Question

Explain Required LIFO reserve disclosures, why they are important?

Answer 1

The LIFO reserve is an accounting term that measures the difference between the first in, first out (FIFO) and last in, first out (LIFO) cost of inventory for bookkeeping purposes. The LIFO reserve is an account used to bridge the gap between FIFO and LIFO costs, when a company uses the FIFO method to track its inventory but reports under the LIFO method in the preparation of its financial statements.

GAAP requires companies which use the LIFO method to disclose the amount of the LIFO reserve in the notes to the financial statements or on the balance sheet.

Importance of LIFO reserve:-

1. Facilitating in making accounts as per FIFO/ LIFO both-

Suppose a company uses FIFO for its internal accounting system, but wants to use LIFO for financial and income tax reporting (due to continuous inflation of its costs). In this instance, the LIFO reserve is a contra inventory account that will reflect the difference between the FIFO cost and LIFO cost of its inventory.

2. The change in the balance in the LIFO reserve will also increase the current year’s cost of goods sold. This in turn reduces the company’s profits and therefore, taxable income.

        3.The disclosure of the LIFO reserve is better for comparing the profits and ratios of a company using LIFO with the            profits and ratios of a company using FIFO.

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