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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