LIFO Reserve Overview, Formula, Journal Entry

lifo reserve journal entry

Therefore, CPAs may be called upon to help manage inventory method
changes. Companies using LIFO would have to switch to FIFO or average
cost. The change would place companies in violation of the conformity
requirement.

For tax planning purposes, companies may consider reducing their
inventories and their LIFO reserves gradually between now and
changeover dates to IFRS. Some companies may decide to be early IFRS
adopters, particularly if a net operating loss or other tax situation
could minimize the impact of recapturing the LIFO reserve. Or they
could wait and see what happens, anticipating some exception to the
conformity principle or an extended section 481(a) period. These parties can use LIFO reserve to compare the financial statements of different companies using LIFO and FIFO. Similarly, they can study the effect of those changes on the various areas described above. Moreover, understanding LIFO accounting can help shareholders assess the realizable value of inventory assets reported on the balance sheet and potential tax implications from inventory liquidations.

Calculating the Change in LIFO Reserve Due to Liquidation

For example, Carter Hauling’s ending inventory on December 31, 2013, is $275,000 using FIFO and $225,000 using LIFO. We can do some adjustments in the accounting equation to reflect the FIFO Inventory costing in the financial statements of the company using LIFO for external uses. From this example, we can see a big difference between the two types of inventory methods. The company will record this difference as a contra-inventory account. By doing little tweaks in the formula for LIFO Reserve, the financial statements of a business using LIFO and another company using FIFO methods can be made comparable. Most companies use the LIFO method for external reporting due to the tax savings and the non-LIFO method for internal reporting.

lifo reserve journal entry

GAAP sets accounting standards so that financial statements can be easily compared from company to company. GAPP sets standards for a wide array of topics, from assets and liabilities to foreign currency and financial statement presentation. The LIFO method is one of the available methods used in inventory management. Clearly the method used to determine which units are sold and which remain in ending inventory determines the value of the cost of goods sold and the ending inventory. As profit depends on the cost of goods sold, the method chosen will affect the profits of a business.

Last In, First Out (LIFO): The Inventory Cost Method Explained

With this data, you can compute the value of ending inventory under LIFO (last units purchased are first sold) and FIFO (first units purchased are first sold). The key takeaway is that subtracting the LIFO reserve gives you the FIFO inventory number for comparison purposes. It reverses the ongoing cumulative difference caused by using LIFO rather than FIFO for inventory reporting valuation.

Well, that’s sort of what happens when LIFO liquidation takes place. Breaking it down to the lowest common denominator, LIFO liquidation occurs when a company sells more inventory than it purchases in the current period. In this case, older inventory costs that lifo reserve journal entry are probably lower than current replacement costs are matched with current sales. This fact causes the cost of goods sold to record as artificially low and inflates net income. To illustrate an inventory method change,
assume BC Co. is a retail business.

Sorry, the comment form is closed at this time.