(An Issue Related to LIFO
Inventory Valuation Method):
Learning objectives of this article:
Define and explain the terms "LIFO reserve and
Definition of LIFO Reserve:
difference between the inventory method used for
internal reporting purposes and LIFO is called "LIFO
reserve" or "allowance to reduce inventory to
Normally more than inventory methods are used by
companies. Many companies use LIFO for tax and
external reporting purposes but maintain a FIFO,
average cost, or standard cost system for internal
reporting purposes. There are several reasons to do
so. These reasons are as follows:
Companies often base their pricing decisions on
a FIFO, average or standard cost assumptions,
rather than on a FIFO basis.
keeping on some other basis is easier because the
LIFO assumption usually does not approximate the
physical flow on the product.
sharing and other bonus arrangements are often on
LIFO inventory assumption.
The use of
a pure LIFO system is troublesome for interim periods,
for which estimates must be made of years-end quantities
between the inventory method used for internal reporting
purposes and LIFO is referred to as the allowance to reduce
inventory to LIFO or LIFO reserve. The change in the
allowance from one period to the next is called the LIFO
effect is the adjustment that must be made to the accounting
records in a given year.
uses the FIFO method for internal reporting purposes and
LIFO for external reporting purposes. At January 1, 2011 the
allowance to reduce inventory to LIFO balance was $20,000,
and the ending balance should be $50,000. The LIFO effect is
therefore $30,000, and the following entry is made at
|Cost of goods
to reduce inventory to LIFO
allowance to reduce inventory to LIFO would be deducted
from inventory to ensure that the inventory is stated on
a LIFO basis at year-end.