Insider. Manufacturing. Having Trouble Saying Goodbye to LIFO? You re Not Alone. In This Issue

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1 Manufacturing Insider Insights & Observations for the Manufacturing Industry Volume 3 :: Issue 2 In This Issue Having Trouble Saying Goodbye to LIFO? You re Not Alone...1, 2, 3 Case Study: Administrative Process Improvement Optimization... 4, 5 Having Trouble Saying Goodbye to LIFO? You re Not Alone. For over 70 years, the IRS has permitted U.S. companies the option of valuing the cost of inventory using the last-in, first-out inventory method of accounting (LIFO) for income tax reporting purposes, as long as the US Company follows a conformity requirement. Under the conformity requirement, US companies who wish to adopt LIFO accounting for income tax reporting purpose, must also use LIFO for financial statement reporting purposes. And many companies in the U.S. want to keep it that way. However, International Financial Reporting Standards (IFRS), the global standards now adopted by over 100 countries including those in the European Union, does not permit the use of LIFO for financial reporting purposes. Consequently, LIFO s days may be numbered as companies adopt IFRS and find they can no longer use LIFO for income tax reporting purposes due to the conformity requirement. Continued on Page 2...

2 The Next Level Of Service UHY LLP Having trouble saying goodbye to LIFO? You re not alone. Continued from Page 1... U.S. officials now wonder if they should change the conformity rule to allow US companies to both comply with IFRS by converting to another approved method such as first in first out (FIFO), for example, and still keep LIFO for calculating U.S. taxes. Such a move would require new federal legislation and strong support to muster passage. Meanwhile, Congress and U.S. Treasury officials see significant new revenue generated without the political hurdle of raising rates or establishing new taxes, should the conformity rules remain unchanged. While that political debate will play out in the coming months, here are some considerations related to IFRS and LIFO to help you further understand the issue: IFRS Conversion Under a LIFO system, ending inventory is deemed to consist generally of goods purchased in the order of acquisition. As a result, LIFO serves to match current sales revenue with current inventory costs, which effectively expenses inflation. While some view LIFO as providing better matching on a company s income statement, the global movement toward IFRS has renewed the focus on presenting the company s balance sheet at fair value for financial reporting purposes, reporting the more current inventory valuations on the balance sheet. As a result, taxpayers currently using LIFO for federal income tax purposes would, upon conversion to IFRS, be required to change from LIFO unless they qualify for an exception to the LIFO conformity requirement. Many US companies with a foreign parent that have already converted, or are in the process of converting, to IFRS have already faced this issue. LIFO Debate Continues Members of President Obama s Administration have argued that LIFO provides an unfair tax deferral opportunity when inventories 2 UHY LLP Manufacturing Insider Volume 3 :: Issue 2

3 increase in value. The Treasury also argued that the repeal of LIFO would remove possible impediments to the potential adoption of IFRS in the U.S. But LIFO supporters contend that the Treasury doesn t need to wait for Congressional approval to modify regulations to address the conflict between the LIFO conformity requirement and IFRS. Faced with a similar situation in the early 1980s when the SEC required increased disclosure for companies on LIFO, the Treasury responded by issuing regulations that relaxed the LIFO conformity requirement without Congress. Planning for LIFO s Demise In the event a taxpayer is required to terminate its LIFO election, they should consider the opportunities available to help alleviate the potential cash tax impact resulting from the termination of the company s LIFO election. Under current IRS administrative procedures, if a taxpayer changes its tax method of accounting from LIFO to another acceptable inventory method, and the change results in a higher inventory value, the positive adjustment to income is taken into account over four taxable years. financial accounting LCM rules, which generally do not apply on an item-by-item basis, and generally define market based on selling prices. Regardless of whether your company changes from LIFO to FIFO as a result of adopting IFRS or because of legislative repeal, such change is likely to have a significant impact on your tax burden. Even if LIFO is extended for your company either through legislation or by qualifying for relief you should plan today for the very real possibility that it will be gone. As any experienced business person knows all too well: Don t rely entirely on a government solution. Article written by F. Michael Zovistoski (Albany, NY) In contrast, the Obama Administration s released its fiscal year 2011 budget proposal on February 1, 2011, which provides for a repeal of the LIFO inventory accounting method for federal income tax purposes effective for years beginning after December 31, This one-time increase in gross income would be spread ratably over ten taxable years. What You Can Do While companies may not be able to avoid unfavorable adjustments to taxable income as a result of changing from LIFO to FIFO, companies may be able to mitigate the impact by selecting favorable valuation methods of accounting for their FIFO inventories. Under LIFO, taxpayers must value their inventories at cost. Under FIFO, taxpayers have the advantage of being able to value their inventories below cost, including using the lower of cost or market (LCM) method and the subnormal goods method. For example, a taxpayer changing from LIFO to FIFO may want to adopt the LCM method to value its ending inventory for US tax purposes. For normal goods, the LCM method allows taxpayers to analyze each item or component in ending inventory and value it at market, defined as reproduction or replacement cost, to the extent market is less than cost. This approach differs from 3 UHY LLP Manufacturing Insider Volume 3 :: Issue 2

4 UHY LLP The Next Level Of Service Case Study: Administrative Process Improvement Optimization The Challenge The Executive Director of Enterprise Accounting Services accepted responsibility for the recently centralized Accounts Payable functions at NewCo. The objective of the centralization was to gain efficiency and productivity opportunities while leveraging economies of scale. The centralization (which was still in progress when the Executive Director took over) would allow for the elimination of accounting functions at field locations, including accounting activities performed by non-accountants such as expense coding, for example. In addition to NewCo centralizing Accounts Payable functions, they also made a decision to offshore transactional activities. Now with an outside service performing part of the process steps, exception queues became the focus for much of the work of the internal NewCo team. The processing of these exceptions required a staff of 29 NewCo employees and contractors. NewCo employs an internal continuous improvement group. While the continuous improvement staff has a background in accounting, finance and audit, the group had traditionally focused on system-related issues and improvements. With a large share of the 19 exception categories having root-causes in the quality of information provided into the process, and other process insufficiencies, the toolset available internally to NewCo provided limited traction in reducing the exceptionrelated workload. Faced with a considerable task that required sustainable operational change, the Executive Director turned to UHY Advisors Management Consulting practice group to implement Enterprise Optimization (EO) services. UHY Advisors five year history with NewCo, its understanding of administrative efficiency and its accounting expertise made it a credible choice. Not only is this true, but UHY Advisors consulting team possessed extensive real-world finance and accounting experience combined with process engineering and improvement expertise. Consultants draw on a broad set of methodologies and select tools most suitable to a specific situation. The tools include Lean, Six Sigma, Theory of Constraint, Total Quality Management (TQM) and Balanced Scorecards. This makes the firm a thought leader as well as a partner capable of implementing and delivering results. More specifically, NewCo wanted to identify any performance gaps as compared to an ideal process with respect to productivity, timeliness and accuracy, so as to: Leverage efforts to centralize, automate and standardize processes and functions as rolled out by NewCo. Create a predictable and reliable environment, where the majority of transactions follow a standard process flow. Improve service to their internal customers by minimizing the effort required in the process and resolving exceptions. The Solution Assessment The change and transformations process started with a threeweek assessment. While UHY Advisors conducted most of the activities performed during the assessment, it became the inception of the ensuing change process. To provide a structural analysis of the process flow, brown paper process maps (i.e. live document flows) were developed for eight areas involving associates at all levels and providing a factual presentation of process inefficiencies and wasted efforts. The following activities became an integral part of the brown paper process mapping: Strategic interviews with area leadership to understand strategy and direction, key issues and planned activities related to the areas assessed. Evaluation of the strength of the tools, processes and information being utilized. Detailed operational observation, studies and data analysis in order to: - Identify opportunities to increase productivity through elimination of redundancies, rework and extensive audit. - Highlight root-causes of stagnation, delays, rework and unnecessary follow up. - Evaluate current transaction mix against resource commitment and materiality. - Provide foundation for factual and constructive discussion to a holistic improvement approach. - Prioritize activities to capture highest-yielding opportunities first. Continued on Page UHY LLP Manufacturing Insider Volume 3 :: Issue 2

5 The Next Level Of Service UHY LLP Case Study: Administrative Process Improvement Optimization Continued from Page 4... The brown paper process maps were first reviewed and studied with more than 30 associates, including internal customers and suppliers of information, and then shown to supervisors and managers. This approach ensured accuracy of the facts and opportunities depicted. Eventually, NewCo executives were involved in the process map review as well. By this time, the organization had already bought into the opportunities identified and had started a dialog using a common process perspective. Implementation Based on the assessment, UHY Advisors developed an implementation plan, prioritizing five areas with the greatest opportunities compared to the implementation effort required: 1. Exception reduction focused on a systematic approach to the root-causes leading to exceptions. This included improved processes, education and training of repeat offenders and exception resolution at the time of detection, eliminating the second touch previously required. 2. Removal of utility invoices and statements from the AP stream, previously accounting for more than 12% of the total AP invoice volume. NewCo created a separate flow for utility charges, integrating an energy dashboard infrastructure already established at the corporate parent. 3. Vendor set-up and maintenance, including the creation of a simple but efficient upload, error-proofing and validation of vendor data reducing the time to set up a vendor from eight minutes to less than one minute. 4. Implementation of UHY Advisors proprietary Optimal Performance Management System (OPMS ), a system of metrics, true capability based goals, visual controls and enhanced behavioral routines that establish accountability with staff, supervisors and managers. The OPMS also allows for timely identification of performance shortfalls and immediate deployment of corrective action. 5. Training of NewCo resources on the UHY Continuous Improvement Methodology; utilizing the same materials, methodology and curriculum as used to train the consultants at UHY Advisors. The changes involved cross-functional teams that drew on the day-to-day experience, understanding of the business and systems knowledge of NewCo employees. UHY Advisors was responsible for specific deliverables, while the detail of the improved processes greatly integrated and reflected the collective intelligence of the organization. Based on limited information available at the time of the assessment, particularly with respect to root-cause classification and frequency, UHY Advisors conservatively outlined Enterprise Optimization goals as follows: Reduction of exception-related activities by at least 33% within six months. Reduction of exception-related activities by at least 50% within one year. Resulting savings that equate between five to 10 full-time employees. The Result By collaborating with UHY Advisors expert consultants, NewCo is now poised to save $1.5M annually. Already they have been able to reduce AP resources by 79% and are thrilled that the final results exceed set expectations by almost double. The engagement will more than pay for itself within the first year and yield an annualized return of four times the implementation fee. Since UHY Advisors Enterprise Optimization assessment and implementation began in May 2010, NewCo has already realized significant new efficiencies, including: 64% reduction in exceptions processed at corporate: A weekly average of 1,506 in April was reduced to the current rate of 536 per week. 55% reduction in rush payments processed from an average of 293 transactions to % increase in on-time payments from 75% to 79%. 80% improvement in the process for utilities payments from five touches to one. 88% improvement in the data-entry process for setting up new suppliers, from an average of eight minutes to less than one. 79% reduction in resources required for the corporate AP function, from 29 resources to six. The implementation involved limited transitioning of additional activities to an outsourced provider. The outsourced provider did not need to increase its resources to handle this additional workload because UHY Advisors improvements reduced the work effort required by the outsourcer. Article written by Frank Fenello (Atlanta, Georgia) 5 UHY LLP Manufacturing Insider Volume 3 :: Issue 2

6 Manufacturing Services UHY LLP recognizes that manufacturing companies require their auditors, tax and business advisors to add value to financial reporting activities. We combine the strength of business and financial expertise with a hands-on, shop floor approach to solving complex business decisions in these key segments: Aerospace & Defense Distribution Automotive & Suppliers Industrial Manufacturing Consumer Products The professionals at UHY LLP help lead the industry in identifying and addressing new trends, accounting requirements, and regulations, ensuring our clients future success. For more information please contact Tom Alongi, our national manufacturing and distribution practice leader at or [email protected]. uhyllp-us.com Georgia Maryland Michigan Missouri New Jersey New York Texas Our Locations Atlanta Columbia Southfield Sterling Heights St. Louis Oakland Albany New York White Plains Dallas Houston Additional UHY Advisors Locations Illinois Texas Washington DC Chicago Houston Washington The statements contained herein are provided for informational purposes only, are not intended to constitute tax advice which may be relied upon to avoid penalties under any federal, state, local or other tax statues or regulations, and do not resolve any tax issues in your favor. Furthermore, such statements are not presented or intended as, and should not be taken or assumed to constitute legal advice of any nature, for which advice it is recommended that you consult your own legal counselors and professionals. UHY Advisors, Inc. provides tax and business consulting services through wholly owned subsidiary entities that operate under the name of UHY Advisors. UHY Advisors, Inc. and its subsidiary entities provide services from offices across the United States. UHY Advisors, Inc. and its subsidiary entities are not licensed CPA firms. UHY LLP is a licensed independent CPA firm that performs attest services in an alternative practice structure with UHY Advisors, Inc. and its subsidiary entities. UHY Advisors, Inc. and UHY LLP are U.S. members of Urbach Hacker Young International Limited, an international association of legally independent professional service firms.