Is LIFO Allowed Under IFRS? Why It’s Not Permitted

Inventory valuation plays a crucial role in financial reporting, affecting both profitability and tax obligations. Different accounting standards dictate which methods companies can use, leading to variations in financial statements across jurisdictions. A key difference between IFRS (International Financial Reporting Standards) and U.S. GAAP is the treatment of LIFO (Last-In, First-Out).

Unlike U.S. GAAP, IFRS does not permit LIFO for inventory valuation. This has significant implications for multinational companies that must comply with different accounting rules depending on where they operate. Understanding why IFRS prohibits LIFO helps businesses navigate compliance requirements and explore suitable alternatives.

IFRS Inventory Valuation Methods

Companies reporting under IFRS can use FIFO (First-In, First-Out) or weighted average cost to value inventory, each affecting financial statements differently.

FIFO assumes the oldest inventory is sold first, meaning the cost of goods sold reflects earlier purchase prices. In periods of rising costs, this results in lower expenses and higher reported profits. It also leads to a higher ending inventory value, improving financial ratios and making a company appear more stable.

The weighted average cost method smooths out price fluctuations by averaging the cost of all inventory units available for sale. This results in a cost of goods sold figure that is less affected by short-term price changes, making financial results more stable. Businesses with large volumes of interchangeable goods, such as retailers and manufacturers, often prefer this approach for its simplicity.

LIFO Restrictions Under IFRS

IFRS prohibits LIFO due to concerns over financial statement comparability and earnings manipulation. LIFO allows businesses to match recent, often higher-cost inventory against current revenues, reducing taxable income during inflationary periods. While this provides tax benefits, it distorts inventory valuation, making it harder for investors and regulators to assess a company’s financial position.

Unlike FIFO and weighted average cost, which align with the natural movement of goods, LIFO can result in outdated inventory costs remaining on the balance sheet for years. This issue, known as “LIFO liquidation,” occurs when older, lower-cost inventory is expensed due to declining stock levels, artificially inflating profits. These fluctuations reduce the reliability of financial statements, making it harder to compare companies across industries and regions.

Another issue with LIFO is its impact on global standardization. Many IFRS-compliant countries emphasize financial statements that reflect current economic conditions. Since LIFO often results in inventory values that do not represent market prices, it contradicts IFRS principles focused on transparency and fair value measurement. This inconsistency complicates cross-border financial analysis, particularly for investors evaluating multinational corporations operating under multiple accounting frameworks.

Acceptable Alternatives

Businesses that previously relied on LIFO but now need to comply with IFRS must adjust their inventory valuation approach. One option is the specific identification method, which assigns actual costs to individual inventory items. This approach is useful for industries dealing with unique or high-value goods, such as luxury retailers, automobile manufacturers, and jewelry businesses. While it provides precise inventory valuation, it is impractical for companies with large or interchangeable stock.

For industries where tracking individual inventory costs is unfeasible, standard cost accounting is an alternative. This method assigns predetermined costs to inventory based on historical data and expected price changes. Many manufacturing firms use this approach to stabilize cost reporting and streamline financial planning. While standard costing requires periodic adjustments to align with actual costs, it helps businesses manage production expenses effectively.

Some companies also use the retail inventory method, which estimates inventory value based on a consistent cost-to-retail price ratio. This approach is common in large-scale retail operations, where tracking individual purchase costs for thousands of products would be impractical. By applying a markup percentage to determine ending inventory value, businesses can maintain a reliable measure of stock without excessive administrative burden.