Financial Conditions Clouded By Current Accounting Standards
May 1, 2015
A seemingly technical accounting issue has important implications for competition between large corporations and smaller firms, for U.S. businesses overseas, and for the ability of individuals to understand the true financial condition of the firms in which they invest.
Since August 2008, the U.S. Securities and Exchange Commission (SEC) has promised greater congruence between Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Harmonizing the two standards would have global effects:
- Standardized financial statements across borders would greatly facilitate the merger and acquisition (M&A) activities of multinational corporations, or businesses that wish to become multinational.
- Multinational corporations would no longer need to implement the time and cost intensive process of "translating" international financial statements into GAAP-compliant documents.
- Shared standards would improve the ability of global investors to compare information across countries.
However, the most important and fiercely contested implications of adopting U.S. standards congruent with IFRS is the effect on businesses' bottom lines. And one of the most controversial issues in this debate is the elimination of the Last In First Out (LIFO) method of inventory valuation.
LIFO inventory valuation allows companies to stockpile relatively inexpensive inventory purchased over the course of many months, and use the sale of identical inputs they acquired more recently at a higher cost to artificially increase the cost of goods sold, thus minimizing taxable income.
Despite mounting international and domestic pressure for standardization, companies have two notable reasons to keep LIFO: minimizing taxable income and attracting equity by having more control over their financial statements. These advantages are consequential, considering the vast size of large firms' inventories. And the upper hand given by LIFO valuation may foster an environment that is not conducive to competition, especially in the case of smaller firms.
Source: Santiago Bello, "The Accounting War: Inflation, Taxes and Financial Transparency," National Center for Policy Analysis, April 30, 2015.
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