I’m slightly confused here because my brain has turned to mush lately.
Balance sheet
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If the company uses LIFO, we want to convert this to FIFO because FIFO’s inventory values are more current. so FIFO = LIFO Inventory + ending LIFO Reserve
This is an increase in current assets, to balance this, we’ll increase equity by the same amount (according to Schweser page 261).
Income statement
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If the company used LIFO, the COGS should reflect the most recent costs. There should be no adjustment here.
Now, if there is a decline in LIFO reserve due to LIFO liquidation, the true current value of the COGS isn’t reflected correctly in the income statement expense since we have dipped into older cheaper inventory. This isn’t sustainable as the firm will eventually have to incur the current cost of inventory for replenishment.
COGS will be lower than what it should be.
On a side note:
We know that COGS LIFO = FIFO COGS + change in LIFO reserve.
If I was to convert COGS LIFO to COGS FIFO, then I understand that my gross profit would increase by a _change_ in LIFO reserve.
Increase in net income would be _change_ in LIFO reserve * (1 - tax rate)
Added income tax expense would be _change_ in LIFO reserve * tax rate
deferred tax liabilities will increase by _ending_ LIFO reserve * tax rate <— I still don’t know why this is the case. I always thought it would be a change in LIFO reserve * tax rate, since this is the extra tax that isn’t paid
and retained earnings will increase by ending LIFO reserve*(1-tax rate) <— Again, don’t know why it’s ending
My question is, when do we want to make this adjustment? And does that adjustment to equity conflict with Schweser (that says to add the full amount of equity?) Is it because they assume that the DTL will not be paid, so we make a direct adjustment to equity? How do we reverse the effect of LIFO liquidation? sorry for all the questions…
