LIFO inventory management and the ACE component of the alternative minimum tax

Changes in accounting rules make it imperative for managers to reevaluate the possibly subtle costs and benefits of alternative accounting methods. The 1990 introduction of the adjusted current earnings (ACE) component of the alternative minimum tax (AMT) is such a rule change. Firms subject to the ACE component of the AMT receive a much smaller tax benefit from using LIFO than firms subject to the regular tax. During periods of rising costs and stable or increasing inventory levels, LIFO produces lower income and lower tax liability relative to FIFO. Under the regular tax, a firm that chooses LIFO saves up to 35% of the current increase in the difference between FIFO and LIFO inventory values. Because of the LIFO adjustment to ACE, an AMT firm saves as little as 5% of this increase.