Accounting principles in the US and abroad have converged in recent years, but one issue on which US GAAP and IFRS (International Financial Reporting Standards) remain divided is valuation methods. of inventories. While US GAAP allows first-in, first-out (FIFO), last-in-first-out (LIFO), and weighted average inventory valuation methods, IFRS only allows FIFO and weighted average methods. In this article, I will argue that the US should also ban the LIFO method of inventory valuation and switch to the IFRS policy of allowing only FIFO and weighted average methods.

Imagine a company that operates using the LIFO method of inventory valuation. This business operates on the assumption that your most recent inventory purchase (last in) will also be the first available inventory item (first out). Compare this to a company that uses FIFO. A company using FIFO operates under the assumption that its oldest inventory pieces (first in) will be the first off the shelf (first out). While the difference may not seem significant or even noteworthy, there are several consequences of using LIFO that I will discuss. Before we begin, it is important to note that these statements are based on the assumption that prices are increasing. While this is often the case, there are times when prices drop over a period of time. However, the following statements are made on the assumption that prices are rising.

In a period of rising prices, the inventory that a business purchases in one operating period will be more expensive than the inventory it already had on hand, which was presumably purchased during a previous operating period when prices were lower. Remember that LIFO stipulates that the most recent inventory purchases will be the first pieces of inventory to be sold. By selling the latest and most expensive pieces of inventory first, a business incurs higher operating expenses during the period. While this may seem counterintuitive because it actually reduces a company’s net income, it is desirable for corporations because it also reduces the amount of income taxes to be paid.

I argue that LIFO should be outlawed for this reason alone. This accounting method is not representative of how business operations work and is nothing more than a trick used by corporations to cheat tax payments. This type of manipulation leads to accounting that is neither conservative nor honest, which should be the only reason not to use it.

There are other reasons for prohibiting the use of LIFO. During a period of prolonged price increases, LIFO generates inaccurate inventory information. Because newer inventory pieces are the first to sell, older inventory pieces can remain buried in balance for years. Those inventory pieces will be assigned current inflated prices, and yet they may be out of date or out of date. This can result in inventory values ​​that are far off the mark. This is a major problem because for many businesses, especially retailers, their inventory stock may be the most important asset on their balance sheet. We cannot be accounting for these inventories in such a way as to lead to a dishonest inventory valuation.

Since FIFO methods and weighted average inventory valuation do not give rise to these problems, they are the methods to use. Making the switch may not be desirable for companies that have been using LIFO, but it will lead to better long-term bookkeeping. IFRS has already made the change and it is time for the US to do the same. The responsible choice is choosing better long-term accounting.