Domestic Inventories

1. Recognize that theoretical problems with LIFO have led the creators of IFRS rules to prohibit its use.

2. Explain that the biggest problem associated with LIFO is an inventory balance that can often show costs from years (or even decades) earlier that are totally irrelevant today.

3. Identify the cause of a LIFO liquidation and the reason that it is viewed as a theoretical concern by accountants.

Question: As a result of the LIFO conformity rule in the tax laws, this cost flow assumption is widely used in

the United States. LIFO, though, is not allowed in many other areas of the world. It is not simply unpopular in

those locations; its application is strictly forbidden. Thus, international companies are often forced to resort to

alternatives in reporting their foreign subsidiaries. For example, a footnote to the 2008 financial statements of

American Biltrite Inc. explains that “Inventories are stated at the lower-of-cost-or-market. Cost is determined

by the last-in, first-out (LIFO) method for most of the Company’s domestic inventories. The use of LIFO results

in a better matching of costs and revenues. Cost is determined by the first-in, first-out (FIFO) method for the

Company’s foreign inventories.”

Why is LIFO not accepted in most countries outside the United States?

Answer: Although LIFO can be supported as providing a proper matching of expenses (cost of goods sold) with

revenues, a number of serious theoretical problems are created by its application. The most common accusation

against LIFO is that it often presents a balance sheet number that is completely out-of-date and useless. When

applying this assumption, the latest costs get moved to cost of goods sold so the earlier costs remain in the

inventory account—possibly for years and even decades. After some period of time, this asset balance is likely to

report a number that has no relevance to today’s prices.

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