One thing I never gained a full understanding for during my level II prep last year was LIFO reserve. Correct me if I’m wrong but the LIFO reserve is the extra amount of ending inventory that a company would report if they used the FIFO inventory valuation method instead of LIFO. In other words, the LIFO Reserve = FIFO Ending Inventory - LIFO Ending Inventory. So in order to adjust a LIFO company’s inventory to FIFO, one simply has to add the LIFO reserve to inventory.
The thing I never fully understood, instead I just memorized, was the adjustment made to COGS. So my question is:
Why do you subtract the year over year change in the LIFO reserve from COGS when converting from LIFO COGS to FIFO COGS?
When converting from LIFO to FIFO, the thinking is that you’re trying to create the financial statements (balance sheet and income statement, primarily) as they would have looked _ had the company been using FIFO all along _. Thus, the change to the (current) balance sheet would show the accumulation of all of the yearly LIFO reserve adjustments: the total LIFO reserve. The change to the (current) income statement would show only the LIFO reserve adjustment for the current year: the change in the LIFO reserve (the rest of the LIFO reserve having been shown on previous years’ income statements).