Definition
The LIFO reserve (or LIFO allowance) is the amount by which inventory measured at current cost, commonly FIFO, exceeds inventory carried under LIFO. It is the cumulative effect of using LIFO. SEC registrants using LIFO must state, if material, the excess of replacement or current cost over the LIFO value (Regulation S-X Rule 5-02.6(c)), and other entities often disclose it too. The disclosure lets users restate inventory and cost of sales to a current-cost basis. "LIFO reserve" is practice shorthand, and the SEC staff discourages that label in supplemental non-LIFO disclosures. The change in the reserve during a year equals the difference between FIFO and LIFO cost of goods sold.
Why it matters in an audit or review
The reserve is a check on LIFO computations and an input to working capital and ratio analysis. Auditors reconcile it to the LIFO calculation, examine liquidations, and evaluate disclosure. A falling reserve points to a LIFO liquidation or falling prices.
Example
(Illustrative) FIFO inventory is $5,400,000 and LIFO inventory is $4,700,000, so the LIFO reserve is $700,000. If last year's reserve was $620,000, LIFO cost of goods sold was $80,000 higher than FIFO this year, and pre-tax income was $80,000 lower.
Common mistakes
- Treating the reserve as a valuation allowance that can be released freely.
- Omitting the reserve from the tie-out of a FIFO-based loan covenant.
Sources
- FASB ASC 330-10-30 and 330-10-35 (inventory cost flow assumptions, including LIFO)
- SEC, Regulation S-X, 17 CFR 210.5-02, Rule 5-02.6 (balance sheet caption for inventories; LIFO disclosure)
- SEC, Staff Accounting Bulletin Topic 11.F (LIFO liquidations)
- https://www.ecfr.gov/current/title-17/section-210.5-02
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error