“A LIFO liquidation matches old inventory costs with current revenues, and can produce an increase in the gross profit margin.” Can someone please explain this? Thanks!
Ok, I’ll give it a try. Normally, LIFO profit margin is understated relative to FIFO because your COGS are coming from the most recent and therefore more expensive items. During a LIFO liquidation, you already exhausted all the more expensive stuff, so now you’re selling the cheaper stuff and thus artificially inflating your margins. Make sense?
Assuming rising prices, in a LIFO liquidation the firm is essentially selling down their inventory (which is accounted for using LIFO). So the further they sell down, without purchasing new inventory, the lower the costs will be. You’re selling at current, higher prices and your COGS is being marked at those older, lower priced inventories and thus you get higher gross profit margins.
This is in regards to a rising prices environment, or normally inflation. Say a company has inventory on its books for 10 years because of using LIFO. They decide to stop operations and sell off the inventory. It is still held at lower of cost or market value and will be included in COGS for the current period. But inflation has caused prices to rise, so the lower book costs will be deducted from the higher priced products. Large profit, big tax consequence.
Well, you got 3 answers, and they’re all the same, so I think that pretty well describes it. ha.
Cool, I got it now!
liquidation = ending inventory< begining inventory