LIFO reserve and Conversion between LIFO and FIFO

LIFO reserve = FIFO inventory - LIFO inventory.

In US, if use LIFO, must report LIFO reserve, usually in footnotes

LIFO to FIFO conversion:
Adjusting for LIFO - balance sheet:
· Add the LIFO reserve to LIFO inventories.
· Add (LIFO reserve) x (Tax rate) to deferred tax liability.
· Add (LIFO reserve) x (1 - Tax rate) to retained earnings.

Adjusting for LIFO - income statement:
· Add the change in LIFO reserves to LIFO COGS.
· Add (change in LIFO reserves) x Tax rate to Tax expense.
· Resulting net income will change by (change in LIFO reserves) x (1 - Tax rate).

INVF= LIFO reserve +INVL

COGSF= COGSL – (change in LIFO reserve) =COGSL –(LIFO reserveE – LIFO reserveB)

Where:
GOGSF - cost of good sold under FIFO
GOSSL - cost of good sold under LIFO
LIFO reserve E - the LIFO reserve at the end of the period
LIFO reserveB - the LIFO reserve at the begining of the period

LIFO reserves build up when number of units in the inventory is rising and/or the price is rising. It represents profit not being recognized and tax not being paid

LIFO reserve liquidation occurs when:
· the number of units in the inventory is falling-> the price of inv are no longer recent price and many years out of date->make COGS very low and profit artificially high ->analyst need to adjust the decline in LIFO reserve
· and/or the price is falling.-> FIFO still provided good estimate for inventory and LIFO still is a good estimate for COGS->analyst no need to adjust LIFO reserve

FIFO to LIFO conversion:
As LIFO is not a true reflection of econ value of inventory, FIFO inventory is no desire to convert. But it is useful to convert COGSF to COGSL:

COGSL= COGSF + BIF x Inflation rate

Where: inflation rate can be determined by 1) industry statistics 2) increase in LIFO for another company that the company's begnning inventory (BI) converted to FIFO

COGSL= COGSW +1/2 (BIW x Inflation rate)
Where: BIW - the begining inventory under average cost method.