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Wednesday, October 16, 2024

Accounting: The Language of Business - Vol. 2 (Intermediate: Part 167)


Proverbs 28:20
"He who hastens to be rich will not go unpunished".

 Short-Term Operating Assets: Inventory (Part M)

by

Charles Lamson 



LIFO Liquidations 


If costs are declining, using LIFO will result in lower cost of goods sold and thus higher net income when compared to FIFO. If inventory unit levels are decreasing and costs are Increasing, then using LIFO may also result in higher net income than FIFO. 


As a company uses LIFO over time, it builds LIFO layers, which are annual increases in the quantity of inventory. When inventory levels decline under the LIFO method and costs are increasing, the company sells older low-cost LIFO layers, reducing cost of goods sold and increasing book (and taxable) income. A decrease in inventory layers under the LIFO method is called a LIFO liquidation and is Illustrated in Example 10.11. Recall that companies choose LIFO to lower their tax bills. Because of the possibility that a LIFO liquidation decreases cost of goods sold and increases taxable income, companies seek to avoid liquidating their LIFO layers. (All LIFO liquidation will not always result in an increase to net income.) For example, Deere & Company, The agriculture and construction equipment company, reported a favorable pre-tax income effect from the liquidation of LIFO inventory during 2016 and 2015 of approximately $4 million and $22 million, respectively. For Deere, the LIFO liquidations were less than a 1% increase in pre-tax income. EXHIBIT 10.7 presents the disclosure that Caterpillar Inc., another leading manufacturer of construction and mining equipment, provided in its 2013 10K, related to a larger LIFO liquidation that resulted in an increase in net income of 12 cents per share or about 2.1%.






*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 528-529*


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Wednesday, October 2, 2024

Accounting: The Language of Business - Vol. 2 (Intermediate: Part 166)


Hebrews 13:5

Keep your lives free from the love of money and be content with what you have, because God has said, “Never will I leave you; never will I forsake you.”


Short-Term Operating Assets: Inventory (Part L)

by

Charles Lamson



The Last-In, First-Out, (LIFO) Cost-Flow Assumption in Detail


The next few parts discuss the issues encountered when using the LIFO method in practice. 



The LIFO Reserve and LIFO Effect


Inventory management is important to the operations of a firm, and LIFO does not provide a conceptually sound cost-flow approach to measuring inventory for most companies. Consequently, a firm that reports externally on the LIFO basis will often measure inventory on its trial balance for internal records on another basis, such as FIFO. If costs are increasing, the firm will then use an allowance account, refered to as the LIFO reserve, to reduce the inventory to the measurement under LIFO. The balance in the LIFO reserve account is the difference between the inventory measured using FIFO and LIFO. The footnotes to the financial statements disclose the LIFO reserve. Example 10.10 illustrates the conversion from FIFO to LIFO. 



In the process of recording the LIFO reserve account adjustment, the company will also adjust the cost of goods sold account As shown in Example 10.10, the income statement adjustment in the LIFO reserve account is referred to as the LIFO effect, which is the change in the LIFO reserve account during the year and its impact on cost of goods sold. 



*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 526-528*


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