The Potential Consequences of the Elimination of LIFO as a Part of IFRS Convergence

Abstract

The SEC has proposed the full adoption of IFRS by U.S. filers by 2014, with larger firms adopting the international standards as early as 2010. One important change to U.S. accounting standards that would accompany a move to IFRS is the elimination of the Last-in First-out (LIFO) accounting method for inventory. Moreover, because of the LIFO conformity rule, a move away from LIFO for financial reporting purposes also means that the advantages of LIFO for tax purposes could be lost to these firms. The purpose of this study is to examine the income, balance sheet, cash flow and tax effects of a required move to FIFO from LIFO. Presently, approximately 36% of U.S. companies use LIFO for at least a portion of their inventories. We examine a sample of 30 such companies with the greatest LIFO exposure. We find that on average, had FIFO been used by these firms in 2007, pre-tax income and net income would be higher by 11.97% and 7.42%, respectively, the current ratio would be higher by 26.2% and shareholders’ equity would be higher by 34.2%. Of particular note is the significant amount of income taxes that these firms would owe, ranging up to the hundreds of millions if not billions of dollars, if they were required to adopt FIFO accounting. Accordingly, investors, lenders and other users of financial statements will want to watch developments on this front carefully.