The Last-In, First-Out (LIFO) inventory method is prohibited under International Financial Reporting Standards (IFRS) but allowed under US GAAP. IFRS prohibits LIFO because it often does not represent the actual physical flow of goods and can result in outdated inventory values on the balance sheet.
LIFO in Accounting Standards
Under IFRS and ASPE, the use of the last-in, first-out method is prohibited. However, under GAAP, the use of Last-In First-Out is permitted. The inventory valuation method is prohibited under IFRS and ASPE due to potential distortions on a company's profitability and financial statements.
Both GAAP and IFRS allow First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. However, GAAP also allows the Last In, First Out (LIFO) method, which is not allowed under IFRS.
As LIFO inventory costing is not permitted under IFRS, companies that utilize the LIFO costing methodology under US GAAP might experience significantly different operating results as well as cash flows.
LIFO is allowed under GAAP in the U.S. but prohibited under IFRS followed outside the U.S. FIFO is considered the better method for accurately presenting inventory costs and profits. But U.S. firms can elect to use LIFO for tax benefits provided they meet GAAP reporting requirements.
Internationally accepted: both International Financial Reporting Standards (IFRS) and US GAAP allow FIFO as a valid valuation method.
Direct Write-off Method: General accepted accounting principles (GAAP) do not recognized the direct write-off method. Under the direct write-off method, bad debt expense is recorded when the customer's account is determine to be uncollectible.
Investors understand that older costs leave first, making the income statement easier to read. If you sell across borders, IFRS requires FIFO or weighted average—never LIFO.
The LIFO method is available only under U.S. Generally Accepted Accounting Principles (GAAP) — it's not permitted under International Financial Reporting Standards (IFRS).
Four common methods for reporting inventory under GAAP are:
LIFO is banned under IFRS due to potential financial distortions. LIFO can understate company earnings and lead to outdated inventory values. Under LIFO, tax liabilities are reduced but at the cost of outdated inventory values.
IFRS and US GAAP allow companies the choice of using either of the following inventory valuation methods: specific identification; first-in, first-out (FIFO); and weighted average cost. US GAAP also allows the use of the last-in, first-out (LIFO) method.
Inventory. Under US GAAP, both Last-In-First-Out (LIFO) and First-In-First-Out (FIFO) cost methods are allowed. However, LIFO is not permitted under IFRS because LIFO generally does not represent the physical flow of goods.
GAAP (US Standard) permits all four costing methods: FIFO, LIFO, Weighted Average, and Specific Identification. IFRS (International Standard) prohibits LIFO entirely, requiring businesses to use FIFO, Weighted Average, or Specific Identification.
LIFO is not permitted by IFRS, but it is still acceptable in the US. In situations with both rising costs and increasing inventory levels, LIFO results in the higher, more recent costs flowing through cost of sales with the lower, older costs in inventories.
Choosing the Right Inventory Valuation Method
The main difference between International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP) is that IFRS does not allow the LIFO method.
FIFO is compliant with both GAAP and IFRS, making it widely accepted internationally. LIFO, however, is only allowed under GAAP and is prohibited by IFRS, meaning businesses using LIFO cannot comply with international financial reporting standards.
The LIFO method permitted under U.S. GAAP is not permitted under IFRS. Any organization using the LIFO inventory method for book and tax purposes would need to select a different method as part of its conversion to IFRS, which could result in a significant tax impact.
IAS 2 prohibits LIFO; US GAAP allows its use.
The International Accounting Standards Board (IASB® Board) eliminated the use of LIFO because of its lack of representational faithfulness of inventory flows.
U.S. GAAP allows companies to choose among the FIFO, LIFO, and average cost methods. IFRS requires companies to use the FIFO method exclusively. LIFO can make companies' incomes appear smaller, affecting tax obligations.
The primary difference between the two systems is that GAAP is rules-based and IFRS is principles-based. This difference appears in specific details and interpretations.
LIFO understates profits for the purposes of minimizing taxable income, results in outdated and obsolete inventory numbers, and can create opportunities for management to manipulate earnings through a LIFO liquidation. Due to these concerns, LIFO is prohibited under IFRS.
Direct Write-Off Method
The write-off method violates the matching principle under U.S. GAAP since the expense is recognized in a different period as when the revenue was earned.
Accrual accounting is the most complex accounting method available. And, it is the only method accepted by GAAP (generally accepted accounting principles).
Under current U.S. GAAP, only accrual-basis accounting is permitted, which records transactions when they occur, not when cash is exchanged.