For securities analysts, dealing with
last-in, first-out (Lifo) inventory accounting is a fact of
life. But it probably won't be missed very much if a new set of
global financial reporting standards eventually results in
The U.S. Securities and Exchange Commission
(SEC) has circulated a "roadmap" for introducing International
Financial Reporting Standards (IFRS) for publicly held
companies by 2014. Unlike the existing framework of Generally
Accepted Accounting Principles (GAAP) that currently guides
U.S. companies, IFRS doesn't include Lifo.
Lifo is an accounting technique designed to
reduce the taxes paid by both public and private companies, but
the Internal Revenue Service's so-called conformity rule
compels those who use it for this purpose to also use it for
"The main benefit to Lifo is that it reduces
taxes during an inflationary period" compared with first-in,
first-out inventory valuation, said Charles Bradford, head of
Bradford Research, New York. But it also "creates a major
complication" for analysts because it's difficult to
independently predict a company's Lifo expenses or credits from
one quarter to the next.
Perhaps the most striking impact of Lifo in
corporate financial reporting during 2008 was a trend from big
Lifo expenses early in the year to large Lifo credits in the
final three months as an inflationary era of rising prices was
transformed after midyear into a commodities pricing rout.
Among the companies booking large Lifo credits in the fourth
quarter were Pittsburgh-based specialty metals producer
Allegheny Technologies Inc. (ATI), with Lifo income of $132.7
million; steelmaker Nucor Corp., Charlotte, N.C., which had
fourth-quarter Lifo income of $82.2 million; and
Pittsburgh-based aluminum producer Alcoa Inc., whose net loss
in the quarter would have been larger than $1.19 billion
without a $73-million Lifo gain.
For securities analysts, who like to be able
to predict such huge credits, this can be a nuisance. Moreover,
some of them point out, the massive credits reported in the
fourth quarter of last year won't necessarily take place in the
first quarter of this year.
Luke Folta, an analyst at Longbow Research in
Independence, Ohio, pointed out that the way a company handles
taking a Lifo expense or declaring Lifo income is often at the
discretion of management. This can mean it's often impossible
for analysts to plug Lifo into their earnings models.
"Management isn't locked in, so there's no way to model it," he
said about Lifo.
However, Folta looks approvingly on the
prospect of U.S. companies moving to international standards.
"I think it's a net positive," he said, noting that among other
benefits it will "allow domestic investors in general to better
understand foreign companies."
Bradford said that while he isn't familiar
with all the details of IFRS, he is generally in favor of
changes that result in "a more uniform, simpler accounting
system" worldwide. He pointed out, for example, that when a
company in South Korea buys back its common stock, those shares
aren't retired but can be voted by management, something that
isn't allowed in the United States. And Brazil's value-added
tax is treated as a deduction from revenue, never showing up on
companies' income statements, he said. The result is that these
companies "look phenomenally more profitable than they would
John Tumazos, another veteran analyst who
runs Very Independent Research LLC in Holmdel, N.J., said that
inventory accounting isn't the issue that's likely to dominate
financial reporting going forward. Instead, it will be the huge
write-offs that metals and mining companies are being compelled
to take as high-priced assets acquired during the "bubble era"
of the past five years or so continue to lose value with
declining commodity prices. "It will take a couple of years for
everything to wash out," he said. Frank