Tax Effects of the Inventory Accounting Method

Alright, the last video we talked about the book advantage, I guess you say, is what I called them

Now we're talking about tax effects because naturally you're dealing with changing cogs, which changes your gross profit, which therein changes your net income

And when you change net income with these, they're going to have a tax effect. So what are the tax effects among the different methods

So let's talk about that. So since inventory costs affect net income, we just talked about that, they inherently have potential tax effects

They will change your taxes in some ways. So why would one company choose another or one method over another one using tax effects

Assuming that we're in an inflationary period, that's what we typically assume when we're doing these things is an inflationary period

Because FIFO yields the highest net income, it's going to result in the company paying the highest amount of taxes

Again, go back to the book advantage. We said that our assets are going to look good because they're going to be at a higher asset, but they're going to be more true as well

So really what we're saying is if you choose to do FIFO, what you're saying is I want my assets to look good for my investors, but in order to get that, I'm probably going to have to pay more taxes

On the other side of that, LIFO, because LIFO yield the lowest income, it will result in the company paying the lowest taxes

Well, LIFO, remember, if it's an inflationary period, what I have on my balance sheet with assets is going to be fairly low

So if I okay having lower inventory assets then that means that I don necessarily have to pay as much in taxes So it a give or take here Ultimately companies don need to choose this based on how much they paying taxes They should do it based on what more accurate in the accounting records

But these are two things that companies do look at. Even more importantly is this next part

And that is, companies can choose to use different methods for financial reporting purposes

and tax reporting purposes. So now that throws a whole big monkey wrench in this

A company can choose to use one method for the purpose of financial reporting and another method for the purpose of tax reporting

So ideally, what you would normally do is you would say, I want to do FIFO for financial reporting purposes because that's going to make my assets be the highest

Maybe it look really good, give me the highest net income. But I'm going to do LIFO for tax reporting purposes because that means that I don't have to pay as much taxes

That's the ideal scenario that you can't do. They won't allow you to do that

However, the IRS requires companies that choose to use LIFO for tax reporting purposes to also use LIFO for financial reporting purposes

You can't have your cake and eat it too. It's pretty much what that gets down to

You cannot get out of paying less taxes and still look really good. The moment you say that you're going to use LIFO for tax reporting, you have to use LIFO for financial reporting purposes

You can pretty much use any other combination you want as long as you're not using LIFO for tax reporting purposes

This is called the LIFO conformity rule. that's what you have to look at when you're dealing with tax effects and choosing one method over the other

Appreciate it