It's time to get rid of LIFO conformity: IASB's move to ban LIFO deserves a thoughtful response.

Now that we're in the 21st Century, shouldn't we be uncomfortable with a significant tax provision that originated before World War II? You might think so, but the last-in, first-out (LIFO) conformity rule has been at work for so long that almost no one even notices it. We certainly have noticed, and we find that the conformity rule forces managers to shortchange stockholders in either the financial statements or the tax return. Without it, financial reporting would provide more useful information, and the economy would be more productive and prosperous.

The flaw of LIFO is its intentionally incomplete description of operating results and its long-tolerated--but misleading--description of financial position. It puts managers in a tough spot. If they want to minimize taxes by choosing LIFO, the conformity rule forces them to publish financial statements that fail to tell the complete story. If they want statements that describe the results of both inventory purchasing and marketing decisions more completely, they will choose first-in, first-out (FIFO), but only by making the corporation pay more taxes.

To eliminate this blind spot, we propose a three-phase solution. First, we would repeal the conformity rule, thereby liberating managers to make better choices. Second, we would encourage managers everywhere to implement a new inventory method that combines the advantages of FIFO and LIFO. Third, we want to promote voluntary use of replacement value accounting.

A LONG-STANDING CLASH

Public policy holds that no taxpayer should ever have to pay more than the minimum amount the law requires. Justice Learned Hand articulated this concept in an oft-cited Supreme Court case (Commissioner v. Newman, 47-1 USTC [paragraph] 9175) in which he declared:

Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced extractions, not voluntary contributions. To demand more in the name of morals is mere cant.

According to this policy, taxpayers must be free to choose among available alternatives when selecting their tax-reporting practices. Because LIFO is acceptable and usually reduces tax liabilities, all taxpayers must be free to use it without adversely affecting financial reporting quality.