In the U.S., firms that use LIFO must report a LIFO reserve. The LIFO reserve is the difference between the inventory balance shown on the balance sheet and the amount that would have been reported had the firm used FIFO. That is:
It represents the cumulative effect over time of ending inventory under LIFO vs. FIFO.
When adjusting COGS from LIFO to FIFO: COGSFIFO = COGSLIFO - Change in LIFO Reserve.
So far, discussions have been based on the assumptions of rising prices and stable or growing inventory quantity. As a result, the LIFO reserve increases over time. However, LIFO reserves can decline for either of the two reasons listed below. In either case, the COGS will be smaller and the reported income will be higher relative to what they would have been if the LIFO reserve had not declined. However, the implications of a decline in the LIFO reserve on financial analysis vary, depending on the reason for the decline.
|shubhamk0: No adjustments are required in case of price decline since it is normal business situation|
|ravinram: No adjustments required when prices fall. but suppose we are in a period of deflation, and Japan for eg, has been facing the problem of deflation for many years..|