# From LIFO to FIFO

A company uses LIFO Inventory Method, its LIFO reserve increase from 40 million to 60 million. The income tax rate is 30 percent. Adjust its income statement and Balance Sheet from LIFO to FIFO. In Income statement The gross profit has decreased by 24 million (60-40), so the income tax has increased by 7.2 million (24*.30). In BS Inventory has increased by 64 million so the total Asset has increased by 64 million. Deferred income tax liabilities has increased by 19.2 mio (64*.30) and retained earnings increase by 44.8 mio (64*.30) The question is : How to understand it is DTL who increased, considering more income tax expense in Financial Statement ? Why DTL does not decreased? Thanks a lot.

this is the example from cfa1, LIFO reserve increased from \$40M to \$64M b/c they use LIFO on tax report and FIFO on income tax report

?? DTL? I really don’t get this.

I personally do not think a DTL ever comes into the picture with the LIFO and FIFO. You have NI which flows thro’ Retained earnings into the Equity section has the difference between 24 and 7.2 coming in. So Equity increases on the Balance sheet. No DTL happens because of Inventory methodology changing from LIFO to FIFO or otherwise. CP

DTL did not decrease because you had less tax under LIFO. Under FIFO more taxes should have been charged so the exceess which is owed is a liability

In the following equation: FIFO inventory = LIFO inventory + LIFO reserve, the LIFO reserve is used to convert the LIFO inventory to a comparable FIFO inventory because the LIFO inventory is: A) understated representing unrecognized losses and deferred taxes. B) understated representing unrecognized profits and deferred taxes. C) overstated representing unrecognized profits and deferred taxes. D) understated representing unrecognized profits and deferred liabilities. I came across this question in Qbank. I still can not understand the dynamics between LIFO and deferred taxes. LIFO results in lower NI and taxes, but how and why they get deferred as according USGAAP both tax and accounting statements should follow LIFO. Can someone please throw more light on this topic. PS: answer is B

In the question above shouldn’t it be taxes not paid instead of deferred taxes ??? experts??

Well, taxes not paid could be paid someday because of LIFO layer liquidations - hence deferred / postponed indefinitely/ is more appropriate. Answer is B because: - LIFO inventory is understated (when prices have been rising) and COGS is overstated. This is because inventory sold is assumed to be the one bought at the higher prices. - unrecognized profits because as COGS is overstated now profit is understated, or unrecognized. - deferred taxes related to the unrecognized profits.

If I’m not mistaken, I believe the IRS requires that if you use LIFO reporting for tax purposes, you also use it for financial reporting purposes. The order here is important: if used for both tax and reporting purposes, there should be no net effect on taxation. The trick is when you use FIFO inventory reporting on your tax statements–and let’s be real, the IRS would welcome it when a firm reports higher income as that would translate into higher taxes. But what if that firm uses LIFO reporting to investors? Well think about it: the firm shows lower net income to investors, but relatively higher income taxes paid because it reports higher income to the IRS. The firm will debit the income taxes expense on it’s ledger, and it will also debit prepaid taxes. These two will balance against the income taxes payable entry, which shows up as a credit. You have thus created a prepaid asset. Hence, that’s the reason why LIFO inventory will be understated (removing higher priced inventory), COGS will be higher (selling higher priced inventory), and income will be unrecognized (because of higher COGS)–although I wouldn’t quite use that language because we’re taught that COGS under LIFO is more reflective of the current business environment versus COGS FIFO, so we’re really actually showing income in its truest form.