LIFO accounting refers to an accounting method used in business operations that means Last In, First Out, wherein newer inventory is disposed of ahead of the old inventory. It is used by businesses to gain tax credits that translate into additional cash flow. It is an accounting method that most business owners have not utilized since it is not commonly advertised by accounting firms. This method is legally recognized and if the business owner wants to use it, then they should file a notice of change of accounting method as a requirement of federal and state laws.
The reason that it is not a popular choice is that not many specialize in it, and it seems counter-intuitive in the sense that the latest inventory is disposed of first then the older inventory. It is logical to use up the old inventory before the new ones as we practice First In, First Out, but what most business owners do not know is that the LIFO method offers a way to make money out of their inventory. Take it this way, if you bought materials for your products at the start of the year for $8 per piece, and you have a sizeable inventory, and at the last quarter, the same material now costs $10 per piece. If you hold on to the old inventory, you can realize a profit of $2 for each material from your old inventory.
This can then be converted into tax credits which can be refunded to the business as additional cash flow. As the economy is facing another inflation hike and businesses at this time are struggling, finding ways to generate additional capital to keep the business afloat is a necessity. If like many other businesses you are also figuring out means to survive the economic crisis, then finding out how to qualify for tax credits is highly relevant. Moreover, this is a legal and above-the-board means of generating funds without having to resort to backroom deals, illegal activities, or creative accounting of your books. Read on to learn more about LIFO accounting and how it can help your business.
How to use LIFO Accounting Method?
The LIFO accounting method is a recognized and valid means of reporting income and preparing the line-item budget for a given year. LIFO means last in, first out which means that the most recently acquired inventory is sold first than those bought at the beginning of the year. As inflation increases, the most recent inventory which was purchased at higher prices will be disposed of first while the inventory with lower prices will be retained for the ending inventory.
The LIFO method does not influence the distribution of the actual product and it is concerned only with the costs of the distribution for the flow of the inventory. This is a legit method and one that is included in the accepted accounting methods according to federal and state laws. Besides, a company does not have to retain the old inventory to apply for the tax credits.
The LIFO method is commonly used to report income, while the opposite method referred to as FIFO (first in, first out) is useful for tracking the movement of inventory in a given period. But what is more beneficial for the business is the LIFO method as they can leverage their old inventory for profit. Without having to use up capital, the business can earn from their old inventory just by holding on to it and reporting it as income. This would enable the business to qualify for tax credits that can be in the form of lower tax dues or as a refund for taxes paid. There is a caveat in this process as the business needs to register first that they used the LIFO accounting method before they could use it in reporting their financial standing.
Before Using LIFO Accounting Method
As the law requires, if a company wants to use the LIFO accounting method, it has to file Form 970 or the Application to Use LIFO Inventory Method if it is a newly established business as part of the requirements for its tax liability computation. However, if the company has an existing accounting method, it has to file Form 3115 or the Application for Change of Accounting Method. It is only upon approval of the application that the company can formally use it.
As the LIFO is a bit complex and most are not familiar with it, the company should hire an accounting firm that can handle it. big companies usually have their accountants and with the benefits that the LIFO method can provide, probably, they are already using this method. For small and medium-sized companies, accountants are usually outsourced as it is more cost-effective that way, so if they want to try out the LIFO method, then it is best to inquire from their accountants whether they are familiar with it and whether they can handle it. If they are not, then the next best thing is to hire a firm that specializes in the method.
Where to Find LIFO Accounting Firms?
Firms that specialize in LIFO accounting methods are not that many, and one might not even be available in your area. Since this method requires a different skill-set and training, it takes a certain specialization to be able to effectively prepare the financial documents for the company. As such, it is a good idea to look for reputable accounting firms that have a team of accountants who can employ the method. You can look for such firms online by doing a simple web search and the result will provide you with a list of the most viable websites of accounting firms.
You need to go through the list and check on each website to determine if they indeed offer LIFO accounting services. Narrow down your choices to your top 3 firms, and try to contact them for a consultation. The firm that replies the soonest is probably the more engaged and has resources that can help you with your company. Meet them for the consultation so that you can listen to the services they are offering and you can also tell them your needs.