BUS103: Introduction to Financial Accounting

LEARNING OBJECTIVES

Explain how the LIFO reserve is calculated and how to report it on the financial statements

KEY TAKEAWAYS
Key Points

• The difference between the cost of an inventory calculated under the FIFO and LIFO methods is called the LIFO reserve. This reserve is essentially the amount by which an entity's taxable income has been deferred by using the LIFO method.
• When dealing with valuing a company using ratios, one must also convert all numbers to FIFO method for easy comparison. This means that, for example, when calculating the current ratio, the LIFO reserve should be added back into the numerator of the equation, resulting in a FIFO inventory.
• The SEC requires that all registered companies that use LIFO report their LIFO reserves for the start and end of the year. A company can always convert from LIFO to FIFO, which is important if you are trying to compare companies when they use different accounting methods.

Key Terms

• FIFO: First in, first out (accounting).
• LIFO reserve: The amount by which an entity's taxable income has been deferred by using the LIFO method.LIFO Reserve = FIFO Valuation – LIFO Valuation
• LIFO: Last-in, first-out (accounting).