SourceCorp: Cost Segregation Studies, R&D Tax Credits, LIFO Accounting Since 1983.

<< back

Corporate Headquarters
6000 Western Place, Ste 800
Fort Worth, TX 76107
817.732.5494

Regional Business Development Contacts:

Texas Gulf Coast Region:
Candace Willingham

Midwest Region:
Diane Smith

Northeast Region:
Jennifer Weston

Southeast Region:
David DeGrand

South Central Region:
Jennifer Chin

Pacific Northwest Region:
Laura Collins

Upper Midwest Region:
Al Schmitt

My inventory doubled. Why didn't my LIFO reserve double?

You must understand that LIFO means last in, first out. In theory, the last item you purchased, at the highest current year price, is the first one sold. In periods of rising inflation, this means that the cost of goods sold is computed from the highest priced items.

There are instances, however, where not all of the items purchased during the current year are sold. The result of this is increased inventory. While LIFO is a benefit when you compare the actual cost of inventory (the price you actually paid for it) to the value of the older inventory you pretend to have in inventory (because you expensed the newer, higher priced items), there is no LIFO benefit in the current year for the part of the inventory which was purchased in the current year because its value for LIFO purposes is the same as its actual cost.

Consider the following example:

Year 1 inventory - 100 items @ $10 each.

Year 2 inventory - 100 items @ $11 each. Purchases for the year - 1,000 items @ $11.

Year 3 Inventory - 200 items @ $12 each. Purchases for the year - 1,000 items @ $12.

The LIFO benefit for year 1 is $0 because the actual cost of the inventory is $1,000 (100 x $10), and the LIFO cost of the inventory is also $1,000 (100 x $10).

In year 2, you can see that the company purchased all its inventory items for $11 each, demonstrating that there was 10% inflation during the year. All of the year's purchases were sold during the year, and the ending inventory was 100 units, again.

The LIFO benefit for year 2 is $100 because the actual cost of the inventory is $1,100 (100 x $11), and the LIFO cost of the inventory is $1,000 (100 x $10).

In year 3, the same number of units were purchased, at an even higher price, but not all the items were sold, leaving an ending inventory of 200 units. Because we are using the principle of last in, first out, we can assume that the inventory that is left is the 100 units with which we began the year (@ $10 each), and an additional 100 units purchased early during the current year (@ $12 each).

The LIFO benefit is computed by comparing the actual cost of the inventory to its LIFO value. Here is the math: actual cost = $2,400 (200 x $12). LIFO cost = $2,200 ((100 x $10) + (100 x $12)).

As you can see, the LIFO benefit on the 100 units considered purchased during the current year is $0 because the same LIFO value is assigned to it as to the actual cost ($12 each). The only benefit which is increased is that which is based on the older 100 units @ $10 each.