Adjust the financial statements of LIFO firms to compare with FIFO firms:
- LIFO inventory < FIFO inventory
- LIFO COGS > FIFO COGS
- LIFO net income < FIFO net income
- LIFO tax < FIFO tax
LIFO reserve (12)
- Amount by which LIFO inventory is less than FIFO inventory when price increase
- Make financial statement prepared under LIFO comparable to those of FIFO firms
- Add LIFO reserve to LIFO inventory in BS
- Increase retained earnings by LIFO reserve
- Tax:
- Cash:= – tax rate * LIFO reserve
- Retained earnings:= + (1-tax rate) * LIFO reserve
- Cash under LIFO and FIFO are the same
- Convert LIFO’s COGS to FIFO COGS
- Note that purchase in the two LIFO and FIFO are the same
- Effects on Ratios
- Profitability
- LIFO produce higher COGS → lower earnings
- Liquidity
- LIFO results in lower inventory → Lower asset → lower current ratio → lower liquidity
- Current ratio: ability of the firm to pay short term debt
- Profitability
- Activity
- Inventory turnover (COGS/average inventory)
- LIFO is higher
- Adjust from LIFO to FIFO → higher days of inventory on hand
- Inventory turnover (COGS/average inventory)
- Solvency
- LIFO → lower inventory → lower total asset → lower stockholders’ equity → higher debt ratio and debt-to-equity ratio