What needed to happen in order for a LIFO liquidation to occur?
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Sorry to resuscitate the discussion, but I agree with the original comment that LIFO-Reserves do not decrease due to LIFO liquidation. In fact, there are only two instances when LIFO-Reserves decrease: Show (1) in a deflationary environment — a less typical situation — and Let’s look at the math: From the definition of LIFO-Reserve: LIFO-Reserve = FIFO-Inventory – LIFO-Inventory so that Change in LIFO-Reserve = Change in FIFO-Inventory – Change in LIFO-Inventory But each change in inventory is given by: Change in FIFO-Inventory = Units purchased * Current Cost of Purchase – Units sold * FIFO-COGS where COGS is “cost of goods sold per unit”. Substituting: Change in LIFO-Reserve = Units sold * (LIFO-COGS – FIFO-COGS) This amount is always positive in an inflationary environment and always negative in a deflationary environment, which covers case (1) above. Note that the change in inventory units (units purchased – units sold) will not affect the sign of the change in LIFO-Reserve. So what is a LIFO liquidation? A LIFO liquidation is NOT (and it does not cause) a decrease in LIFO-Reserve. A LIFO liquidation is a decrease in inventory units (when one is using the LIFO method), in other words, it’s the result of “burning” old inventory which was bought at prices lower than current prices (in the typical inflationary environment) but still higher than the costs accounted under FIFO. In an inflationary environment, a LIFO liquidation causes a smaller increase in the LIFO-Reserve than what would have been if instead the inventory units had not decreased during the period (that is, the company had produced at least the same amount that it sold during the period). In the less typical deflationary environment, it causes a smaller decrease in the LIFO-Reserve than what would have been otherwise. So instead of looking for a decrease in LIFO-Reserve in order to find the possibility of earnings management, one needs to look for small increases in LIFO-Reserve, since that is what characterizes a LIFO liquidation. 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During inflationary periods, a company that allows this liquidation to occur will have to pay higher federal income taxes.
How can LIFO liquidation be prevented?LIFO liquidations provide a certain risk for inventory concept as it may affect negatively to first in inventory. A company can be avoided LIFO liquidations by combining similar goods for sale out. Further, this combination of goods is termed the LIFO pool approach.
How does LIFO liquidation affect LIFO reserve?In an inflationary environment, a LIFO liquidation causes a smaller increase in the LIFO-Reserve than what would have been if instead the inventory units had not decreased during the period (that is, the company had produced at least the same amount that it sold during the period).
What is the rule of LIFO?Last in, first out (LIFO) is a method used to account for inventory. Under LIFO, the costs of the most recent products purchased (or produced) are the first to be expensed. LIFO is used only in the United States and governed by the generally accepted accounting principles (GAAP).
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