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%.

Source: Caterpillar Inc, Annual 10K Report, December 31, 2013

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

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