Subtract $30 in costs from the $40 in revenue, and the company has $10 in income. If the company uses the FIFO inventory accounting method, it would deduct the cost of the first unit of inventory purchased, namely the unit purchased for $30 in January. In this simplified example, assume inventory is the company’s only cost. The firm then sells one unit for $40 in December. To demonstrate the differing effects of LIFO and FIFO, consider a company with no beginning inventory that purchases three units of inventory over the course of the year: one for $30 in January, one for $31 in June, and one for $32 in November. Lastly, services firms sell services, not physical goods, and thus likely have no inventory. There may be several distributors and wholesalers between the manufacturer and the retailer. There are wholesalers and distributors, which purchase goods from manufacturers and sell them to retailers, who sell them to the final customer. Importantly, there are usually several layers of merchandising firms in the supply chain. Merchandising firms, meanwhile, purchase finished physical goods from a supplier and then sell them to customers they only have finished goods inventories. Manufacturers turn raw materials and labor into finished products and have several different types of inventories-raw materials, works in progress, and finished goods.
Consider companies in three loose categories: manufacturers, merchandising firms, and service firms. These methods can affect companies differently. The FIFO inventory method, by contrast, allows companies to deduct the cost of inventory at the price of the oldest acquired items and assumes the first inventory purchased is the first to be sold.
The LIFO inventory method allows companies to deduct the cost of inventory at the price of the most recently acquired items and assumes that the last inventory purchased is the first to be sold. While repealing LIFO might seem like an inconsequential way to raise revenue, it would penalize investment in inventory and move the tax system away from neutrality towards investment. Today, thanks to several factors such as rising inflation, high deficits, supply chain issues, and industry-specific concerns, LIFO has re-entered the policy discussion. Repealing Last-In, First-Out accounting appeared in many Obama administration budget proposals and was included in the Dave Camp tax reform package in 2014. The tax treatment of inventories may be an obscure policy, but it is still significant. Inventory Investment and Supply Chain Resiliency.The Two Philosophies of Taxes and Income.
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