Manufacturers who use the Last In, First Out (LIFO) inventory method may be in for an unpleasant surprise in the near future. As the name suggests, LIFO requires that inventory sold be expensed at the most recently purchased/produced price of a unit of inventory on hand at the time of the sale. This results in inventory on the balance sheet being reflected at unit costs from less-recent purchases, which are generally lower dollar amounts. As a result, manufacturers that have maintained consistent inventory levels for long periods of time may have inventory on the balance sheet that is costed at purchase values from decades ago.
Supply Chain Disruption Impact on LIFO
Supply chain disruptions and labor shortages manufacturers have experienced over the past year-and-a-half coupled with sustained or even increased demand for their products in recent months are causing many manufacturers to see their inventories depleted. Accordingly, manufacturers that use a LIFO inventory method could be selling off their LIFO reserves. That can result in significant profit margins in the current year – and while that can be a great thing, it could also generate significant tax liabilities.
Furthermore, most ERP systems do not support LIFO inventory methods, and due to the overall complexity of the calculations, many companies that use the LIFO method often wait until after year-end to quantify and record their LIFO inventory adjustment. That means they may not discover the tax impact until it’s too late – an unpleasant surprise on top of the many other strains they’ve been experiencing.
AICPA Requests Tax Relief for LIFO
Recognizing the looming challenge and negative impact on manufacturers, the American Institute of Certified Public Accountants (AICPA) has provided a comment letter to the IRS requesting tax relief for companies that use the LIFO method, and whose ability to obtain replacement inventory has been negatively impacted as a result of external events (such as the global pandemic, which has disrupted supply chains around the world at record-breaking levels). You can find details of the AICPA’s comments on their website.
What You Can Do
If you have questions about this report or are concerned that your business may be at risk for these LIFO method issues, contact us for a free consultation with a member of our Manufacturing team. As always, we’re here to help.