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3.5 Accounting changes to/from LIFO
Publication date: 31 Dec 2021
us Inventory guide
A change to LIFO from another costing method or a change to another costing method from LIFO is a change in accounting principle. Under ASC 250-10-45-2, a change in accounting principle can only be made if the use of an allowable alternative is preferable. SAB Topic 6.G.2.b provides interpretive guidance on how a company may justify the preferability of one accounting principle over another. See IV 3.5.2 for considerations specific to changes from LIFO to another method.
3.5.1 Accounting changes to LIFO
A change in accounting principle generally must be reported through retrospective application of the new principle to all periods presented. Given the need to establish a base-year cost (or quantity, if using the specific-goods approach), the retrospective application of LIFO may be impracticable, as indicated in ASC 250-10-45-7 and Example 1 in ASC 250-10-55-3.
As noted in the FinREC LIFO guidance, if a company changes to LIFO, there is a presumption that it would do so for all inventories. This presumption can be overcome only if the company has a valid business reason for not fully adopting LIFO and can justify the preferability of continuing to use the non-LIFO method for the remaining inventories. The FinREC LIFO guidance discusses various business reasons for not fully adopting LIFO. For example, a company may want to adopt LIFO only for inventory categories that are substantially affected by inflation, or exclude certain inventories from LIFO if quantities fluctuate greatly, significant reductions are anticipated, or prices are volatile.
If a company adopts LIFO for certain domestic inventories, LIFO should be applied to similar inventory categories at international locations unless there are valid reasons not to do so. Such reasons may include no or low inflation in the foreign country or inventory that is subject to different economic considerations. Another valid reasons for not applying LIFO for all inventories is that certain foreign jurisdictions do not recognize LIFO for tax purposes.
Companies that have not fully adopted LIFO should disclose the dollar amount of ending inventories carried at LIFO cost and the related LIFO reserve. Companies that change their methodology should disclose the justification for the change.
3.5.2 Accounting changes from LIFO
A change from LIFO to another method should be accounted for by retrospectively adjusting the financial statements for all prior periods presented in accordance with ASC 250. Because perpetual inventory records are generally kept on a FIFO or average cost basis, unlike a change to LIFO, the impracticability exception is unlikely to be available for a change from LIFO.
In order to comply with the disclosure requirements in ASC 250-10-50-1(b)2, an entity would need to perform a LIFO calculation in the year of the change, even if the change was adopted in the first fiscal quarter. For example, a public company with a calendar year-end that changes from LIFO to FIFO in the first quarter of 20X1 would be required to show the effects of the change for the full year ended December 31, 20X1 in its 20X1 annual financial statements.
Circumstances in which a change from the LIFO method has been justified include the following:
- FIFO is used by peer group companies.
- The company’s financial distress has lead creditors to place greater emphasis on the balance sheet.
- LIFO is not being used internationally.
- The company has experienced increased productivity gains (e.g., because of technological advances) resulting in a decline in the unit cost of inventory.
- There has been a permanent decline in inventory costs because of supply and demand in the marketplace.
- The change will provide for a better matching of expenses with revenues (currently and for the foreseeable future).
The following reasons are generally not persuasive in justifying a change from LIFO:
- The change will provide the company additional equity and, therefore, facilitate compliance with existing debt covenants.
- The internal cost of performing the LIFO calculation is too great.
- The company does not expect future inflation as high as it was when the company initially adopted LIFO.
- The company does not use LIFO for internal management purposes.
See FSP 30 for additional details on the disclosure requirements related to accounting changes.
As a result of the IRS conformity regulations, changing from LIFO to FIFO for book purposes will likely trigger the need to change from LIFO to another method for tax purposes.
3.5.3 Changes in method of applying LIFO
As discussed in Chapter 9 of the FinREC LIFO guidance, a change in the method of applying LIFO (e.g., a change to dollar value from specific goods, a change from double extension to link chain, a change from a single pool to multiple pools) is a change in accounting principle, unless, as noted in ASC 250-10-45-1b, the change is necessitated by transactions or events that are clearly different in substance from those previously occurring. Otherwise, any such change is acceptable only if the company can provide justification for the preferability of the new method.
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