Understand Why Companies Select Given Inventory Methods.

Understand Why Companies Select Given Inventory Methods.

Companies ordinarily prefer LIFO in the following circumstances: (1) if selling prices and revenues have been increasing faster than costs and (2) if a company has a fairly constant "base stock." Conversely, LIFO would probably not be appropriate in the following circumstances: (1) if sale prices tend to lag behind costs, (2) if specific identification is traditional, and (3) when unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide.

Identify the Major Advantages and Disadvantages of Lifo.

Identify the Major Advantages and Disadvantages of Lifo.

The major advantages of LIFO are the following: (1) It matches recent costs against current revenues to provide a better measure of current earnings. (2) As long as the price level increases and inventory quantities do not decrease, a deferral of income tax occurs in LIFO. (3) Because of the deferral of income tax, cash flow improves. Major disadvantages are: (1) reduced earnings, (2) understated inventory, (3) does not approximate physical flow of the items except in peculiar situations, and (4) involuntary liquidation issues.

Explain the Dollar-value Lifo Method.

Explain the Dollar-value Lifo Method.

Explain the Dollar-value Lifo Method. For the dollar-value LIFO method, companies determine and measure increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool.

Understand the Effect of Lifo Liquidations.

Understand the Effect of Lifo Liquidations.

Understand the Effect of Lifo Liquidations. LIFO liquidations match costs from preceding periods against sales revenues reported in current dollars. This distorts net income and results in increased taxable income in the current period. LIFO liquidations can occur frequently when using a specific-goods LIFO approach.

Explain the Significance and Use of a Lifo Reserve.

Explain the Significance and Use of a Lifo Reserve.

Explain the Significance and Use of a Lifo Reserve. The difference between the inventory method used for internal reporting purposes and LIFO is referred to as the Allowance to Reduce Inventory to LIFO, or the LIFO reserve. The change in LIFO reserve is referred to as the LIFO effect. Companies should disclose either the LIFO reserve or the replacement cost of the inventory in the financial statements.