Clark 136 214,900,000 23.10%
International Paper 114 213,000,000 25.00%
PPG Industries 217 206,000,000 28.56%
Longs Drug Stores 453 204,900,000 36.90%
Holly 484 199,400,000 33.10%
Honeywell International 73 199,000,000 26.40%
Anheuser-Busch 149 183,600,000 40.00%
United Technologies 39 173,000,000 28.80%
Rohm & Haas 295 170,000,000 23.40%
AmerisourceBergen 28 154,900,000 37.10%
Dominion Resources 161 152,000,000 39.70%
Effective Availability October, 2008, per 10-K

4. POTENTIAL ALTERNATIVES

4.1 Accept the change for tax purposes netting the government approx. $27 billion
This would be the standard way of accepting a change in accounting policy. However, no past change
has had the potential tax effect of causing many industry groups to pay such high one year costs.
Corporations are not going to support the notion that they have had years of opportunity to hold cash in
lieu of paying taxes on inventory values that should have moved to the income statement. However, it is
hard to argue that the inventory values on their current balance sheets are at market or fair value.
Anytime a company has to erode a LIFO layer there is a significant mismatch on the income statement
between current revenue and older valued cost of goods sold.

4.2 Accept US version of IFRS without elimination of LIFO

A number of countries have taken this approach. For example, Singapore has accepted IFRS with the
exception of IFRS (forbidding off balance sheet entities) for banks. This would be a difficult path for the
U.S. to take. The U.S. does not accept altered IFRS financial statements from foreign firms. It is unlikely
it could accept an altered IFRS from U.S. firms.

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 153
4.3 Maintain two systems, one for tax and one for financial
IFRS is not related to taxation. Therefore, the USA could adopt IFRS without exception for financial
reporting, and allow LIFO inventory reporting for tax purposes. For those industries with little inventory
this is probably not a cost effective method. So, this might be feasible as a compromise alternative to
inventory laden industries, such as the oil and gas industry.

4.4 US Government provide a onetime tax break at a lower rate; perhaps at 5%

During the Bush administration a New Jobs Bill was passed which allowed corporations to repatriate
foreign earnings at a 5% rate if the money was used to create jobs. It was not to be used to repurchase
stock or to spend on research and development. However, cash is hard to follow. Using this same
technique, the government could allow the income related to the adoption of FIFO to be taxes at a lower
than statutory rate.

5. CONCLUDING COMMENTS

A standard method of choosing an accounting method is to following the practices of other firms in a
company’s industry. Out of the Fortune 500, there are 110 firms still using LIFO as a valuation method at
this time. Of those, a number are inconsistent with their industry use of FIFO.
From looking at the industries on Table 1, the petroleum refining industry has 70% of the estimated tax
burden if revaluing inventory from LIFO to FIFO. After their recent spectacular earnings figures, they can
afford this change more than any other industry. Table 2 lists the top 50 LIFO valuation by company.
Some firms have begun changing their inventory valuations method to be more consistent with their
international subsidiaries, such as Pfizer, Inc. in 2000.

“In 1999, we changed the method of determining the cost of all of our remaining inventories previously on
the "Last-in, first-out" (LIFO) method to the "First-in, first-out" (FIFO) method. Those inventories
consisted of U.S. sourced pharmaceuticals and part of the animal health inventories. We believe that the
change in accounting for inventories from LIFO to FIFO is preferable because inventory costs are stable
and substantially unaffected by inflation. The change in the method of inventory costing resulted in a pre-
tax benefit of $6.6 million included in COST OF SALES for 1999 (Pfizer's 2000 10-k).”

Eli Lilly & Co. is now the only U.S. based pharmaceutical company to be using LIFO (10-k, 2007). As
mentioned previously ARB54 states that the selection of the method should be made on the basis of the
individual circumstances, it is obvious that financial statements will be more useful if uniform methods of
inventory pricing are adopted by all companies within a given industry. Since most reporting for internal
purposes (cost accounting) is done on a FIFO basis, it would certainly be simpler to have one inventory
valuation system than two. The issue is taxation.
The current federal taxation regulations require that firms which use FIFO for financial inventory valuation
also use FIFO for tax reporting. Clearly, the U.S. Treasury could certainly use the additional revenue. No
group has come up with an answer to this problem. This paper has shown that the LIFO discontinuation is
not a U.S. industry problem, but rather a significant issue for the petroleum refining industry, with
industrial and farm equipment, and the auto industry next in line. A special tax rule for the change in
accounting principle necessary for the implementation of IFRS would certainly make the transition easier
and more palatable to the firms involved.

REFERENCES:

Accounting Research Bulletin 43, Restatement and Revision of Accounting Research Bulletins, Chapter
3: Working Capital, Section A, Current Assets and Current Liabilities. par.9.
Epstein, Keith (2008-08-28). An SEC Timetable for Global Accounting Rules. Business Week.
Retrieved on 2008-08-28.

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 154
Financial Accounting Standards Board (2008): http://www.fasb.org/intl/MOU_09-11-08.pdf.
International Accounting Standards Board (2007) International Financial Reporting Standards 2007
(including International Accounting Standards (IASs(tm)) and Interpretations as at 1 January 2007).
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International Accounting Standards Board (2007):
http://www.iasb.org/Current+Projects/IASB+Projects/IASB+Work+Plan.htm, Retrieved on 2007-04-19.
Original texts of IASs/IFRSs, SICs and IFRICs adopted by the Commission of the European
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http://ec.europa.eu/internal_market/accounting/ias_en.htm#adopted-commission.

Process of Prescribing Accounting Standards, http://www.ccdg.gov.sg/account.htm, ‘’ Retrieved on 2008-

02-29.

U.S. Securities and Exchange Commission (2008-08-28): SEC Proposes Roadmap Toward Global
Accounting Standards to Help Investors Compare Financial Information More Easily. http://www.sec.gov .
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U.S. Securities and Exchange Commission (2008): http://www.sec.gov/rules/final/2008/ 33-8879fr.pdf.

U.S. Securities and Exchange Commission (2008):

http://www.sec.gov/Archives/edgar/data/78003/0000930413-00-000548.txt.

AUTHOR PROFILES:

Dr. Peggy Ann Hughes earned her Ph.D. from Rutgers University in 1999. Currently, she is Assistant
Professor of Accounting at Fairleigh Dickenson University in Teaneck, New Jersey, USA. She previously
taught at Montclair State University in Montclair, New Jersey.

Nancy Stempin is an Adjunct Professor of Accounting at Fairleigh Dickenson University in Madison, New
Jersey, USA. She teaches in the Executive MBA Program.

Matthew D. Mandelbaum has just graduated from Montclair University in Montclair, New Jersey with a
B.S. in Accounting.

 
REVIEW OF BUSINESS RESEARCH, Volume 9, Number 4, 2009 155
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