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 

Examples: 

LIFO liquidation:

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