LIFO/FIFO- Net Income and Retained Earnings

CFA Level II
#1

So to get FIFO Retained Earnings, we add the LIFO reserve and subtract taxes (this represents the increase in profit due to lower COGS less assumed taxes on that profit). To get FIFO Net Income, we add the change in LIFO reserve and subtract taxes (again representing the increase in profit due to lower COGS less assumed taxes on that profit). Why for Net Income are we taking the CHANGE in LIFO reserve though?

#2

Because the LIFO reserve is essentially a static balance sheet number: it represents the difference in value between the reported LIFO inventory carrying amount and the inventory amount that would have been reported under FIFO. This number alone isn’t relevant to NI, but the change over periods is (just like if you had two different asset values on balance sheet over reporting periods, for NI purposes the reported number isn’t relevant but rather the change over periods is).

#3

You take the delta in LIFO reserve because you’re measuring that specific periods net Income versus RE which is a cumulative figure, hence the total LIFO reserve

BS = Most recent cumulative view of the company’s financial position

IS = (mostly) explains BS change from one period to the next

#4

Understand it now, thanks

#5

The LIFO reserve is cumulative since time immemorial: the change in the LIFO reserve last year, plus the change in the LIFO two years ago, plus the change in the LIFO reserve three years ago, ad infinitum. The change in the LIFO reserve each year is the effect you would have seen _in inventory and COGS that year _.

The idea of switching from LIFO to FIFO (for analysis) is that you’re determining the effect _ as if they’d been using FIFO all along _. Thus, you change retained earnings for the cumulative effect (the whole LIFO reserve), and you change the income statement for the effect that year (change in LIFO reserve). (Note: if you wanted to, you could change all of the income statements since forever, one at a time, as well as all of the balance sheets, one at a time. There’s no need; you’re likely only interested in the effect as of this year.)