|Author||Topic: LIFO to FIFO adjustment to Balance Sheet|
|This is a general question. When we adjust the Balance Sheet from LIFO to FIFO we 1) add the LIFO reserve to inventory (assets). 2) Add LIFO reserve*(1-t) to retained earnings (equity), and t*LIFO reserve to deferred taxes (liability). The notes state that you should add the entire LIFO reserve (without the after-tax adjustment) to retained earnings (equity). They even have a practice question where they make an adjustment to equity by adding the entire LIFO reserve, and the answer states that no tax adjustment is necessary. Why the discrepancy? What am I missing? Can anyone help clear this up for me?|
For ratio analysis purpose you should add the entire LIFO reserve to equity. I think this makes sense because when you adjust LIFO inventory to FIFO inventory you add LIFO reserve, and since you should add the same amount to assets and to equity respectively to make the book balance, LIFO reserve is what should be added to equity as well. I am pretty confused about the tax effect as well but i think it only comes into play when we are concerned about changes to income statement figures. However, since adjustment made to net income is also reflected in retained earning thus equity, it seems that we should add the after-tax adjustment to equity. I guess the better way to solve this problem is not to link changes made to income statement to changes to balance sheet. Otherwise, the discrepancy always presents.
This is only my opinion on this problem. Is there anyone else who has a better solution to the question? plz share your thoughts with us.