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3.6 LIFO liquidations
Publication date: 31 May 2024
us Inventory guide
LIFO liquidations, which may also be referred to as decrements, refer to situations when inventories in old LIFO layers, carried at their original acquisition costs (which in many cases will typically be less than current acquisition costs of similar inventory) are deemed to have been sold due to an overall decrease in inventory quantities. All other things being equal, a LIFO liquidation will generally increase current year income (as those older, lower costs, are charged to cost of sales). In these situations, the principle underlying the LIFO method of inventory pricing—that current costs are matched with current revenue—will be violated. SEC SAB Topic 11.F requires disclosure (either in a footnote or parenthetically on the face of the income statement) of the impact of LIFO liquidations on net income and earnings per share. See FSP 8.4.3.
It would not be appropriate to defer the effect of the liquidation at year-end even if affected inventories are expected to be replaced soon after year-end. See IV 3.7.1 for interim reporting considerations for LIFO decrements.
3.6.1 Measurement of amount to be disclosed in LIFO liquidation
The basic objective of the LIFO inventory method is to match current costs with current revenues. Thus, the required disclosure of the effect of LIFO liquidations on pre-tax income and earnings per share should be based on decrements in specific LIFO pools and should be measured as the difference between the actual charge to cost of sales and the charge that would have been made if the quantities in the depleted pools had been replaced using the company’s customary method of applying LIFO. Neither the effects of increments in other pools nor the effects of price increases applicable to quantities sold and replaced should be offset in determining the amount to be disclosed.
In practice, calculating the impact may be difficult because of the method used for pricing LIFO increments. For example, if a company using a dollar-value inventory method has a liquidation in the first quarter, the theoretical effect on cost of sales is based on the cost of replacing the inventory at the time it was sold. If the company uses the year-end price or index to compute the effect of the liquidation, some distortion could result. The same problem could arise if the liquidation occurred late in the year but the company uses a price or index from early in the year to compute the effect. Because precise information as to replacement cost at the time of liquidation may not be available, the price or index that would have been used to value a current year increment, had there been one, is usually used to compute the effect of the liquidation.
In situations when the specific period and reason for the LIFO decrement can be identified, however, it is appropriate to compute the income effect with reference to the costs of the particular period. For example, assume a decrement occurs in the third quarter of the year because of a strike or other unforeseen event and the company knows that the decrement will not be restored before year end. The computation of the income effect of the liquidation with reference to third quarter inventory costs would be appropriate even though the company ordinarily uses first quarter costs to value LIFO increments.
The effect on pre-tax income of a liquidation can frequently be determined as follows:
- Quantity method – units liquidated by layer multiplied by the difference between the unit price that would have been used to price a LIFO increment in the current year and the unit prices at LIFO of each layer liquidated
- Dollar-value method – base-year dollars liquidated by layer multiplied by the difference between the price index that would have been used to price a LIFO increment in the current year and the price index of each layer liquidated. This approach is easier to apply when pools are defined as natural business units. See Sections 4 and 5 of the LIFO Issues Paper for application examples.
3.6.2 LIFO liquidations triggered by a disposal of a business or group of assets
When a company disposes of a significant amount of inventory, for example all of the inventory in a manufacturing facility as part of a disposal of the business or group of assets, and that inventory forms part of a larger LIFO pool, a question may arise as to whether the entire disposition should be treated as a LIFO liquidation or if the pool should be retrospectively split between the disposed of and ongoing businesses such that any true decrement or liquidation would relate only to current year changes in inventory levels for the remaining business. There is no authoritative literature that addresses this specific question. However, paragraphs 5-32 through 5-37 of the LIFO Issues Paper address the presentation of LIFO inventory liquidations resulting from business discontinuances and implicitly acknowledge that such a disposal could give rise to a LIFO liquidation. Thus, we believe any "bulk" disposal of inventory should be treated as a normal sale of inventory for LIFO purposes, and the LIFO cost of the remaining inventory would be determined by referring to the aggregate LIFO layers remaining in inventory after the disposal. If the “bulk sale” causes a decrement, which will be the likely outcome in many cases, the LIFO cost basis of the layers liquidated within a single LIFO pool should be determined on a LIFO basis.
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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