LIFO Reserve Adjustment

Adjusted Inventory = LIFO Inventory + LIFO Reserve This increases assets by LIFO Reserve. On the other side we have : Adjusted deferred taxes = deferred taxes + LIFO Reserve (t) Adjusted Retained Earnings = RE + LIFO Reserve (1-t) Can anybody please confirm if this is correct ?

Looks correct to me. Assets increased by Ending LIFO Reserve. Liabilities (DTL) increased by Ending LIFO Reserve * (t) Equity increased by Ending LIFO Reserve * (1-t) So Both Assets and (L+E) have finally been increased by LIFO Reserve # when converting the Balance sheet of a LIFO Company to FIFO.

CP, If deferred taxes are not given in the balance sheet, do we increase equity directly by LIFO reserve ?

usually - that is what has been done in most examples. Usually they also end up making a statement like the DTL is not going to reverse - which means it must be treated as equity. So in that case rather than do the two step process: For Inv: Assets up, DTL Up, Equity Up then for reversing DTL: DTL Down, Equity Up. They do it in one step as: Assets Up, Equity Up --> for the Inventory from LIFO to FIFO - by the LIFO Reserve amt.

Ahh right …that makes sense… yeah actually i had read both of this …so wanted to confirm… I’m just trying to nail down all the adjustments in Synthesis this weekend… I’m an engineer and this is the weakest area for me in entire curriculum… :frowning: Thanks …

I usually do the direct to equity trick as cpk mentioned. Since they almost always give that the DTs are not going to reverse.

I’m slightly confused here because my brain has turned to mush lately. Balance sheet _______________ If the company uses LIFO, we want to convert this to FIFO because FIFO’s inventory values are more current. so FIFO = LIFO Inventory + ending LIFO Reserve This is an increase in current assets, to balance this, we’ll increase equity by the same amount (according to Schweser page 261). Income statement __________________ If the company used LIFO, the COGS should reflect the most recent costs. There should be no adjustment here. Now, if there is a decline in LIFO reserve due to LIFO liquidation, the true current value of the COGS isn’t reflected correctly in the income statement expense since we have dipped into older cheaper inventory. This isn’t sustainable as the firm will eventually have to incur the current cost of inventory for replenishment. COGS will be lower than what it should be. On a side note: We know that COGS LIFO = FIFO COGS + change in LIFO reserve. If I was to convert COGS LIFO to COGS FIFO, then I understand that my gross profit would increase by a _change_ in LIFO reserve. Increase in net income would be _change_ in LIFO reserve * (1 - tax rate) Added income tax expense would be _change_ in LIFO reserve * tax rate deferred tax liabilities will increase by _ending_ LIFO reserve * tax rate

I’m guessing we can only have one or the other? If we assume FIFO on the BS, then we are forced to assume FIFO for the income statement?

no you have LIFO for Balance sheet - no adjustment there- and FIFO for the Balance sheet. If a company is switching from LIFO to FIFO - it is a one time switch. Up until that time - they have built up considerable LIFO reserves - all of that will kind of be removed. So Ending LIFO Reserve * (1-Tax Rate) will be the one time change in the Retained Earnings. You cannot keep switching between LIFO and FIFO multiple times - it is a one-time only situation. and this one time revocation will increase the earnings - so there is a one time impact to the DTL as well - since the company would pay higher taxes… do not know if this is just chatter here…

I think that actually makes sense CP. For analytical purposes, the entire LIFO reserve will be exposed to tax on a one-time switch for analytical reasons. However, if FIFO adjustment is made for the balance sheet, as per the recommendation by charu (and in the other post), then I must use FIFO COGS? Adjusted deferred taxes = deferred taxes + LIFO Reserve (t) Adjusted Retained Earnings = RE + LIFO Reserve (1-t)

you never make any adjustment if the company is using the LIFO COGS on the income statement. The adjustment is always made automatically - because when you increased the Ending Inventory to reflect the LIFO Reserve on the Asset side - the adjustment is made to the Equity as well. So the income statement effect - to increase the income - which increased the retained earnings --> is already automatically adjusted…

I think I get it. Thanks very much for your help.