Assets - Converting LIFO to FIFO

To make the conversion possible, U.S. GAAP requires companies that use LIFO to report a LIFO reserve (found in footnotes). The LIFO reserve is the difference between what their ending inventory would have been if they used FIFO.

Formula 8.2

LIFO reserve = FIFO inventory - LIFO inventory

Or

FIFO inventory = LIFO inventory + LIFO reserve

Recall:

COGS = beginning inventory + purchases - ending inventory

Or

COGS = change in inventory levels

So:

Formula 8.3

COGS (FIFO) = COGS (LIFO) - change in LIFO reserve
Or

COGS (FIFO) = COGS (LIFO) - (LIFO reserve at the end of the period - LIFO reserve at the beginning of the period)

Long Conversion
A longer way to convert LIFO to FIFO is to calculate purchases, convert both beginning and ending inventory to FIFO levels, and then calculate COGS using the FIFO inventory levels and purchases.

COGS = beginning inventory + purchases - ending inventory

Rearrange the terms:

Purchases = ending inventory - beginning inventory + COGS (LIFO)

We also know that:

Ending inventory (FIFO) = Ending inventory (LIFO) + ending period LIFO reserve

Beginning inventory (FIFO) = Beginning inventory (LIFO) + Beginning LIFO reserve

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

To make the two companies comparable, we need to do some additional adjustments.

  • Under different methods COGS will vary and as a result net income should be adjusted.
  • If COGS under the LIFO was higher than the COGS under the FIFO method:
    • That would mean this company would have used the FIFO method, it would have declared a higher gross profit and hence a higher net income. But it would have also had to pay higher taxes and reduce its cash flow. A simple way to account for that is to take the positive difference in COGS and multiply it by (1-tax rate).
    • This difference would also be included in shareholders' equity.
    • The additional tax would be recorded in income tax liability.
  • If COGS under the LIFO was lower than the COGS under the FIFO method:
    • That would mean this company would have used the FIFO method, it would have declared a lower gross profit and hence lower net income. But it would have also had to pay lower taxes and increase its cash flow. A simple way to account for that is to take the negative difference in COGS, divide the COGS by (1-tax rate).
    • This difference would also be included in shareholders' equity.
    • The additional tax would be recorded in income tax asset.
Converting FIFO to LIFO


Related Articles
  1. Fundamental Analysis

    Inventory Valuation For Investors: FIFO And LIFO

    We go over these methods of calculating this component of the balance sheet, and how the choice affects the bottom line.
  2. Fundamental Analysis

    Inventory: FIFO, LIFO

    Whether a company chooses FIFO or LIFO has important implications for the bottom line and for tax liability.
  3. Options & Futures

    Financial Statements: Working Capital

    By David Harper (Contact David)A recurring theme in this series is the importance of investors shaping their analytical focus according to companies' business models. Especially when time is ...
  4. Investing Basics

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  5. Economics

    International Financial Reporting Standards

    Learn about the purpose of the IFRS, as well as its benefits, goals and fundamental difference from the U.S. GAAP.
  6. Investing

    Days Sales of Inventory

    Days Sales of Inventory, also called Days Inventory Outstanding, is a key financial measurement of a company's performance pertaining to inventory management. In simple terms, it tells how many ...
  7. Economics

    What You Should Know About Inflation

    Find out how this figure relates to your investment portfolio.
  8. Fundamental Analysis

    Reading The Inventory Turnover

    Inventory turnover is a ratio that shows how quickly a company uses up its supply of goods over a given time frame. Inventory turnover may be calculated as the market value of sales divided by ...
  9. Economics

    How to Calculate Average Inventory

    Average inventory is the median value of an inventory at a specific time period.
  10. Economics

    What is Involved in Inventory Management?

    Inventory management refers to the theories, functions and management skills involved in controlling an inventory.
RELATED TERMS
  1. LIFO Liquidation

    When a company using the LIFO (Last In, First Out) method of ...
  2. Dollar-Value LIFO

    An accounting method used for inventory that follows the last ...
  3. Flow Of Costs

    Refers to the manner in which costs move through a firm. Typically, ...
  4. Last In, First Out - LIFO

    An asset-management and valuation method that assumes that assets ...
  5. First In, Still Here - FISH

    An accounting buzzword that describe when companies still have ...
  6. Lot Relief Method

    A method of computing the cost basis of an asset that is sold ...
RELATED FAQS
  1. If during a period of rising prices, a LIFO liquidation occurs ...

    The correct answer is: b) Remember that LIFO transmits the latest prices of inventory over to cost. Therefore, what's left ... Read Answer >>
  2. How can the first-in, first-out (FIFO) method be used to minimize taxes?

    Understand what the FIFO inventory method is and how it can be used to minimize taxes. Learn why it would also decrease overall ... Read Answer >>
  3. What are some examples of industries that cannot claim cost of goods sold (COGS)?

    Discover which types of businesses are not allowed to list cost of goods sold on their income statement or claim their COGS ... Read Answer >>
  4. How does inventory accounting differ between GAAP and IFRS?

    Learn about inventory costing differences between generally accepted accounting principles, or GAAP, and International Financial ... Read Answer >>
  5. What is the formula for calculating inventory turnover?

    Learn about the inventory turnover ratio, how it is calculated and what this efficiency metric tells businesses about their ... Read Answer >>
  6. What qualifies as "goods" in cost of goods sold (COGS)?

    Learn what qualifies as "goods" in cost of goods sold, or COGS, so you can keep an accurate record for your business' income ... Read Answer >>
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center