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3.10 Retail industry LIFO practices
Publication date: 31 Dec 2021
us Inventory guide
Retailers may use the LIFO method for inventory valued at cost or for inventory valued under the retail inventory method (RIM). When using LIFO for inventory valued using the retail inventory method, inventory is valued using retail dollars, and increments and decrements are converted from retail dollars to cost using a cost complement percentage or index. Some retailers use an internally-developed LIFO index for book purposes and an externally-developed Bureau of Labor Statistics LIFO index for tax purposes. The book and tax LIFO indexes, as well as other aspects of the LIFO computations, may differ without violating the LIFO conformity rule.
3.10.1 Application of LIFO when using RIM
The following is an overview of the basic principles on how LIFO is applied when using RIM:
- The inventory in each pool at retail value is reduced to its base-year retail price by the application of the cumulative LIFO index appropriate for the pool, similar to the manner in which a cost-based LIFO index calculation would occur.
- The closing inventory at its base-year retail price is compared to the previous year’s closing inventory at its base-year retail price.
- If this comparison indicates an increase in inventory (an increment), such increase is multiplied by the cumulative LIFO index applicable to the current year to get the current year retail value of the increase.
- If this comparison indicates a decrease in inventory (a decrement or liquidation), it is considered to have come from the most recently added LIFO layers. Therefore, deductions to cover the decrease are made from the latest period in which there were additions to inventory and at the prices at which they were previously added to the retail value of the inventory. If there have been no increases, the deductions are taken from the base year at the base-year retail price.
- An increase (i.e., a new LIFO layer) is then adjusted to LIFO cost through the use of the applicable cost complement percentage for the pool for the current year. In the case of a decrease, it is measured at the LIFO cost of the respective liquidated layers, or portion thereof.
- The adjusted increase or decrease (now reduced to LIFO cost) is added to or subtracted from the closing LIFO inventory of the previous year to obtain the closing inventory at LIFO as of the current year-end.
- The current cost of the inventory under the retail inventory method when FIFO is used as determined by the inventory control records is compared to the LIFO closing inventory figure. The difference is the cumulative LIFO adjustment at that year end and represents the net difference between LIFO and FIFO since the base year.
- The cumulative LIFO adjustment at the end of the current year is compared to the cumulative LIFO adjustment at the end of the previous year. The difference represents the annual LIFO adjustment, which is the effect on pretax income for the current year.
Figure IV 3-1 illustrates the application of LIFO when using the retail inventory method.
Figure IV 3-1
Inventory cost and LIFO reserve - retail LIFO method
Inventory cost and LIFO reserve - retail LIFO method
The following table reflects the calculations necessary to estimate the LIFO cost of merchandise inventory through the application of the retail LIFO method.
Ending inventory |
|||
20X3 |
20X4 |
||
Cost – traditional RIM FIFO |
$50,000 |
$63,900 |
|
Current retail |
82,000 |
100,000 |
|
LIFO cost complement* |
64% |
67% |
|
Cumulative index |
1.17 |
1.25 |
|
*The calculation of the LIFO cost complement is not shown in this example.
Analysis of year-end 20X3 inventory (beginning 20X4 inventory)
Year |
LIFO cost complement |
Cumulative index |
Retail layer (Base-year cost) |
LIFO cost |
FIFO cost |
LIFO reserve |
20X1 |
62% |
1.00 |
$50,000 |
$31,000 |
||
20X2 |
63% |
1.12 |
10,000 |
7,056 |
||
20X3 |
64% |
1.17 |
10,000 |
7,488 |
||
$70,000 |
$45,544 |
$50,000 |
$4,456 |
The ending LIFO inventory cost, resulting LIFO reserve and LIFO impact on income for 20X4 would be calculated as follows:
12/31/X4 inventory at retail |
$100,000 |
At base-year retail ($100,000/1.25) |
80,000 |
12/31/X3 inventory at base-year retail |
(70,000) |
New layer at base-year retail |
$10,000 |
Inflation index |
× 1.25 |
New layer at current retail |
$12,500 |
Current year cost complement |
× 67% |
New layer at LIFO cost |
$8,375 |
12/31/X3 inventory at LIFO cost |
$45,544 |
12/31/X4 inventory at LIFO cost |
$53,919 |
12/31/X4 inventory at RIM FIFO |
63,900 |
LIFO reserve at 12/31/X4 |
$(9,981) |
LIFO reserve at 12/31/X3 |
4,456 |
LIFO provision – 20X4 |
$5,525 |
Analysis of year-end 20X4 inventory
Year |
LIFO cost complement |
Cumulative index |
Retail layer (Base-year cost) |
LIFO cost |
FIFO RIM cost |
LIFO reserve |
20X1 |
62% |
1.00 |
$50,000 |
$31,000 |
||
20X2 |
63% |
1.12 |
10,000 |
7,056 |
||
20X3 |
64% |
1.17 |
10,000 |
7,488 |
||
20X4 |
67% |
1.25 |
10,000 |
8,375 |
||
$80,000 |
$53,919 |
$63,900 |
$9,981 |
3.10.2 Alternative retail LIFO computation
An alternative approach is used by some retailers that uses the traditional FIFO RIM costs to determine the LIFO index and ending LIFO inventories. This approach is summarized as follows:
- Each LIFO pool at retail value is reduced to cost by applying the applicable cost complement for the respective year.
- The closing inventory at cost is reduced to base-year cost by the application of the cumulative inflation index for the pool.
- The closing inventory at base-year cost is compared to the previous year’s closing inventory at base-year cost.
- If this comparison indicates an increase in inventory (an increment), such increase is multiplied by the cumulative index applicable to the current year to determine the LIFO value of the increase.
- If this comparison indicates a decrease in inventory (a decrement or liquidation), it is considered to have come from the most recently added layers. Therefore, deductions to cover the decrease are made from the latest period in which there were additions to inventory and at the prices at which they were previously added to the LIFO value of the inventory.
- An increase (i.e., a new LIFO layer) is then adjusted to LIFO cost through the use of the applicable cost complement percentage for the pool for the current year. In the case of a decrease, it is measured at the LIFO cost of the respective liquidated layers, or portion thereof.
- The adjusted increase or decrease (now reduced to LIFO cost) is added to or subtracted from the closing LIFO inventory of the previous year to obtain the closing inventory at LIFO as of the current year-end.
- The current cost of the inventory under the retail inventory method when FIFO is used as determined by the inventory control records is compared to the LIFO closing inventory figure. The difference is the cumulative LIFO adjustment (reserve) at that year end and represents the net difference between the LIFO and FIFO inventory since the base year.
- The cumulative LIFO adjustment at the end of the current year is compared to the cumulative LIFO adjustment at the end of the previous year. The difference represents the annual LIFO adjustment, which is the effect on pretax income for the current year.
Figure IV 3-2 illustrates an alternative application of LIFO when RIM is used.
Figure IV 3-2
Inventory cost and LIFO reserve – alternative retail LIFO method
Inventory cost and LIFO reserve – alternative retail LIFO method
The following table illustrates the calculations necessary to estimate the LIFO cost of merchandise inventory through the application of the retail LIFO method.
Ending inventory |
||||
20X3 |
20X4 |
|||
Cost – RIM FIFO |
$50,000 |
$63,900 |
||
Current retail |
82,000 |
100,000 |
||
LIFO cost complement |
64% |
67% |
||
Inflation index |
1.17 |
1.25 |
||
Analysis of year-end 20X3 inventory (beginning 20X4 inventory)
Year |
LIFO cost complement |
Cumulative index |
Base-year cost |
LIFO cost |
RIM FIFO cost |
LIFO reserve |
20X1 |
62% |
1.00 |
$31,000 |
$31,000 |
||
20X2 |
63% |
1.12 |
6,800 |
7,616 |
||
20X3 |
64% |
1.17 |
7,055 |
8,254 |
||
$44,855 |
$46,870 |
$50,000 |
$3,130 |
The LIFO inventory and reserve for 20X4 would be calculated as follows:
12/31/X4 inventory at retail |
$100,000 |
LIFO cost complement |
× 67% |
12/31/X4 inventory at RIM FIFO cost |
$67,000 |
Cumulative index |
÷ 1.25 |
12/31/X4 inventory at base year cost |
$53,600 |
12/31/X3 inventory at base-year cost |
(44,855) |
20X4 layer at base-year cost |
8,745 |
Cumulative index |
× 1.25 |
20X4 cost layer at current costs |
$10,931 |
12/31/X3 LIFO inventory |
46,870 |
12/31/X4 inventory at LIFO |
$57,801 |
12/31/X4 inventory at RIM FIFO cost |
63,900 |
12/31/X4 LIFO reserve |
$6,099 |
12/31/X3 LIFO reserve |
3,130 |
20X4 LIFO impact |
$2,969 |
Analysis of year-end 20X4 inventory
Year |
LIFO cost complement |
Cumulative index |
Base-year cost |
LIFO cost |
RIM FIFO cost |
LIFO reserve |
20X1 |
62% |
1.00 |
$31,000 |
$31,000 |
||
20X2 |
63% |
1.12 |
6,800 |
7,616 |
||
20X3 |
64% |
1.17 |
7,055 |
8,254 |
||
20X4 |
67% |
1.25 |
8,745 |
10,931 |
||
$53,600 |
$57,801 |
$63,900 |
$6,099 |
3.10.3 Effect on retail LIFO of changes in pricing structure
The retail LIFO method measures current year increments and decrements assuming that the general pricing structure of retailers (e.g., full service, every day low price, or warehouse) remains the same. If a retailer changes its pricing structure, which suddenly increases or decreases its retail prices, the retail LIFO method may not properly measure the current year increment or decrement because of the distortion that could arise in the index calculation as a result of the price change, which would not reflect an underlying change in cost. If this type of change in pricing structure occurs, a more detailed analysis may be required to ensure the proper measurement of the increment or decrement.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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