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101 Concepts for the Level I Exam

Concept 52: LIFO Reserve and LIFO Liquidation


LIFO reserve is the difference between LIFO inventory reported and the amount that would have been reported in inventory if the FIFO method had been used. Under US GAAP, companies that use the LIFO method must disclose the LIFO reserve in their financial notes. This information can be used to adjust reported ending inventory and COGS in order to compare this company with a company using the FIFO method.

LIFO liquidation occurs when the number of units in ending inventory is less than the number of units in the beginning inventory (i.e. the firms sells more than it purchases during the year). If inventory unit costs have gone up from year to year, this will increase gross profits. However this increase in the gross profit margin is temporary and not sustainable.