Environment & Energy

IFOWONCO

(16 posts) Wed Jun 13, 2012, 03:45 PM Jun 2012

LIFO Accounting as an Energy Tax Break

I was doing research for an paper I wrote recently, and wanted to share and maybe get some crowdsource-research one particularly crazy part.

Last In First Out (LIFO) accounting allows firms to assume for the purposes of federal taxation that the costs of items in their inventory were equivalent to the cost of the most recent purchase of that item. To clarify, using LIFO accounting, if a company makes two purchases of oil in a year, the first for $80/barrel and the second for $100/barrel, that firm could legally deduct $100 for every barrel as an expense. If it is not clear to you how this is different from lying to the federal government in order to pay less in taxes, then you are understanding this idea correctly.

I saw a statistic that attributed 80% of the tax break through this loophole to energy firms, which makes sense, but I wasn't able to back it up. I am assuming the other 20% is mostly commodity companies as well. Anyone else know anything useful about this?

</shameless self promotion>
Link to my article
<\shameless self promotion>

2 replies

= new reply since forum marked as read

Highlight:

LIFO Accounting as an Energy Tax Break (Original Post) IFOWONCO Jun 2012 OP

your understanding of "last in first out" is meaningfully incorrect unblock Jun 2012 #1

LIFO as an Alternative to FIFO On the Road Jun 2012 #2

unblock

(52,527 posts)

1. your understanding of "last in first out" is meaningfully incorrect

Reply to IFOWONCO (Original post)

Wed Jun 13, 2012, 03:59 PM

Jun 2012

as the name implies, only the FIRST used items get deducted based on the LAST items purchased.

in your example, if you used more barrels than you purchased last at $100, then the excess would be deducted at $80.

e.g:

jan: buy 1,000 barrels @ $80/bbl.
jun: buy 1,000 barrels @ $100/bbl.
jan-dec: use 1,800 barrels.

LIFO says the 200 barrels you still have in inventory are the first ones purchased, at $80/bbls. So you can deduct:
1,000 * $100 = $100,000
+
800 * $80 = 64,000
=
$164,000.

not $180,000 as your middle paragraph implies.

if prices were random without inflation, then LIFO would be neither better nor worse than FIFO (first in, first out). however, inflation means the "last in" items are usually (though not always, due to randomness and other factors) the most expensive, so LIFO works out better.

the more inflation there is in a company's expenses, the better this works out for them.

On the Road

(20,783 posts)

2. LIFO as an Alternative to FIFO

Reply to IFOWONCO (Original post)

Wed Jun 13, 2012, 05:10 PM

Jun 2012

has been established for over 30 years. Since it leads to somewhat lower taxes, it was adopted by industries which hold a lot of inventory such as manufacturing and retail.

If I understand your example, it is NOT true that LIFO allows a company to deduct the highest price paid for all reductions in inventory. That would indeed be a violation of Generally Accepted Accounting Principles. It would constitute tax evasion if done on a tax statement, and a violation of GAAP if disclosed to investors.

The difference is one of timing: When a company makes a sale and reduces inventory, does it use the cost of the oldest or the newest unit of inventory in the journal entry?

I do not think that the recent tax benefits to the oil industry were the original intention. As I understand it, LIFO gained traction in the 70s primarily in response to double-digit inflation, when inventory timing made a greater difference than it does today. In fact, when oil prices fall, oil companies get hit with a larger tax bill.

Reply to this discussion