Saturday, October 08, 2011

Converting FIFO to LIFO

CFA Level 1 - Assets

There is no precise mathematical equation to convert FIFO accounting to LIFO because the equivalent of the FIFO reserve does not exist. Furthermore, there is little value in converting inventory under FIFO to LIFO, since LIFO inventory is not a reflection of the true economic value of inventory. Nonetheless, analysts can estimate what the inventory and COGS would have been if the company used the LIFO accounting method.
Analysts would first need to estimate what the beginning inventory would have been under LIFO. Inventory can be affected by economic inflation, inflation of raw assets with a particular industry, among others. As a result, COGS (LIFO) can be estimated by using this formula:

COGS (LIFO) = COGS (FIFO) + [beginning inventory (FIFO) * (adjustment or inflation rate)]

Looking at a company within a similar industry that uses the LIFO method can also be done to derive the adjustment rate.

Adjustment rate = LIFO reserve / beginning inventory (LIFO)

Converting Average-cost Method to LIFOAs stated previously, since the average-cost method is a simple average of COGS, COGS would be in between LIFO and FIFO.

COGS (LIFO) = COGS (average) - ½ * (beginning inventory (Average) * (adjustment or inflation rate)

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