A good video that explains LIFO Reserve Basics
Points to Note
LIFO Inv + LIFO Reserve = FIFO Inv
For the next year
LIFO Reserve = Prev year’s LIFO Reserve + ( LIFO Cogs – FIFO Cogs)
To make it easy to digest, we can rearrange the above and state as
LIFO Cost of good sold = FIFO Cost of goods sold + ( Change in LIFO reserves)
Year 1 — LIFO Inv = 200, LIFO Res = 100, then FIFO Inv = 300
Year 2 – If LIFO Cogs = 400 and FIFO Cogs = 50, then this difference is 350. This is to be added to the opening balance of LIFO Reserve which is 100 resulting in the new LIFO Reserve for year 2 as 100 + 350 = 450.
When LIFO method is used in US GAAP, the LIFO Reserve needs to be reported as well to signify the reserve or additional inventory had the FIFO method was followed ( in an environment of increasing inventory cost).
When LIFO liquidation happens, LIFO is selling more goods that was bought at lower cost , thereby increasing gross profit. Gross profit due to LIFO liquidation =( # of units liquidated) * (Replacement cost of the units liquidated – historical purchase cost of those units).
Good reference link for Inventory related topic.