LIFO liquidation

  • LIFO Liquidation (13)
    • Sells (or issues) the old stock of merchandise (or raw materials) inventory. It occurs when a company using LIFO method sells (or issues) more than it purchases.
    • Occurs when a LIFO firm’s inventory quantities decline
      • Older/Lower cost are included in COGS → higher profit margin 
    • LIFO reserve = FIFO inventory – LIFO inventory, typically >0
      • Reduced when 
        • A firm is liquidating its inventory 
        • Prices are falling
      • Equal to 0 if all inventories are sold
    • Result in higher profit margin and higher income taxes compared to what they would be if inventory quantities were not declining 
    • Increase in profit margins from LIFO liquidation are not sustainable
      • Could use a LIFO liquidation to artificially inflate period earnings
    • Can be caused by events outside management’s control
      • Strikes/Materials shortage at key supplier
      • Decline in expected customer orders → voluntary reduction in inventory
    • LIFO reserve disclosures in the footnotes
    • LIFO liquidation 
      • decrease in COGS → increase gross profits → increase pretax income → increase net income
      • Decreased cash expenses → increase operating cash flow
  • In absence of strike, no inventory liquidation, ending inventory is calculated based on older price → lower
  •  With inventory liquidation → ending inventory is calculated based on the most recent price 


LIFO liquidation: