Come On, People, Get a LIFO
While accounting policy is not a normal area of comment for me, there was a story in today’s Wall Street Journal about LIFO accounting that just made my blood boil. The implication of the story is that Exxon is systematically understating both their profits and taxable income by utilizing LIFO accounting for inventory. Let me say in advance that I am neither a defender nor a critic of Big Oil, but that this article and related commentary is such a piece of garbage that it almost defies comment (but not quite).
The 2 second summary of LIFO is this: LIFO means “Last In, First Out.” The idea is to try and match revenues with costs, and given that the acquisition cost of inventory varies over time and generally bears some relationship to the revenues generated that it makes sense to match current revenues (i.e., the money garnered from the retail pump at today’s prices) with current costs (i.e., the prices paid most recently for oil delivered to retail, be it at spot or delivered pursuant to forward contracts). This, friends, is called Generally Accepted Accounting Principles (GAAP), which is the basis upon which financial statements are (or, at least, should be) prepared.
Companies have a choice of inventory valuation methods - FIFO, LIFO, Average Cost, etc. - and depending upon your perspective arguments can be made for each. Further, depending upon whether one’s cost of inventory is rising or falling, the impact of LIFO may be to “overstate” profits and taxable income (relative to the average carrying value of inventory). However, it cannot be disputed that income statement presentation and earnings power is most accurately reflected using LIFO due to the fact that it reflects TODAY’s environment. Any other method distorts the picture and makes financial statements much less useful for the financial analyst.
The thing that really irks me is that nobody seems to have a memory here - this witch hunt goes on EVERY UP CYCLE IN PRICES. Did anybody squawk when oil prices fell from $40 to $10 per barrel in the mid-1990s, and poor Exxon was reporting higher profits and paying higher taxes? No, but they sure did in the 1970s. Can’t we stop wasting time and column inches by re-hashing old issues that have no intellectual currency? Listen: Exxon is making a lot of money. Yes, they have a large LIFO reserve and a matching deferred tax liability due to their choice of accounting method. SO WHAT!?! Their acccounting is clear, consistent, GAAP-compliant and provides better income statement and earnings power information than any other method. So let’s move on, shall we?
