INVENTORY VALUATION

Suggested Answers
LIFO RESERVE
 Arises when firm follows LIFO method for
inventory valuation and estimation of COGS
 COGS = Op. Inventory + Purchases – Closing
Inventory
 In an environment of inflation, estimation of
inventory using LIFO method, is at the earlier
consignments value
 LIFO Inventory Valuation < FIFO Inventory
Valuation
 COGS using LIFO > COGS using FIFO

 It results in savings of income tax

 Closing Inventory Valuation as per FIFO Method –
Closing Inventory Valuation as per LIFO Method
LIFO RESERVE PROBLEM
 PQR Inc. is a company engaged in producing products and
services in the healthcare industry.

 In a note accompanying its 2018 financial statements, the

company disclosed that it uses the LIFO inventory method for
87% of its inventories and FIFO for the remainder. The
company’s balance sheet reported inventories of $8,153
million and $7,127 million at the end of 2018 and 2017
respectively.

 The inventory disclosure note reports that if the FIFO method

has been used to value the entire inventory, instead of just
13% of it, inventories would have been $8,244 million and
$7,283 million at the end of 2018 and 2017 respectively
 Partial income statements for 2018 and 2017 are as follows:
LIFO RESERVE PROBLEM

($ in millions)
2018 2017
Sales revenue $92,977 $86,983
Cost of goods sold 88,645 83,206
(COGS)
Gross profit 4332 3777
Operating expenses 3068 2651
Operating income 1264 1126
LIFO RESERVE PROBLEM
 A note included in 2017 financial statements reports that
2016 ending of $7,495 million would have been $7,682
million on all FIFO basis.

 Assume that the PQR Inc. has decided to value all of its
inventories using the FIFO method in 2018 i.e. as if 100%
FIFO had been used

 Required:
 How PQR Inc. would report COGS by its newly adopted
method , 100% FIFO
 What adjustment will be required to appropriate accounts?

 What disclosure note should provide as additional

information?
 
LIFO RESERVE
 LIFO Reserve 2018
= $8244 million – 8153 million = $91 million

 LIFO Reserve 2017

= $7283 million - $ 7127 million = $156 million

 LIFO Reserve 2016

 $7682 million - $7495 million = $187 million
ESTIMATION OF COGS – USING FIFO
 2018 – Factory Cost
 COGS using LIFO = Opening Inventory using
LIFO + Factory Cost – Closing Stock using LIFO
 88,645 = 7127 + Factory Cost – 8153
 Factory Cost = 89,671 million

 2018 – COGS using FIFO

 COGS using FIFO = Opening Inventory using FIFO +
Factory Cost – Closing Stock using FIFO
= 7283 + 89,671 – 8244
= $ 88,710 million
IMPACT ON PROFITS 2018 – USING
FIFO
 2018 : Gross Profits will decrease by $65 million

 = COGS FIFO – COGS LIFO

 = 88710 -88645 = $65 million

 Gross Profit will increase by LIFO Reserve 2018

(in closing inventory) $91 million and decrease
by LIFO Reserve 2017 $156 million

 Net Impact: decrease in Gross Profits by $ 65

million
ESTIMATION OF COGS – USING FIFO
 2017 – Factory Cost
 COGS using LIFO = Opening Inventory using
LIFO + Factory Cost – Closing Stock using LIFO
 83,206 = 7495 + Factory Cost – 7127
 Factory Cost = 82,838 million

2017 – COGS using FIFO

 COGS using FIFO = Opening Inventory using FIFO +
Factory Cost – Closing Stock using FIFO
= 7682 + 82,838 - 7283
= $83,237 million
IMPACT ON PROFITS 2017 – USING
FIFO
 2017 : Gross Profits will decrease by $ 31 million

 = COGS FIFO – COGS LIFO

 = 83237 - 83206 = $31 million

 Gross Profit will increase by LIFO Reserve 2017

(in closing inventory) $156 million and decrease
by LIFO Reserve 2016 $187 million

 Net Impact: decrease in Gross Profits by $35

million