CFA CFA Level 2 LIFO Reserve Adjustments

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• 4

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.

Now what I memorized, but never understood, was why you add the change in the LIFO reserve to COGS to convert LIFO COGS to FIFO COGS.

Can anyone explain?

• 5

It’s to do with the differences in LIFO vs FIFO – best way is to run through an example. The ‘subtract change in LIFO reserve’ method is a simplification of the total calculations needed, as elaborated below.

Example:

Company ABC uses LIFO.

Year-end inventory = \$2m
Beginning inventory = \$3m
LIFO reserve at year-end = \$1m
LIFO reserve at the beginning of the years = \$500,000
COSG = \$5m

Simple way to convert LIFO to FIFO

COGS (FIFO) = COGS (LIFO) – change in LIFO reserve
COGS (FIFO) = \$5m – (\$1m – \$0.5m) = \$4.5m

Complex way

Purchases = ending inventory – beginning inventory + COGS (LIFO)
Purchases = \$2m – 3m + \$5m = \$4m

Ending inventory (FIFO) = ending inventory (LIFO) + ending period LIFO reserve
Ending inventory (FIFO) = \$2m + \$1m = \$3m

Beginning inventory (FIFO) = beginning inventory (LIFO) + beginning LIFO reserve
Beginning inventory (FIFO) = \$3m + \$0.5m = \$3.5m

COGS (FIFO) = purchases + beginning inventory (FIFO) – ending inventory (FIFO)
COGS (FIFO) = \$4m + \$3.5m – \$3m = \$4.5m

• 5

Ahhhh, that is a brilliant way of explaining it. And just as a sanity check, purchases under LIFO and FIFO are the same correct?

Thanks so much, this is definitely going into my revision notes for this section.

• 3

Hey all,

I wanted to get the LIFO reserve formulas all in one place bc the text doesn’t and they trip you up every time they can w the EOC Q’s.

Here are all of them and I’ll question some of them.

COGS FIFO = COGS LIFO – â†‘ reserve – charges incl. in COGS for inventory write-downs (charges)

INV FIFO = gross INV LIFO + reserve

NI F = NI L + â†‘ reserve – (â†‘ reserve X T) + charges

CFO F = CFO L – â†‘ reserve X T

Q: Would all the figures get that damn “charges” figure to deal with? (If you don’t know what I’m talking abt, you can look at the LIFO reserve EOC Q’s to get majorly frustrated.)

Retained Earnings/Equity/”profit retained in business” F = RE L + reserve x (1-T)
Q: Is this accurate? I see conflicting formulas in the CFAI curriculum vs. the EOC.

Cumulative taxes F = cum. T L + (beg. reserve x beg. tax) + (â†‘ reserve x new tax)
Q: Is that for regular “yearly” taxes? I see Taxes F = T F + (â†‘ reserve x T)

Cash F = cash L – â†‘ reserve x T
Q: All of these are the same Q: is yearly taxes or cumulative taxes the # we’re supposed to use? I saw CFAI do it w cumulative taxes.

Thank you much. Hope this helped.

• 2

Sorry, I think I messed up that last part. It should be:

Why do you subtract the year over year change in the LIFO reserve from COGS when converting from LIFO COGS to FIFO COGS?

• 1

In my attempts to understand it earlier, I had forgotten one key point: the balance sheet (inventory) is a point-in-time statement, whereas the income statement (COGS) reflects a particular period of time. So ending inventory will reflect the accumulation of all LIFO reserve adjustments up to that point, whereas COGS only reflects the LIFO reserve adjustment for the current period (hence the subtraction of the change in LIFO reserve).