Definition of LIFO Reserve:
The difference between the inventory method used for internal reporting purposes and LIFO is called "LIFO reserve" or "allowance to reduce inventory to LIFO". Explanation: Normally more than inventory methods are used by companies. Many companies use LIFO for tax and external reporting purposes but maintain a FIFO, average cost, or standard cost system for internal reporting purposes. There are several reasons to do so. These reasons are as follows:
The LIFO effect is the adjustment that must be made to the accounting records in a given year. Example: ABC company uses the FIFO method for internal reporting purposes and LIFO for external reporting purposes. At January 1, 2011 the allowance to reduce inventory to LIFO balance was $20,000, and the ending balance should be $50,000. The LIFO effect is therefore $30,000, and the following entry is made at year-end. Cost of goods sold 30,000 Allowance to reduce inventory to LIFO 30,000 The allowance to reduce inventory to LIFO would be deducted from inventory to ensure that the inventory is stated on a LIFO basis at year-end. |