New vehicle inventories have continued to build since the lows experienced during and immediately following the pandemic, and with inflation and profits at near record levels, it may be time to revisit whether electing LIFO makes sense for your auto dealership.
To elect a LIFO inventory valuation method for 2023 and take the deduction, auto dealerships must include a LIFO adjustment and report it in their 12th month dealer factory statement. This means time is of the essence to weigh the economic and dealers-specific factors and decide.
What is LIFO?
LIFO is a method for valuing your inventory and stands for Last-In, First-Out. Inventory valuation is important as it determines your cost of goods sold, which is usually higher under LIFO in an inflationary environment. Higher cost of goods sold means less taxable income.
In auto dealerships this is usually with respect to new vehicles, but there are multiple options and opportunities for electing LIFO valuation methods. For example, you can elect LIFO for used vehicles, but you can’t write-down inventory that is valued under LIFO, and most dealers find it more beneficial, easier and cost-effective to write-down their used inventory at year-end rather than go through a LIFO calculation. You can also elect LIFO for parts inventories, but given their relatively smaller size, this doesn’t generally generate a significant deduction.
How does it work?
LIFO works by adjusting your inventory to assume you’re selling the most recent vehicles you’ve purchased, i.e. last-in, first-out, which will generally be at a higher cost than similar units acquired previously. There are a couple methods to choose from in calculating these adjustments, but most of our dealers use what is known as the alternative dollar value method. Under this method, you’re creating a LIFO reserve based on the cumulative impact of inflation on vehicles that are actually in inventory. This generally requires an analysis of inventory schedules and invoices for any new vehicles in inventory at year-end, but typically yields the best result. Another option, the inventory price index computation (IPIC) method determines a similar adjustment, but it is done using the total inventory cost and changes in the consumer price index from year-to-year. The IPIC calculation is less complex and less information is needed, but the adjustment is not generally as favorable as the dollar-value method.
What are the impacts of LIFO on auto dealers?
Regardless of which method you choose, LIFO is most beneficial when inflation is high and inventories are stable or growing. In years where inventory is increasing, the adjustment equals the prior year inventory multiplied by current year inflation. As an example, let’s assume your 2023 new vehicle inventory is higher than 2022, and your 2022 inventory was $2,500,000. At 2% inflation you’d end up with a $50,000 deduction for LIFO ($2,500,000 x 2%).
In years where inventory decreases, the calculation isn’t as straight forward, but can still result in a deduction if inflation is high enough; however, if inventories decrease too drastically, as was seen during the pandemic, there is potential for LIFO recapture, which will result in additional taxable income. In fact, many dealers revoked their LIFO elections when the pandemic hit, which allowed them to spread out the income over four years. Those dealers that elected to revoke LIFO are now ineligible to elect LIFO again for five years, so they’re missing out on potential deductions resulting from the recovering inventory supplies and inflation.
Is LIFO right for my dealership?
Whether electing LIFO is the right move for a dealer depends on their individual facts and circumstances. For example, if your new vehicle inventory supply hasn’t recovered or is historically low (e.g. Toyota or Subaru), or is expected to decrease in the next couple of years, LIFO isn’t likely to be worth it. However, if you’re a dealer that’s seeing inventories rise, costs increasing, and high profits, then LIFO is another tool available to help reduce your taxable income.
LIFO is an opportunity that you should be discussing with your tax advisor before year-end. In order to take the deduction, you must include a LIFO adjustment and report it in your 12th month dealer factory statement.
ARB’s Auto Dealership Advisory Services Team is actively involved in the industry and committed to helping auto dealerships maintain effective, efficient, and compliant financial operations. We want to help you create and implement strategic accounting practices to maximize profitability for the long term. If you’re ready to talk about whether LIFO is an appropriate strategic choice for your dealership, contact one of our dealership team members today!
Matthew Marcoullier is a senior manager at ARB. He focuses primarily on financial accounting and consulting services for auto dealerships, commercial businesses, and closely-held businesses. Matt previously served as a Senior Auditor for the State of Maine Department of Audit.