LIFO is a last-in-first-out accounting process used to value your inventory for tax purposes or for product comparative analysis. Use this process to compensate for the value added to your inventory by inflation. When you sell stock using the LIFO philosophy, the inventory sitting on the shelf is valued at the original costs. Use the LIFO process to calculate a lower inventory value and tax.
The LIFO Inventory Valuation Report is typically run at a fiscal or calendar year end. However, you can run the report more often, such as quarterly, depending on your business needs.
A pool is a collections of products your company sells. You are eligible to use LIFO tax accounting if you have more of a product on hand at the end of the current year than you had at the end of the previous year. You can pool your products to determine your company's overall eligibility for LIFO tax accounting, according the rules determined by the Internal Revenue Service (IRS). Even though some products may have lower on-hand quantities at the end of the year, if the sum of on-hand quantities for all the products in the pool is greater than the sum for the previous year, then all the products in the pool are eligible.
For example, if your company sells plumbing and electrical supplies, you define two pools. If your company only sells plumbing supplies, you define just one pool for all your products.
Use the Valid LIFO Product Pools control maintenance record to define your pools. Every product must be assigned to a pool. You can use the Mass Load program to assign pools all at once or assign products to pools individually.
You must select a cost basis for doing the valuation for tax calculation purposes. For example, COGS-COST is usually used. In addition, you can also select a second cost basis, for internal reporting purposes. These selections are not changed or updated.
Use the Use Default Cost Basis For LIFO Cost Update control maintenance record to indicate whether the system should use the replacement cost when calculating the current year's LIFO cost for items that were not purchased or transferred within the current year. The default is N.
See Understanding System Defined Basis Names for a complete description of basis names.
You must also select a cost comparison method. Your tax accountant can advise you on the best option for your company. You can select one of the following:
BASE-YEAR – Compares current year pricing with pricing for a designated beginning or starting year.
LINK-CHAIN – Compares current year pricing with previous year pricing.
The system values the inventory at each price and calculates an Index number that represents the inflation percent. You can then reduce the current inventory value by using the Index % as prescribed by the IRS. This deducts the profit due to inflation that otherwise would be taxed. Make a journal entry in the General Ledger by posting a credit to the LIFO Reserve account and a debit to the LIFO COGS account.
Before running the LIFO Inventory Valuation Report, you need to run the LIFO Updating program. Once a LIFO update has been run, you can use the LIFO Maintenance screen to modify the counts and cost information, on a product-by-product basis, as needed.
The following tasks describe the process for creating a LIFO Inventory Valuation: