Potential Solutions
There are many potential solutions that could provide companies with more of an incentive to adopt IFRS. If the US Treasury Department were to eliminate the conformity rule, this would allow companies to continue using LIFO for tax-reporting purposes, and use FIFO or weighted average cost for IFRS. Another possibility would be to enable companies adopting IFRS to extend the period over which the tax liabilities generated by the switch from LIFO to FIFO could be settled. For example, instead of spreading the tax payments over four years, they could be spread over 10 years. Another suggested approach is the possible use of net operating loss carrybacks and carryforwards to offset the tax liabilities. All of these would require compromises on behalf of company executives, shareholders, boards of directors, and policy-makers.
As IFRS adoption is most critical for companies whose equity is traded in the public markets, smaller companies may simply keep LIFO and never adopt these standards. If no compromises are reached, larger companies may gradually and voluntarily have to lower their ending inventories over the adoption period, to minimize the impact of the tax liabilities represented by their LIFO reserve. By lowering inventory levels, the historical costs imbedded in the inventory valuation are finally realized. This is called LIFO liquidation, meaning the LIFO reserve is taken back into income, due to the physical reduction in ending inventory relative to prior periods. This can sometimes be impossible to achieve, given the necessary safety stock that is required to meet product demand.
Conclusion
There are many advantages to adopting IFRS for public companies. Convergence of US GAAP and IFRS has evolved over the past three years, as the result of collaboration between the IASB and the US Financial Accounting Standards Board (FASB). Recent FASB standards have harmonized the treatment of many accounting transactions, including the treatment of goodwill and intangibles on the balance sheet. However, the adoption of IFRS by LIFO-based companies represents a huge test for all stakeholders. The current SEC chairperson, Mary Shapiro, has indicated that she will not be held to the timetable outlined by her predecessor, and has challenged the quality of the rules underlying IFRS.
Adoption would mean that financial statement users—analysts, shareholders, lenders, and others—would also need to adapt to the new method of inventory valuation, and its impact on earnings, cashflow, assets, and equity. The change would result in the recalibration of performance ratios typically used by rating agencies, debtholders, banks, and analysts to determine liquidity, financial stability, and profitability of the adopting firm. Additionally, compensation committees of the boards of directors would need to realign their incentive compensation structure and expectations to reward executives for performance, and not for the accounting impact of the inventory valuation change.
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