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. Investing

### 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.
2. Investing

### Inventory: FIFO, LIFO

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

### 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.
4. Taxes

### Using Tax Lots: A Way To Minimize Taxes

The method of identifying cost basis can help you to get the most out of reduced tax rates.
5. Insights

### What You Should Know About Inflation

Find out how this figure relates to your investment portfolio.
6. Investing

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 ...
7. Investing

### Operating Income

Amount of profit realized from a business's operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation.
8. Investing

### How to Calculate Average Inventory

Average inventory is the median value of an inventory at a specific time period.
9. Investing

### Explaining Carrying Cost of Inventory

The carrying cost of inventory is the cost a business pays for holding goods in stock.