I was just thinking about this today. It would increase COGS, right? LIFO liquidation perhaps?
In a rising cost environement, this will decrease COGS as a proportion of revenue due to LIFO liquidation. The company is selling more inventory than produced, which results in older (cheaper) inventory being sold.
OK but what if it’s just due to fewer inventory purchase?
I thought the formula was FIFO COGS = LIFO COGS - (change in lifo reserve)
EDIT: Sorry, I meant in the context of converting the financial statements to FIFO.
This is not rocket science. It doesn’t matter if it is a rising cost or declining cost environment. Use the formula.
FIFO COGS = LIFO COGS - (CHANGE IN LIFO RESERVE)
Therefore, under the scenario you posed, FIFO COGS would be higher than LIFO COGS.
A stroll woods? Unfortunately not, my European friend! I live in the city. But I’ve discovered (as sick as it is) that I actually enjoy accounting. In fact today I was reading a short thesis on seekingalpha.com where the author had heavy analysis based on a expected rate of return on a pension that he felt was overly optomistic. Ahhhh! It’s like we can never escape the CFA!!
this is wierd
If lifo reserve is dropping, there is lifo liquidation, therefore the decreasing lifo reserve causes COGS to decrease.
If converting from LIFO to FIFO for a period in which the LIFO reserve is dropping, this is how I think it through: LIFO reserve is usually increasing. FIFO usually results in lower COGS, lower by the change in LIFO reserve. Since the LIFO reserve is being special this time around and decreasing instead, then the effect must be the opposite: converting to FIFO would increase COGS by the difference in the LIFO reserve. I know there’s a formula for this, but that’s not how I personally work the problems. So COGS increases, which decreases gross margins, and decreases profit margins, although turnover ratios would increase.
When Positive Change in LIFO = represents COGS is more in LIFO than FIFO. That is why when converting to FIFO, you minus the increase in LIFO reserve in order to reduce COGS. So vice versa, when Negative Change in LIFO = represents COGS is lesser in LIFO in FIFO. So when converting to FIFO, COGS would increase.
Your explanation helped me, thanks.