Question

LIFO is not allowed under IFRS, but is allowed under GAAP. Why do you think LIFO is not allowed under IFRS? Should it be disallowed under GAAP as well? Why or why not?

Answer 1

The main reason of prohibited LIFO UNDER IFRS IS THE

focus of IFRS shifted from the income statement to the balance sheet and, therefore, away from LIFO.

Under the last-in, first-out (LIFO) method of inventory valuation, the last inventory purchased is assumed to be the first sold. Ending inventory, therefore, is assumed to be made of purchases from earlier periods. Of the inventory valuation methods, LIFO most closely follows the matching principle (i.e., matching current costs with current revenues very well), but may result in unrealistic ending inventory valuation in times of changing costs.

During periods of rising prices (inflation), ending inventory is assumed to consist of earlier purchases at lower prices, which may undervalue ending inventory. During periods of falling prices (deflation), ending inventory is assumed to consist of earlier purchases at higher prices, which may overvalue ending inventory. In general, inventory valuation under LIFO might be too old to be relevant for the users of financial statements.

Because LIFO most closely follows the matching principle of revenues and expenses, it can be said to focus more upon the income statement. FIFO, on the other hand, provides a more up-to-date ending inventory figure for the balance sheet because its ending inventory is assumed to be the most recent purchased.

Therefore, LIFO is prohibited under IFRS because the focus of IFRS shifted away from the income statement to the balance sheet and, therefore, away from LIFO.

Another reason are

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low. It can also result in inventory valuations that are outdated and obsolete. Finally, in a LIFO liquidation, unscrupulous managers may be tempted to artificially inflate earnings by selling off inventory with low carrying costs.

Why GAAP ALLOW LIFO

Uniquely, GAAP standards originated when the SEC spurred the private sector to set standards for themselves. Clearly, companies had a stake in minimizing taxes, and some may even operate their inventories as LIFO. This explains why the business practice is allowed under GAAP.