After much debate, the fate of U.S. generally accepted accounting principles continues to hang in the balance. Currently, the Securities and Exchange Commission is deciding whether and to what extent U.S. accounting standard-setting should be melded with the system of international financial reporting standards (IFRS). If a recent ruling by the Internal Revenue Service is any indication, the SEC should act promptly to help companies from being caught between the two systems.

In the case in point, the chief counsel of the IRS issued a memorandum on Thanksgiving that found that a U.S. corporate taxpayer using last-in, first-out (LIFO) inventory accounting standards must forfeit the benefits of LIFO because it prepared non-LIFO financial statements using IFRS standards. That was the case even though the statements were merely for internal-reporting purposes, the chief counsel ruled.

The subject of the ruling, which we’ll call TP, is a wholly-owned subsidiary and a member of a consolidated group of companies dubbed ABC. ABC, in turn, is wholly-owned by a foreign parent (FP). The FP reported its worldwide consolidated financial statements using IFRS for Tax Year 1. TP adopted IFRS for the first time for Tax Year 1.

The LIFO inventory method, however, is not an allowable method under IFRS. The TP had been using the LIFO method for a portion of its inventory for both tax and financial reporting purposes for a number of years, and it continued to use the LIFO method for Tax Year 1.

The TP provided financial statements to its the FP based upon IFRS standards for Tax Year 1. The TP also provided an IFRS-only balance sheet and income statement to its lending bank. Further, the company provided its lending bank with tabulated versions of its balance sheet and income statement in which each was presented on an IFRS and U.S. GAAP standard.

Specifically, the tabulated financial statements made adjustments (including LIFO adjustments) to the IFRS column to arrive at U.S. GAAP. The IRS ruled that the TP violated the “LIFO conformity” requirement.

Section 472(c) of the Internal Revenue Code provides that a taxpayer who elects LIFO for tax purposes must establish to the satisfaction of the U.S. Secretary of the Treasury that it has used no method other than LIFO in inventorying its goods to ascertain the income, profit, or loss for financial reporting or credit purposes.

The use of an inventory method other than LIFO to ascertain the value of the taxpayer’s inventories for purposes of reporting the value of the inventories as assets isn’t considered the same as it is for the purposes of income, profit, or loss. But the disclosure of income, profit, or loss for a taxable year on a balance sheet issued to creditors or shareholders is considered to be a breach with the LIFO conformity requirement if the company uses an inventory method other than LIFO.

At the same time, using a disclosure method other than LIFO isn’t considered at variance with the requirement if the disclosure is made in the form of a footnote to the balance sheet or a parenthetical disclosure on the face of the balance sheet.

Further, an income disclosure is not considered at variance if the disclosure is made on the face of a balance sheet labeled as a supplement to the taxpayer’s primary presentation of financial position.

For its part, the TP provided the same IFRS-only balance sheet and income statement to its lending bank as it did to its FP. It also provided tabulated versions of these documents that adjusted the IFRS amounts to arrive at U.S. GAAP amounts.

Both the balance sheets and income statements involve the ascertainment of items of income, profit, or loss. There’s no question the IFRS-only versions used a method other than LIFO to ascertain income, profit, or loss. Arguably, the tabulated versions of the financials provided to the lending bank conformed to the LIFO conformity requirement, since they used U.S. GAAP to determine income, profit, and loss.

The catch is that the TP also used IFRS. The LIFO conformity requirement doesn’t merely require the use of LIFO; it requires that no method other than LIFO be used. Moreover, here the financial statements were “for credit purposes.” The TP’s continued receipt of credit was dependent upon the provision of such financial statements.

With respect to the tabulated balance sheets, the disclosure of income, profit, and loss using IFRS wasn’t made in the form of a footnote to the balance sheet or a parenthetical disclosure on the face of the balance sheet. Even if the disclosure qualified as a parenthetical (despite the lack of parentheses), there’s still the problem of the tabulated income statement. Information reported on the face of a taxpayer’s financial income statement for a taxable year is not considered a supplement to, or explanation of, the taxpayer’s primary presentation of income, profit, or loss. Here, the IFRS information was reported on the face of the income statement and not as part of a note to the income statement.

Even if the tabulated financial statements conformed to the requirements of the LIFO conformity requirement, the TP also provided the lending bank with the same balance sheet and income statement it provided to the FP. These documents were prepared based solely on IFRS and were not identified as supplemental, explanatory, or appendixes. Thus, the issuance of these financial statements to the lending bank violated the LIFO conformity requirements.

Robert Willens, founder and principal of Robert Willens LLC, writes a tax column for CFO.com.

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