LIFO Reserve

What is a LIFO Reserve?

The LIFO reserve is an account used to reconcile the difference between the FIFO and LIFO methods of inventory valuation, when a business is using the FIFO method as part of its accounting system but is using the LIFO method to report in its financial statements.

Under the FIFO inventory method (first items in are first out), the inventory at the end of a period contains the items brought into stock last, under the LIFO inventory method (last items in are first out) the inventory at the end of the period contains the items brought into stock first. Assuming prices are increasing, the FIFO valuation of inventory will therefore be greater than the LIFO valuation.

In these circumstances, to reduce the FIFO value of inventory to the LIFO value, the LIFO reserve needs to be a credit entry. This credit balance is then offset against the FIFO inventory valuation resulting in a net balance representing the LIFO valuation. The LIFO reserve account is therefore used as a contra inventory account or more generally a contra asset account.

LIFO Reserve reconciles FIFO and LIFO
FIFO cost
LIFO cost LIFO reserve
How to Calculate LIFO Reserve

The balance on the LIFO reserve will represent the difference between the FIFO and LIFO inventory amounts since the business first started using the LIFO inventory method.

The LIFO reserve formula can be stated as follows:

LIFO reserve = FIFO inventory cost – LIFO inventory cost

and

The change in the LIFO reserve for an accounting period reflects the difference between the change in the FIFO inventory and the change in the LIFO inventory as a result of inflation, and is referred to as the LIFO effect.

LIFO Effect = LIFO reserve movement = Change in FIFO inventory – Change in LIFO inventory

As the change in inventory is a component of the cost of goods sold, the other side of the double entry posting would be to the cost of goods old account.

The double entry bookkeeping entry to record the LIFO reserve adjustment would be as follows:

LIFO Reserve Account Adjustment
Account Debit Credit
Cost of goods sold XXX
LIFO reserve account XXX

The entry effectively increases the cost of goods sold, as under the LIFO method the most recent (and therefore higher cost) items are sold first.

LIFO Reserve Example

Suppose a business has a LIFO inventory reserve at the beginning of the year of £2,000, and at the end of the year the FIFO inventory valuation was £40,000 and the LIFO valuation was £35,000. The LIFO reserve at the end of the year is given by

LIFO reserve = FIFO inventory cost – LIFO inventory cost
LIFO reserve = 40,000 – 35,000 = 5,000

As the opening LIFO inventory reserve was £2,000, the adjustment to the reserve, and the LIFO effect is £5,000 – £2,000 = £3,000, and the double entry bookkeeping entry to record the adjustment would be

LIFO Reserve Account Example
Account Debit Credit
Cost of goods sold 3,000
LIFO reserve account 3,000

The LIFO reserve is sometimes referred to as excess of FIFO over LIFO cost, LIFO allowance, or revaluation to LIFO.

Last modified November 6th, 2016 by Team

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