LIFO conformity rule definition
/What is the LIFO Conformity Rule?
The LIFO conformity rule requires that, if the LIFO cost flow method is used to compile taxable income, it must also be used in the financial statements. The rule is designed to prevent organizations from using LIFO accounting to reduce the amount of their taxable income, while using a different inventory cost flow method (such as FIFO) to derive a higher income figure in their financial statements. This income reporting disparity arises because the LIFO method allows you to charge the cost of the most recently-acquired inventory items to expense when sales occur, while the FIFO method allows you to do so using the cost of the oldest inventory items remaining in stock. Given the effects of inflation, the older items in stock are presumed to have been acquired at a lower cost than the more recently-acquired items. Thus, the LIFO method results in a higher cost of goods sold (and therefore lower profits) than the FIFO method.
Disadvantages of the LIFO Conformity Rule
An adverse effect of the LIFO conformity rule is that organizations electing to use LIFO are essentially reporting lower financial results to their lenders, investors, and creditors than is really the case. This could result in a reduced market value for a business, and possibly the denial of credit from lenders and creditors. Consequently, the rule has tended to reduce the adoption of the LIFO method by businesses.