LIFO reserve conversion
A company reports LIFO inventory of $800,000 and a LIFO reserve of $200,000. What inventory would it report under FIFO?
Solution: FIFO inventory = LIFO inventory + LIFO reserve = $800,000 + $200,000 = $1,000,000.
In rising prices, FIFO produces lower COGS, higher ending inventory, higher profit, and usually higher taxes than LIFO. To compare a LIFO reporter with FIFO peers, add the LIFO reserve to inventory and subtract the change in the reserve from LIFO COGS.
5
Concepts
4
Formulas
1
Decisions
4
Quiz Questions
Analysis of inventories tests how cost flow assumptions and write-down rules affect profit, assets, taxes, cash flow, and ratios. Focus on the direction of each effect, then use the LIFO reserve formulas to restate a US GAAP LIFO reporter to a FIFO basis.
Go to the CFA Level 1 Financial Statement Analysis hub| Topic | Formula or rule | CFA Level 1 exam angle | Interpretation |
|---|---|---|---|
| FIFO in rising prices | Oldest costs flow to COGS first | Reports lower COGS, higher net income, higher inventory, and higher taxes. | Balance sheet inventory is closer to current replacement cost. |
| LIFO in rising prices | Newest costs flow to COGS first | Reports higher COGS, lower net income, lower inventory, and tax savings under US GAAP. | Income can be conservative, but inventory may be understated. |
| LIFO reserve | FIFO Inventory = LIFO Inventory + LIFO Reserve | Used to restate a LIFO company to FIFO for cross-company comparison. | A rising reserve usually means FIFO inventory exceeds LIFO inventory by more over time. |
| Inventory turnover | COGS / Average Inventory | Measures how quickly inventory is sold or used in production. | Higher turnover can signal efficiency, but very high turnover can also signal stockout risk. |
| Days of inventory | 365 / Inventory Turnover | Converts turnover into the average number of days inventory is held. | Lower days is usually faster conversion, but context matters by industry. |
A company reports LIFO inventory of $800,000 and a LIFO reserve of $200,000. What inventory would it report under FIFO?
Solution: FIFO inventory = LIFO inventory + LIFO reserve = $800,000 + $200,000 = $1,000,000.
A company buys 100 units at $10 and then 100 units at $12. It sells 120 units. Compare periodic FIFO and LIFO COGS and ending inventory.
Solution: FIFO COGS = (100 × $10) + (20 × $12) = $1,240; ending inventory = 80 × $12 = $960. LIFO COGS = 120 × $12 = $1,440; ending inventory = 80 × $10 = $800. FIFO therefore reports $200 lower COGS and $160 higher ending inventory in this simplified example.
Inventory turnover equals cost of goods sold divided by average inventory. Higher turnover can indicate faster inventory movement, but compare it with industry norms and check whether stockouts are suppressing inventory.
Do not reverse the rising-price effects, forget to subtract the change in the LIFO reserve from LIFO COGS, or apply LIFO under IFRS. A LIFO liquidation can release older low costs into COGS and temporarily inflate profit.
IFRS prohibits LIFO and permits reversal of qualifying inventory write-downs when net realizable value recovers. US GAAP permits LIFO but generally does not reverse inventory write-downs.
A US GAAP company reports LIFO inventory of $480 million, a year-end LIFO reserve of $70 million, LIFO COGS of $320 million, and a $10 million increase in the LIFO reserve. What are FIFO inventory and FIFO COGS?
B is correct. FIFO inventory = $480m + $70m = $550m. FIFO COGS = $320m − $10m = $310m. The reserve is added to inventory, while the increase in the reserve is subtracted from LIFO COGS.
5 concepts covered in this module.
First In, First Out. Ending inventory reflects recent costs (closer to replacement cost). In rising prices: higher income, higher inventory.
Last In, First Out (US GAAP only). COGS reflects recent costs. In rising prices: lower income (tax savings), lower inventory, better cash flow.
The complete set of concepts for this module lives in the study dashboard, alongside flashcards, quizzes, mind maps and progress tracking.
4 essential formulas for this module.
Where: To make LIFO companies comparable to FIFO
Where: Δ = change in LIFO reserve during period
The complete set of formulas for this module lives in the study dashboard, alongside flashcards, quizzes, mind maps and progress tracking.
1 decision frameworks to guide your analysis.
Visual overview of how concepts connect in this module.
See the full mind map in the study dashboard
The interactive mind map for this module lives in the study dashboard, alongside flashcards, quizzes and progress tracking.
Try 5 sample flashcards and one quiz question here for free. This module's full flashcard deck and quiz live on the study dashboard.
No signup needed to look around. Create a free account to save your progress.
Try it right here
FIFO
Tap to reveal the answer