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Frequently Asked Questions About Inventory Price Index Computation (IPIC) LIFO

Why would a business choose LIFO accounting?
If inventory costs are increasing, LIFO allows a business to reduce income taxes and keep more cash in the business. Assuming inventory levels will remain constant in future years, the reduction to income taxes may be estimated as follows:

FIFO Cost Value Beginning of First LIFO Year		$10,000,000
Estimated Future Inflation*	x	.10
Estimated Reduction of Taxable Income		$1,000,000
Assumed Tax Rate	x	.40
Estimated Reduction of Income Taxes		$400,000

*inflation should be the cumulative inflation for a number of years

What types of businesses can benefit from LIFO accounting?
Any business with rising inventory costs. It does not matter how large or small the inventory items are or how fast the inventory turns over.

Which types of businesses would not benefit from LIFO accounting?
Businesses experiencing deflation* should not use LIFO. In addition, businesses that do not pay taxes and do not expect to do so for the foreseeable future have no reason to elect LIFO. If LIFO is used for tax purposes, it must be used in primary income statements issued to owners and creditors. Companies may not want to adopt LIFO because it reduces their earnings.
* - It is possible, however, that companies experiencing deflation could realize an inflationary benefit by choosing the IPIC LIFO method since it is based on domestic price data.

How can I elect LIFO?
If LIFO is used for tax purposes, it must be used in primary financial statements issued to owners and creditors. Therefore, a company electing to use LIFO for tax purposes must issue primary LIFO financial statements. Primary financial statements include annual financial statements and interim statements that can be combined to equal a full year's income. Supplement non-LIFO information may accompany the primary LIFO statements provided it is labeled as a supplement to the primary LIFO statements. In addition, it must attach a LIFO election form to the tax return for the year that LIFO is elected.

Do I have to elect LIFO for all inventories?
No, your LIFO election can be limited to only a portion of your inventory.

Why would I want to defer income? Or, If it's only a deferral, why elect LIFO?
Because LIFO generates cash, interest-free. Businesses find it more challenging today than ever to stay competitive. It is not often that an interest-free loan is made available. To put it in another perspective, why does one contribute to an IRA, a 401K, or other retirement account? You do it even though you know you will pay taxes on the contributions and the earnings some day. The reason every business should consider LIFO accounting is that, properly invested, deferred income taxes compound into hundreds of thousands and even millions of dollars.

I'm on LIFO and will probably have less inventory at the end of this year than I did at the end of last year. How will this affect my LIFO reserve?
Unless a business has significantly decreased inventory, or inventory unit costs have declined during the year, the LIFO investment account typically increases even when inventory levels drop. When the LIFO reserve decreases, a company in affect pays back some of the benefits of the LIFO method, but a portion of the LIFO reserve will remain.

Is it possible to "turn" inventory too often, or too infrequently, to make LIFO a worthwhile alternative?
NO! Inventory turns have absolutely nothing to do with LIFO benefits.

I'm already valuing my inventory at "Lower of Cost or Market". Why would I want to consider LIFO accounting?
For tax purposes, a LIFO taxpayer may not write down its inventory. If write downs have been taken in the past, they must be recaptured over a three year period when LIFO is adopted. Many businesses have not considered LIFO because they think they are getting all the benefit they can from write downs. When inventory costs rise, it will not take long before the LIFO reserve is greater than write-downs. In fact, write downs are not an effective tax planning tool because the business must recapture the tax benefit as soon as the written-down inventory is sold. With a LIFO election, the benefit is not attached to any individual item, and the benefits can continue to increase every year. When this concept is understood, there is no real choice - In an inflationary environment, LIFO is far superior to write-downs.

How long do LIFO benefits last?
The LIFO benefit continues until inventory costs fall below the levels when LIFO was adopted, the business has no ending inventory or until the business elects to discontinue LIFO.

Every business in our corporate umbrella uses a different LIFO method for taxes. Isn't there one method that will work for all?
Yes, the Inventory Price Index Computation (IPIC) method is available to any business with inventory. Wholesalers, Manufacturers, Distributors, and Retailers can all enjoy the benefits of LIFO under the same basic method. This method uses indexes published by the Bureau of Labor Statistics.

Is a published index better than an internally generated index?
The IPIC method utilizes Consumer Price Indexes (CPI) or Producer Price Indexes (PPI) published by the Bureau of Labor Statistics. For many businesses, published indexes provide more tax benefits than internally generated indexes. The published indexes will reduce taxable income when the inflation shown by the published indexes is greater than actual inflation.

Recently, the IRS's Industry Specialization Program (ISP) has identified certain LIFO methods that IRS agents should challenge upon audit. A voluntary change to the IPIC method is made without any income adjustment and precludes the IRS from changing questionable LIFO method in earlier years.

Another benefit of published inflation data is it gives SourceCorp the ability to quickly and accurately provide quarterly estimates and annual computations.

How can I tell if IPIC would be the best solution for my business?
Our specialists can provide your business with multiple IPIC "models" (scenarios) that compare the benefits of utilizing the IPIC method versus your current LIFO method. Even when income is not reduced, a company may want to change to the IPIC method in order to preclude the IRS from changing its LIFO method in an earlier year.

I'm concerned my LIFO calculations wouldn't pass an IRS audit. What can I do?
When it changes a LIFO method upon audit, the IRS restates all LIFO years, even barred years, using the new LIFO method. Any adjustment is included in income in the earliest year under audit. The IRS has provided an automatic approval for taxpayers wishing to change their LIFO inventory methodology to use the Inventory Price Index Computation (IPIC) method, while also granting audit protection for prior LIFO index computation methods utilized by the taxpayer. If a business has doubts about the way its LIFO computations have been done in the past, they owe it to themselves to investigate this "safe harbor", because a change to the new valuation method will protect the prior valuation method from audit. Filing under the automatic change procedure is like taking out an insurance policy. SourceCorp can help LIFO companies identify questionable LIFO methods.

Is there a better, less time consuming way to calculate LIFO?
Yes, SourceCorp provides a turn-key approach for businesses to take advantage of the Inventory Price Index Computation (IPIC) method and the benefits it provides.

Does the IPIC method have to be used for all inventories on LIFO?
A taxpayer that elects to use the IPIC method FOR A SPECIFIC TRADE OR BUSINESS must use that method to account for all items of dollar-value inventory.

How quickly can I receive my final LIFO computation after year end?
The BLS indexes are published monthly; therefore, a company not using the retail method may elect to use a monthly index that is published before its year end. SourceCorp can provide the computation a couple of days upon release of the BLS data -- The business simply submits an inventory file and we do the rest!