Question

Describe what LIFO Liquidation is and how it can affect reported earnings.

Answer 1

LIFO liquidation refers to the practice of selling or issuing of older merchandise stock or materials in a company’s inventory. It is done by companies that are using the LIFO (last in, first out) inventory valuation method. The liquidation occurs when a company using LIFO sells more goods or issues more old stock than it buys.

There are a number of reasons why LIFO liquidation occurs, including:

• A sudden cash flow problem within the company
• An unexpected spike in demand for the goods the company sells
• A lack of more recent inventory (either because of failure/inability to buy or an issue with production)
• The need to relocate or get rid of inventory, most likely due to a desire for storage space for newer and/or more goods that fit in with the wants and needs of consumers

Businesses can choose from a variety of methods to account for inventory. Each method affects the cost of goods sold, or COGS, and the cost of ending inventory. One of the methods is called "last in, first out," or LIFO. The income statement uses COGS to determine gross profit. The balance sheet lists ending inventory as a current asset. LIFO and LIFO liquidation affects both types of statements