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HMRC internal manual

Business Income Manual

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Stock: valuation: FIFO not LIFO: Minister of National Revenue v Anaconda American Brass Ltd

LIFO means last in first out, FIFO means first in first out

Section 13 of FRS102 prohibits the use of LIFO in valuing inventories. However, LIFO is not specifically prohibited by SSAP9 or IAS2 and so might be appropriate under GAAP in limited circumstances. However, it does not truly reflect its profit for tax purposes.

A LIFO cost method of valuing stock means that you assume that the stock which is unsold is the oldest stock of that type, so the cost value is the cost of the oldest stock. FIFO assumes you sell the oldest stock first, so the cost value is the cost of the most recent stock.

Minister of National Revenue v Anaconda American Brass Ltd [1956] 2 WLR 31 was a Privy Council decision made on appeal from the Supreme Court of Canada. The judgment was delivered by Viscount Simonds.

The company carried on the business of purchasing metals, manufacturing them into sheets, rods and tubes, and selling the manufactured products. It constantly bought metals and kept records of the purchase price but did not keep records from which the actual metals used during the year could be identified. In order to value its stock at the end of the year it adopted a last in first out method. In this method the cost of the material most recently purchased is deducted from the next sale of the processed product. In the year of the company’s accounts, 1947, there had been large increases in the price of metal, so, by attributing the higher costs to metals processed and the lower costs to the value of stock, the company showed a lower profit.

The Canadian Minister of Inland Revenue took the view that although LIFO might be appropriate for the company’s accounts it did not truly reflect its profit for tax purposes, and that FIFO was the appropriate method of valuing stock for tax purposes. This decision was not upheld by the Courts in Canada and came on appeal to the Privy Council.

Viscount Simonds said:

`The income tax law of Canada, as of the United Kingdom, is built upon the foundations described by Lord Clyde in Whimster & Co v CIR [1925] 12TC813, in a passage cited by the Chief Justice which may be here repeated. “In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income Tax Act, ….. For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchant’s or manufacturer’s business the values of the stock in trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower; although there is nothing about this in the taxing statutes.” For many years before and ever since this decision what is to be valued at the beginning and end of the accounting period has for tax purposes been taken to be the actual stock so far as it can be ascertained. It is in fact, so far as tax law is concerned, a novel and even revolutionary proposal that the physical facts would even where they can wholly or partly be ascertained be disregarded for the purpose of the opening and closing inventory and a theoretical assumption made which is based on a supposed “flow of cost” and an “unabsorbed residue of cost”.’

Viscount Simonds went on to say:

`Their Lordships do not question that the LIFO method or some variant of it may be appropriate for the corporate purposes of a trading company. Businessmen and their accountant advisers must have in mind not only the fiscal year with which alone the Minister is concerned. It may well be prudent for them to carry in their books stock valued at a figure which represents neither market value nor its actual cost but the lower cost at which similar stock was bought long ago. A hidden reserve is thus created which may be of use in future years. But the Income Tax Act is not in the year 1947 concerned with the years 1948 or 1949.’

`……..it is implicit that no assumption need be made unless the facts cannot be ascertained. There is no room for theories as to flow of costs, nor is it legitimate to regard the closing inventory as an unabsorbed residue of cost rather than as a concrete stock of metals awaiting the day of process. It is in their Lordships’ opinion the failure to observe, or, perhaps it should be said, the deliberate disregard of, facts which can be ascertained and must have their proper weight ascribed to them, which vitiates the application of the LIFO method to the present case. It is the same consideration which makes it clear that the evidence of expert witnesses, that the LIFO method is a generally acceptable, and in this case, the most appropriate, method of accountancy, is not conclusive of the question that the court has to decide. That may be found as a fact by the Exchequer Court and affirmed by the Supreme Court. The question remains whether it conforms to the prescription of the Income Tax Act. As already indicated, in their Lordships’ opinion it does not.’