Federal Tax

Inventories: General Principles; LIFO Method (Portfolio 578)

  • The Portfolio, Inventories: General Principles; LIFO Method, discusses the tax aspects of inventories with particular emphasis on the last-in, first-out (LIFO) method.


Bloomberg Tax Portfolio, Inventories: General Principles; LIFO Method, No. 578, discusses the tax aspects of inventories with particular emphasis on the last-in, first-out (LIFO) method. The use of inventories for tax purposes is generally required whenever the sale of merchandise is an income-producing factor.

This Portfolio analyzes when inventories must be used, the methods of valuation (e.g., cost, lower of cost or market, etc.), and the methods of determining the flow of inventory costs (e.g., specific identification, FIFO, LIFO). A decision to place all or a part of inventory on LIFO may have substantial tax effects in the year of election and subsequent years. Thus, the Portfolio describes the practical operation of LIFO and how it may be applied to a manufacturing or merchandising business.

The Portfolio discusses the tax considerations surrounding LIFO and is intended as a guide to current practice. It has been designed not only for taxpayers considering the adoption of LIFO, but also as a reference source for those already on LIFO.

It should be noted that although this Portfolio discusses the valuation of inventories for manufacturers under full absorption costing, these rules were significantly expanded under the Tax Reform Act of 1986 and a full examination of these rules is beyond the scope of this Portfolio. A discussion of the rules can be found in 576 T.M., Uniform Capitalization Rules: Inventory; Self-Constructed Assets; Real Estate, and 577 T.M., Uniform Capitalization Rules: Special Topics; Method Change Rules.

Table of Contents

I. General Introduction
II. The Need for Inventories
III. Basic Requirements
IV. Valuation of Inventories in General
V. Valuation of Inventories for Manufacturers
VI. Inventory Valuation Methods for Special Taxpayers
VII. LIFO – An Overview
VIII. Historical Development of LIFO
IX. Technical Requirements for Adoption and Use of LIFO
X. The Specific Goods Method
XI. The Dollar-Value Method
XII. Principles for Establishing LIFO Pools
XIII. What Is an Item?
XIV. The Inventory Price Index Computation Method and Simplified LIFO
XV. Retail LIFO Method
XVI. Bargain Purchase
XVII. Qualified LIFO Inventory Liquidations
XVIII. Transfers of Inventory in Nontaxable Transactions
XIX. Financial Reporting Conformity Requirements
XX. Changes in LIFO Procedures Where LIFO Is Continued
XXI. Technical Rules for Combining and Splitting Pools
XXII. Termination of LIFO
XXIII. LIFO Recapture on C to S Corporation Conversions

Kristine Mora
Ernst & Young LLP
Barry Tovig
Retired Partner
Ernst & Young LLP