Accounting Chapter 8: LIFO Reserve

Questions and Answers

What do companies use LIFO for?

Many companies use LIFO for tax and external reporting.

What do companies use FIFO for?

FIFO is used for internal reporting, recordkeeping, pricing decisions, and profit sharing arrangements.

What is a LIFO Reserve?

The LIFO Reserve is the difference between the inventory method used for internal reporting purposes and LIFO.

What is LIFO Liquidations?

LIFO Liquidations occur when older, low-cost inventory is sold, resulting in lower COGS, higher net income, and higher taxes. Signup and view all the answers

What is Specific Goods LIFO?

Specific Goods LIFO is an approach to costing goods on a unit basis. Signup and view all the answers

What is Specific Goods Pooled LIFO Approach?

It reduces recordkeeping and clerical costs, but can lead to untimely LIFO liquidations. Signup and view all the answers

What is Dollar Value LIFO?

Dollar Value LIFO pools dollar values instead of tracking individual items. Signup and view all the answers

Under what method are profits highest?

FIFO. Signup and view all the answers

Under what method are profits lowest?

LIFO. Signup and view all the answers

Under what method is midrange profit?

Average. Signup and view all the answers

Study Notes

LIFO and FIFO Inventory Methods

LIFO (Last In, First Out) is primarily utilized for tax purposes and external financial reporting.
FIFO (First In, First Out) is favored for internal reporting, enhancing recordkeeping, pricing decisions, and profit-sharing arrangements.

LIFO Reserve

Represents the difference between the inventory method for internal purposes and LIFO, also known as the Allowance to Reduce Inventory to LIFO.
Adjusted annually, reported as a contra asset account on the Balance Sheet.
With rising costs, LIFO reserve shows a credit balance, resulting in lower reported costs in inventory (LIFO Inventory + LIFO Reserve = FIFO Inventory).

Cost of Goods Sold (COGS)

An increase in the LIFO reserve requires an addition to the COGS account for accurate income statement reporting.

LIFO Liquidations

Aims to align current costs with revenues; selling older, lower-cost inventory leads to reduced COGS, increased net income, and higher tax liabilities.
More frequent LIFO liquidations can distort net income, necessitating disclosure if significant increases occur.

Specific Goods LIFO

Involves costing goods on an individual unit basis, which is time-consuming and costly.

Specific Goods Pooled LIFO Approach

Lowers recordkeeping and clerical expenses, making it more challenging to erode inventory layers.
Uses quantities as a measurement approach, which can cause untimely liquidations.

Dollar Value LIFO

The most prevalent LIFO method, pooling inventory values instead of tracking individual items.
Measures inventory changes in total dollar values, using price indexes to adjust for current and base year costs.
The formula for the Price Index helps in determining the valuation adjustments.
Popular price index includes CPI-U; companies may use external or internally generated indexes.

Profit Comparisons

FIFO results in the highest reported profits.
LIFO leads to the lowest profits reported.
Average cost method yields mid-range profits.

Description

Explore the concepts of LIFO and FIFO inventory methods with this engaging flashcard quiz. Understand how companies use these methods for tax reporting and the importance of the LIFO reserve. Test your knowledge on key definitions and differences between these inventory strategies.