- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 6. Analysis of Inventories
- Subject 3. Presentation and Disclosure

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**CFA Practice Question**

How should gross profit be adjusted to account for the illusory income effect associated with LIFO liquidation?

B. Subtract the before-tax LIFO liquidation amount.

C. Subtract the after-tax LIFO liquidation amount.

A. Add back the before-tax LIFO liquidation amount.

B. Subtract the before-tax LIFO liquidation amount.

C. Subtract the after-tax LIFO liquidation amount.

Correct Answer: B

By subtracting the before-tax LIFO liquidation amount from the gross profit (which is a before-tax amount), the analyst can determine the portion of gross profit that is sustainable.

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**User Contributed Comments**
3

User |
Comment |
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kalps |
LIFO liquidation implies that the gross profit is higher than it should be as it is based on old ost base, hence the liquidation amount should be subtracted from the cost base in order to give a realistic lower profit. |

shasha |
Should no LIFO liquidation happen, do we need to illustrate its effect on GP, which is "clean" from too old stock? |

mtcfa |
The answer is equivalent to saying "increase COGS by adding back the decline in the LIFO reserve." |