Net Income under FIFO Vs. LIFO
I need help understanding the derivation of this formula:
Net IncomeFIFO = Net IncomeLIFO + (LIFO ReserveEnd - LIFO ReserveBeginning)*(1-TaxRate)
It works, but I do not understand why it works.
EDIT: Updated for future readers to the corrected formula :)
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Your formula’s off just a bit:
Net IncomeFIFO = Net IncomeLIFO + (LIFO ReserveEnd − LIFO ReserveBeginning) × Marginal tax rate
The change in LIFO reserve (Δ LIFO reserve = LIFO ReserveEnd − LIFO ReserveBeginning) is, by definition, the difference between LIFO COGS and FIFO COGS for that period:
Δ LIFO reserve = COGSLIFO − COGSFIFO
– or –
COGSFIFO = COGSLIFO − Δ LIFO reserve
As you work your way down the income statement, no other line item changes (until taxes), so,
Gross MarginFIFO = Gross MarginLIFO + Δ LIFO reserve (because COGS is subtracted)
EBITDAFIFO = EBITDALIFO + Δ LIFO reserve
EBITFIFO = EBITLIFO + Δ LIFO reserve
EBTFIFO = EBTLIFO + Δ LIFO reserve
EBTFIFO × Marginal tax rate = (EBTLIFO + Δ LIFO reserve) × Marginal tax rate
EBTFIFO × Marginal tax rate = (EBTLIFO × Marginal tax rate) + (Δ LIFO reserve × Marginal tax rate)
Net IncomeFIFO = Net IncomeLIFO + (Δ LIFO reserve × Marginal tax rate)
Simplify the complicated side; don't complify the simplicated side.
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That’s perfect! I see it now, thanks!
–
Sometimes I see that a definition of change in LIFO as Δ LIFO reserve = COGSLIFO - COGSFIFO
Is this just a preference on starting points of where we reconcile from?
My mistake: I got the Fs and the Ls backward. (I was thinking Ending Inventory and writing COGS.)
I’ve fixed it.
Good eye!
Simplify the complicated side; don't complify the simplicated side.
Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/