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. Professionals

    Converting FIFO to LIFO

    CFA Level 1 - Converting FIFO to LIFO. Learn how to both FIFO and the average-cost method to LIFO. Provides formulas showing how both conversions affects COGS.
  2. Professionals

    Causes of Decline in LIFO Reserve

    CFA Level 1 - Causes of Decline in LIFO Reserve. Learn why a company's LIFO reserves might decline. Describes "LIFO liquidation" and its effects on profitability and COGS.
  3. Fundamental Analysis

    Why Last In First Out Is Banned Under IFRS (XOM)

    We explain why Last-In-First-Out is banned under IFRS
  4. Professionals

    LIFO and FIFO Valuation of Inventory

    LIFO and FIFO Valuation of Inventory
  5. Professionals

    Inventory Analysis

    CFA Level 1 - Inventory Analysis. Learn how to calculate ending inventory balances and how unstable price environments cause costing methods to yield different results.
  6. Fundamental Analysis

    When & Why Should a Company Use LIFO

    By using LIFO (last in, first out) when prices are rising, companies reduce their taxes and also better match revenues to their latest costs.
  7. Professionals

    Effects of Misstated Inventory

    CFA Level 1 - Effects of Misstated Inventory. Learn the effects of overstating or understating inventory for each of the four inventory costing methods.
  8. 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.
  9. Fundamental Analysis

    Inventory: FIFO, LIFO

    Whether a company chooses FIFO or LIFO has important implications for the bottom line and for tax liability.
  10. Professionals

    Effects of Inventory Accounting

    CFA Level 1 - Effects of Inventory Accounting. Learn how a company's accounting choice affects their income, cash flow, balance sheet and various financial ratios.
RELATED TERMS
  1. LIFO Reserve

    The difference between the FIFO and LIFO cost of inventory for ...
  2. LIFO Liquidation

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

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

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

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

    An accounting buzzword that describe when companies still have ...
RELATED FAQS
  1. What are the business consequences of using FIFO vs. LIFO accounting methods?

    Learn about the real business consequences from using a first-in, first out inventory accounting method versus a last-in, ... Read Answer >>
  2. Does US GAAP prefer FIFO or LIFO accounting?

    Investigate the use of LIFO and FIFO inventory accounting methods under U.S. GAAP, and learn why there is pressure from some ... Read Answer >>
  3. What are the disadvantages of the FIFO accounting method?

    Learn how the FIFO accounting method differs from the LIFO method and the primary disadvantages for a company using the FIFO ... Read Answer >>
  4. 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 >>
  5. 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 >>
  6. How do I calculate cost of goods sold (COGS) using the first in, first out (FIFO) ...

    Learn how to use the first in, first out, or FIFO, method of cost flow assumption to calculate the cost of goods sold, or ... Read Answer >>
Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  3. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  4. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  5. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
Trading Center