LIFO Reserves and Their Implications for Financial Statements

Increase in LIFO Reserves: Implications Explained

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Question

An increase in the LIFO reserves implies which of the following?

I. Prices may have risen.

II. More goods might have been sold than purchased.

III. Firm may have changed inventory accounting from FIFO to LIFO.

IV. The firm may have indulged in excess purchasing to reduce taxes.

Answers

Explanations

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A. B. C. D.

C

The LIFO Reserve equals the difference in the inventory value under FIFO and under LIFO. This reserve will increase if either prices have risen sufficiently to cause a high ending inventory value or if the firm purchased more goods than it sold in times of rising prices. Note that II represents a LIFO liquidation, not an increase in the reserves. III does not lead to a change in LIFO reserves. Finally, remember that IV is one way firms using LIFO can manipulate earnings and taxes, by changing the purchasing behavior at year-end.

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