ACCT 101 ANSWER TO CHAPTER 8 REVIEW QUESTION #3:
3a.) Liquidation of a LIFO reserve occurs when the old, low costs used in valuing a
LIFO inventory pass into the cost of goods sold. As a result, the CGS is based upon old
and relatively low costs, resulting in the recognition of an unusually large amount of
b.) Liquidation of a LIFO reserve occurs when inventory falls to an unusually low
level at year-end. This may occur as a result of several different facts, including:
Replacement merchandise becomes unavailable because of material
shortages or labor strikes.
Co. reduces the size of its inventory by discounting specific product lines
or closing specific stores
Management deliberately slows its merchandise replacement purchases
near year-end with the specific objective of allowing inventory levels to
fall and inflating earnings through the liquidation of the LIFO reserve.
c.) Liquidation of a LIFO reserve usually increases the rate of gross profit. The
LIFO reserve exists because the costs used in the valuation of inventory are well
below current replacement costs. Liquidation of the reserve means that these low
costs flow into the cost of goods sold. When these low costs are offset against
current sales prices, the rate of gross profit will be substantially higher than if the
cost of goods sold were based upon current purchase costs.