Yes, LIFO is allowed under GAAP. The FASB’s Accounting Standards Codification Topic 330 lists last-in, first-out alongside FIFO and average cost as acceptable inventory cost-flow methods. What complicates the decision is a federal tax rule: any company that uses LIFO on its tax return must also use LIFO in its primary financial statements, so the choice ties book and tax reporting together in a way no other inventory method does.
Where GAAP Authorizes LIFO
ASC 330-10-30-9 states that inventory cost “may be determined under any one of several assumptions as to the flow of cost factors,” including FIFO, average cost, and LIFO. The standard directs companies to pick the method that “most clearly reflects periodic income” given their circumstances.1Deloitte Accounting Research Tool (DART). Chapter 2 — Financial Statement Accounting and Disclosure Topics 2.13 Inventory
LIFO is most attractive when costs are rising. Matching newer, higher-cost inventory against revenue produces a larger cost of goods sold, lower reported income, and a lower current tax bill. The trade-off is that older, cheaper costs stay on the balance sheet, so the reported inventory value drifts further from current replacement cost the longer LIFO is in use.
Dollar-Value LIFO
Tracking LIFO item by item is impractical for a business carrying thousands of similar products. GAAP allows companies to group inventory into pools and measure cost changes in total dollar terms rather than individual units. Each year the company adds inventory, a new cost layer is created at that year’s price level within a pool, and over time these layers stack up. Dollar-value LIFO requires careful price-index construction to separate real quantity changes from inflation, but it dramatically reduces the bookkeeping burden compared with tracking every SKU.
Required Disclosure of the LIFO Reserve
Companies that elect LIFO must disclose the LIFO reserve in the notes to their financial statements. The reserve is the gap between inventory valued under LIFO and what the same inventory would be worth under FIFO or at current replacement cost. Because LIFO leaves older, lower costs on the balance sheet during inflation, this gap can grow very large over time. Disclosing it lets analysts convert LIFO-based financials to a FIFO-equivalent basis and compare companies that use different methods.
The LIFO Conformity Rule
The most consequential condition on using LIFO comes from the IRS, not the FASB. Under Internal Revenue Code Section 472 and Treasury Regulation 1.472-2(e), a company that uses LIFO to calculate taxable income must also use LIFO as the basis for its primary financial statements, including the income statement, balance sheet, and cash-flow statement.2eCFR. 26 CFR 1.472-2 – Requirements Incident to Adoption and Use of LIFO Inventory Method The rule exists to stop companies from claiming LIFO’s tax benefit while showing investors a higher-income picture under FIFO.
A company first elects LIFO by filing Form 970 with its tax return for the year it intends to begin using the method.3Internal Revenue Service. About Form 970, Application to Use LIFO Inventory Method Once made, the election locks the company into LIFO for both tax and financial reporting. Violating conformity gives the IRS authority to terminate the election entirely, forcing a switch to another method and triggering a recalculation of prior years’ earnings and taxes.
Five Exceptions to Conformity
The rule is not as airtight as it sounds. The IRS recognizes five situations in which non-LIFO information can be presented without endangering the election:4Internal Revenue Service. Practice Unit – LIFO Conformity
- Supplemental disclosures in news releases, shareholder letters, or a management analysis section, as long as they do not appear on the face of the income statement.
- Non-LIFO inventory values on the balance sheet, provided the company does not also disclose non-LIFO earnings.
- Internal management reports using any method, as long as they are not shared with shareholders or other equity holders.
- Interim reports covering a period shorter than a full year, such as quarterly filings.
- Writing inventory down to the lower of LIFO cost or market for book purposes, even though the tax return uses actual LIFO cost.
These exceptions matter most to public companies that want to give analysts FIFO-equivalent data while keeping the LIFO tax election. The organizing principle is that the primary annual financial statements must reflect LIFO; supplementary information presented outside those statements generally gets a pass.
The Lower-of-Cost-or-Market Gap
IRC Section 472(b) requires that LIFO inventory be valued at cost for tax purposes.5Office of the Law Revision Counsel. 26 U.S. Code 472 – Last-in, First-out Inventories A company that previously used lower-of-cost-or-market to write down declining inventory must reverse all prior write-downs and add those amounts back into taxable income when it switches to LIFO.6Internal Revenue Service. Practice Unit – Adopting LIFO
Book treatment is different. The FASB’s 2015 update to Topic 330 replaced LCM with a simpler “lower of cost or net realizable value” test for most methods, but explicitly left LIFO and the retail inventory method unchanged.7Financial Accounting Standards Board. Inventory (Topic 330) – Simplifying the Measurement of Inventory LIFO inventory on the GAAP balance sheet still follows the traditional LCM framework and can be written down when market value falls below cost. The result is a permanent gap: write-downs are allowed for book, not for tax. That is why the fifth conformity exception exists.
Getting Out of LIFO
The conformity rule cuts both ways. If a company later decides LIFO no longer works, the exit affects both sets of books.
Voluntary Change of Method
A company that wants to stop using LIFO files Form 3115, Application for Change in Accounting Method, using Designated Change Number 56.8Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method This is an automatic change, so advance IRS approval is not required and there is no user fee. The original Form 3115 is attached to the timely filed return for the year of change, and a signed copy goes to the IRS National Office.
The switch generates a Section 481(a) adjustment covering the cumulative difference between LIFO and the new method. If the adjustment increases income, which is the typical outcome after years of LIFO deferral, the company spreads it over four tax years. If the adjustment decreases income, it is taken entirely in the year of change.8Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method
Recapture on S-Corporation Conversion
A C corporation that converts to S-corporation status faces a mandatory LIFO recapture under IRC Section 1363(d). The recapture amount is the excess of inventory valued under FIFO over the same inventory valued under LIFO, measured at the close of the last C-corporation tax year, and that full amount is included in gross income for the final C-corporation year.9Office of the Law Revision Counsel. 26 USC 1363 – Effect of Election on Corporation
The tax increase is payable in four equal installments. The first is due with the final C-corporation return (without regard to extensions), and the remaining three are due with each of the next three S-corporation returns.9Office of the Law Revision Counsel. 26 USC 1363 – Effect of Election on Corporation For companies with large LIFO reserves, the recapture can be a meaningful cost of the S-election and belongs in the conversion analysis well before the election is made.
One Boundary: LIFO Is Not Allowed Under IFRS
GAAP’s permission for LIFO does not carry over internationally. IAS 2 prohibits LIFO and permits only FIFO and weighted average cost, so companies in the 140-plus jurisdictions that follow IFRS cannot use the method at all.10IFRS Foundation. Use of IFRS Standards by Jurisdiction For a multinational, that means the U.S. parent may run LIFO domestically while foreign subsidiaries reporting under IFRS cannot. If GAAP and IFRS ever converge on this point, LIFO users would likely have to unwind their cost layers and restate inventory under an allowed method, with the same kind of income recognition and tax consequences that a voluntary change produces today.