As we all (hopefully) know we adjust LIFO COGS to FIFO COGS by subtracting change in LIFO reserve. I came across an example where there was a LIFO liquidation in a given year and LIFO reserve still increased. Shouldn’t we adjust COGS somehow for the LIFO liquidation, not only change in LIFO reserve? I got confused… To me it makes sense to to do this: FIFO COGS = LIFO COGS - change in LIFO reserve + LIFO liquidation. But the answer did not account for LIFO liquidation. Why is that?
Was it a periodic inventory system or a perpetual inventory system?
Not stated, as always in L2 questions but I assume (hopefully correct) that periodic.
LIFO liquidations generally lower COGS, not raise COGS: you’re taking old, (presumably) low costs out of inventory and running them through COGS.
Yes, exactly! LIFO liquidations lower COGS, because of old, lower-cost inventory is sold. So when using FIFO method, we would’t have that boost in gross profit so IMO we shoul add LIFO liquidation to fairly and accurately show FIFO COGS.
Let’s try an example.
You have 10 units in inventory: $100 under LIFO ($10 each), $150 under FIFO ($15 each), so your LIFO reserve is $50.
You buy 10 units at $25 each, and sell 15 units. Goods available for sale is 20 units; $350 under LIFO, $400 under FIFO. You have a LIFO liquidation (units sold > units purchased).
Your LIFO COGS is $300 (10 units at $25, 5 units at $10), so your LIFO ending inventory is $50 (5 units at $10).
Your FIFO COGS is also $275 (10 units at %15, 5 units at $25), so your FIFO ending inventory is $125 (5 units at $25).
Your ending LIFO reserve is $75 ($125 – $50), so you’ve had a LIFO liquidation and your LIFO reserve has grown (by $25).
FIFO COGS ($275) = LIFO COGS ($300) – ΔLIFO reserve ($25). No LIFO liquidation in this formula.
Well done, got it! Thank you!
S2000 as always priceless