LIFO reserve adjustments following, addition, decrease, equation, reserve

lxwarr30

Declining prices (negative LIFO reserve) would result in FIFO inventory being less than LIFO inventory based on the following equation:

FIFO inventory = LIFO inventory + LIFO reserve

The balance sheet adjustment would decrease assets (inventory) by the $20 LIFO reserve. In addition, the analyst would decrease liabilities by $7 ($20 LIFO reserve

johnnyBuz

"Why do they adjust liabilities by the after-tax value?"

Because using different inventory accounting also affects your COGS (think about it), which would affect your net income and therefore your taxes.

Lower COGS = higher NI = higher taxes (with the reverse true as well)

nitoha

When there is an increase in prices and a consequent increase in LIFO reserve over the period to convert from LIFO to FIFO an analyst must:

Add the LIFO Reserve to inventory (current assets)

Add (LIFO Reserve * tax rate) to deferred tax liabilities (curent liabilities)

Add [LIFO Reserve * (1 - tax rate)] to retained earnings (shareholders' equity)

If there is a decrease in prices, simply do the opposite (i.e. instead of adding, just subtract the above-calculated amounts)

The DTL adjustment might require more explanation. In a period of rising prices, by only subtracting LIFO COGS instead of FIFO COGS from sales, a company is able to recognize lower gross profits. Lower taxable income leads to lower taxes being paid out in the current period. Therefore, in a period of rising prices, a LIFO delays paylment of a certain portion of taxes to a later period. Hence, the increase in DTL when converting to FIFO.

Just remember the three adjustments and you'll be fine.

Bluetick1010

beatthecfa has already posted a complete answer. I will just try to add a conceptual note.

Always have this fundamental equation in mind
A = L + E

1) Your Asset (A) has decreased by $20.

2) Means right side of your equation (L or E or both) MUST decrease in value, in order to balance it. (or you increase some other Asset, which is not the case here)

3) Now, Equity (E) gets affected thru Net Income mostly. (There are cases when Equity can be affected directly, but this is not one of them). And Net Income you get is AFTER the Tax Effect. So, in this case, decrease in your Equity (E) can only be upto ($20 x .65) = $13

4) You now have only reduced the left side by $13. And remaining $7 can only be reduced from Liability (cannot reduce from E any more amount).

5) And the remaining $7 is reduced from L as 'tax liability'. 'Deferred tax liability' in this case.

Last step (5) would be answer to your question "Why do they adjust liabilities by the after-tax value?".