ABC Corp. uses LIFO. Which of the following best describes the adjustments that would be made to ABC’s financial statements if you were to compare ABC with other companies in the same industry, but use FIFO. An increase in ABC’s LIFO RESERVE for the year would be: a. added to ending inventory b. added to COGS c. subtracted from ending inventory d. subtracted from COGS
If price is increasing, I will choose A. LIFO Inventory is understated by the LIFO reserve as compared to FIFO Inventory. If price is falling, I will choose C. Nothing to do with LIFO COGS as LIFO is a good measure of COGS.
to arrive at FIFO EI – always add LIFO Reserve Whether Prices are falling or increasing, LIFO EI must be adjusted to arrive at the FIFO EI by adding the LIFO Reserve End. Other key formulae: COGS(F) = COGS (L) - Delta LIFO Reserve NI (F) = NI (L) + Delta Lifo Reserve * (1-T) RE (F) = RE (L) + Lifo Reserve End * (1-T) where T = Tax Rate. NI = Net Income RE = Retained Earnings.
I think this is some sort of wordy, trick question. I got it right out of a sample exam. The anser is D: subtract from COGS. I guess it makes sense because an increase in the LIFO reserve would be subtracted from COGS to equal COGS on a FIFO basis.
deleted… It says Increase in LIFO Reserve for the year… so subtract from COGS is correct.
The increase in the LIFO Reserve is an indicator that inventory replacement costs were rising. A) To compare ABC’s inventory balance to that of its FIFO competitors, we would add the entire LIFO Reserve to ABC’s inventory balance, not just the increase in the LIFO Reserve. B) COGS are already higher under LIFO in this situation (and a better indicator of current replacement costs, as is always the case with LIFO). Adding the change in the LIFO reserve to COGS would double-count the increase of replacement costs, depressing gross margins further, making ABC even less comparable to its FIFO peers, and add no analytical value. C) LIFO inventory balance under this situation (rising prices) is already understated. Subtracting the increase in the LIFO Reserve makes ABC’s inventory balance even less comparable to its FIFO peers. D) ABC’s FIFO peers are enjoying higher gross profits during this situation of rising prices. In order to compare gross profits between the firms, we should decrease ABC’s COGS by the increase in the LIFO Reserve, which removes the impact of rising inventory prices for this reporting period and helps us compare ABC’s profitability to its peer group.
to hiredguns1- You’re the man, thanks for the detailed response.
Just got done studying this stuff. An increase in the LIFO reserve is the LIFO Effect, hence we’re talking of a change. With only this factor, COGS(FIFO) = COGS(LIFO) - LIFO Effect Hence we subtract the change. In order to translate Inventory(LIFO) to Inventory(FIFO), we must add the entire LIFO Reserve. But we’re only given the LIFO Effect.