ESTABLISHING THE LIFO CONFORMITY RULE

By William D. Cooper, CPA, Charles F. Malone, CPA, Gwendolyn McFadden-Wade, CPA, North Carolina A&T State University

Rarely have tax codes and accounting procedures been written with the other in mind. One notable exception is the Revenue Act of 1938. In 1938 and 1939, Congress revised the Internal Revenue Code to allow LIFO for tax purposes. The only limitation was that LIFO must be used for financial purposes if it were used in determining taxable income.

The reason LIFO had to be used for both tax and financial reporting was revealed in a 1979 interview with Carman G. Blough, the first chief accountant of
the SEC and later the AICPA's first full-time research director. In 1938, the general counsel for the Treasury Department established a three-member committee consisting of Edward A. Kracke (Haskins & Sells), Roy B. Kester (a professor at Columbia University), and Blough to act as advisors in the preparation of the new code. One of the changes proposed was the introduction of LIFO into the tax code. Blough was adamantly opposed to the LIFO method as he believed that LIFO did not reflect the flow of inventory. Edward Kracke favored the acceptance of LIFO. Kracke countered Blough's opposition by noting that since LIFO generally reduced profits, companies would be reluctant to adopt it for financial reporting purposes. Blough, while still questioning the LIFO method, felt that Kracke's logic was sound and accepted LIFO because he believed that few firms would actually adopt it. The committee's final recommendation was that companies should be allowed to use LIFO, provided they used it for both financial and tax reporting. This requirement, known as the LIFO conformity rule, was adopted and for nearly 60 years company managers have been forced to select which financial presentation is best for them. Ironically, the use of LIFO has expanded over time and Blough's prediction that usage would be limited proved to be incorrect. In later years, Blough regretted his decision and lobbied against the usage of LIFO.