LIFO Reserve, COGS and LIFO Liquidation

[ajm036]

Hi All,
Have a question that I’m reasonably certain I’m making more complicated than it need be…but probably just need some clarity.
Schweser Mock, Volume 1, Morning Session Exam 1, Question 8:
Basically they are restating a company’s statements from LIFO to FIFO. and during the year the LIFO reserve decreased by 7 (was 35, went to 28). The question is “If Rawsfield (the analyst) restates GNNY’s (LIFO) accounts using TBBB’s (FIFO) inventory accounting method, GNNY’s (LIFO) net profit margin for the year is most likely to:”
Answer: DECREASE
I get that FIFO COGS = LIFO COGS - (Change in LIFO Reserve)…so that a decrease in the reserve will increase FIFO COGS…but here is where I am getting tripped up. Isn’t decrease in the LIFO reserve the same thing as a LIFO liquidation? If so, aren’t LIFO liquidations supposed to boost profits during the year they occur? Because they’re selling old, cheap inventory? Probably thinking about this the wrong way, but any help would be appreciated!

 

[Harrogath]

Are you sure the company is in an inflationary enviroment? If yes, your statement is correct and the test has a mistake. If the company is in a deflationary enviroment, then the net profit margin would decrease as the test says.

 

[fr_clem]

LIFO liquidation = decrease in LIFO reserve (a LIFO liquidation occurs when a LIFO-reporting firm sells more stock than it buys => stock decreases and LIFO reserve decreases).
While in general LIFO implies a higher COGS than FIFO (since FIFO COGS = LIFO COGS - Change in LIFO reserve), the LIFO COGS is lower than the FIFO COGS in case of inventory liquidation (when the change in LIFO reserve in negative).
So in this specific case, restating from LIFO to FIFO will increase the COGS, resulting in lower profits. The answer is correct.

 

[S2000magician]

fr_clem wrote:LIFO liquidation = decrease in LIFO reserve (a LIFO liquidation occurs when a LIFO-reporting firm sells more stock than it buys => stock decreases and LIFO reserve decreases).

Although under normal curcumstances – historically rising costs – a LIFO liquidation will result in a decrease in the LIFO reserve, this isn’t always the case. If costs have been falling, the LIFO reserve may, in fact, be negative, so a LIFO liquidation would result in an increase in the LIFO reserve.
A better way of stating it is that in a LIFO liquidation, the LIFO reserve will move toward zero. If it’s positive (the usual situation), it will decrease; if it’s negative (rare, but not impossible), it will increase.

 

[Chirantana]

Since change in LIFO reserve is negative , that means COGS has been decreased over a period of time This means COGS for fifo> lifo. Result to low NI thus NPM