Corporate firms and businesses around the world have to effectively manage their production process and stock piles in order to account for their profit margins in relation to government policies such as taxation and tax reporting. There are two methods that have been used around the world in the management of corporate financial processes and inventories. These two accounting methods are FIFO and LIFO. FIFO is an abbreviation of the idea of first in- first out. Under this technique, the goods that are the oldest with the inventory are reported and recorder as being sold first. This means that any taxation policies through government policy would be based on the oldest goods in the inventory. On the other hand, LIFO is an abbreviation of the idea of last in – first out. This means that the goods that are the newest in the stock pile are reported as having been sold. This means that things such as tax reporting at a given time would be based on the newest items in the inventory(Wild, 2011, p.41).
Considering that corporate firms are out to maximize profit, many companies in the United States in the early 1970’s when the United States was facing an economic meltdown with economic impacts such as the oil shocks of 1973, many companies moved from the traditional use of FIFO and instead began to use LIFO as an accounting management and reporting technique. This technique was meant to reduce the impact of the inflation on the companies at the time. By reporting the goods that come in first companies would be in a position to use the pricing of the goods that characterized the market at the time. By so doing the profit margins generated by these corporate firms would appear smaller compared to what it would be if the oldest stock was reported as being sold using the FIFO accounting technique. The difference between the total costs of the inventory reported in LIFO and FIFO is known as the LIFO reserve figure. Therefore efforts by the United States’ companies to shift from FIFO to LIFO were meant to increase the size of their LIFO reserve.
Despite the advantages that are associated with the shift from FIFO to LIFO with regards to corporate forms, such a move is detrimental to the amount of revenue generated by the government through taxation. The use of LIFO techniques reduces the amount of taxes that are collected by the government through the taxation of the income of corporate firms. The meta-question in this move by the US corporate market is whether the United States is going to be in a position to favorable to compete with other nations that use the FIFO reporting standard. One thing is important to realize is that the United States has to use a uniform reporting standard as the rest of the world if it going to remain stable to the global market(Larson, 1990, p.29). Many nations across the world have a single-set standard that requires corporate firms to use the FIFO reporting standard.
In addition, the international market bars companies from using LIFO. FIFO has for many years been considered as been the International Financial Reporting Standard. In terms of the domestic commerce in the United States, the US revenue code requires that companies a uniform reporting system that is similar to that of the various stockholders in the firms and also the lenders to these companies. One thing that is important to bear in mind is the fact that some of the corporate firms have international lenders and shareholders. These lenders and shareholders use the International Financial Reporting standard that recognizes FIFO not LIFO. This means that the multi-national companies in the United States which use LIFO are not compliant with the US revenue code which requires for the use of a uniform reporting system that is similar to that of the lenders and the stakeholders of the companies(Hansen, 2000, p.31).
The actuality of the matter is that profit is the greatest motivation for many companies in the corporate market. This means that companies that are currently using LIFO can hardly shift to FIFO without putting up a fight due to the fact that doing so would reduce their profit margins. Shift to FIFO would mean that these firms would pay more taxes to IRS compared to what there are currently paying. This would shrink their profit margins; an economic outcome that any company would seek to avoid (Wild, 2011, p.44). Companies cling onto the LIFO reporting standard because under this type of reporting system the value of goods in the inventory is based on the current prices in the market. This means that in a situation whereby there is inflation in the country, the LIFO reporting system enables corporate firms to report higher buying prices for their goods, which in turn leads to the reporting of lower profits margins. This would mean that the incomes that are generated by these companies would also be reported as being lower.
This would reduce the amount of income taxes that are paid by companies that use the LIFO reporting standard. Therefore, based on the profits that are generated by companies using the LIFO reporting standard, it would require the passing stricter government legislation such as the repeal of tax laws so that all companies can use a single-set reporting standard that generates income for the government and one that matches the International Financial Reporting Standard that recommends the use of FIFO not LIFO.
References
Hansen, D. R., & Mowen, M. M. (2000). Cost management: accounting and control (3rd ed.). Cincinnati, Ohio: South-Western College Publishers.
Larson, K. D. (1990). Fundamental accounting principles (12th ed.). Homewood, IL: Irwin.
Wild, J., Shaw, K., & Chiappetta, B. (2011). Fundamental accounting principles (20th ed.).New York, NY: McGraw-Hill.
