Accounting

LIFO – Tax and Cash Flow Note

A company’s pre-tax cash flows are not affected by the choice of LIFO versus FIFO.

In the US, a tax law known as the “LIFO conformity rule” mandates that if a US company uses LIFO for tax reporting, it must also use LIFO for public financial reporting (i.e. U.S. GAAP reporting).

When prices are rising, LIFO accounting creates lower taxable income, which in turn increases after tax cash flow.

The management of a company may prefer to show a high net income to investors, but LIFO will generate more cash in an inflationary environment.

This legal/regulatory policy keeps companies from “getting the best of both worlds” by using LIFO for taxes to increase real cash flows, but then using FIFO for public financial reporting to show investors a higher net income than the net income reported to tax authorities under the LIFO method.

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