 Hello, and welcome to this session in which we would look at what is LIFO liquidation? Well, LIFO liquidation occurs when older, lower cost inventory is liquidated, liquidated means sold, resulting in a higher net income and a higher taxes. Hold on a second. This is not what we learn about when we learn about LIFO. When we learn about LIFO, we said LIFO usually give us the highest cost of goods sold. So simply put, when we learn about LIFO and we said, well, if prices are rising and we assume that's the norm, when prices or cost is rising, what's going to happen? Cost of goods sold is higher. As a result, net income is lower. As a result, taxes are lower. And that's the main purpose why companies use LIFO over FIFO over the weighted average, because LIFO is going to give you higher cost of goods sold. And what we are saying here is LIFO liquidation occurs, when it occurs, it results in higher net income and higher taxes. So why would that happen? Well, that happens because the old inventory, now notice the inventory for LIFO, now let's focus on the inventory, 23,000 is different than 29,500. It's different than 26,952. So their inventory is way lower than them. It's way lower. So the inventory is lower. And now what's happening as this lower inventory is being liquidated, the cost of goods sold becomes lower. So you have to understand the relationship between rising cost and declining cost when it comes to LIFO and the weighted average. That's very important. This topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website. I don't replace your CPA review course. I am a useful addition to your CPA review course. I provide additional information, additional explanation, additional exercises, additional multiple choice. By doing so, I can help you improve your performance on your CPA review course by product. As a result, you will do better on the exam. Your risk is one month of subscription to give me a try. Your potential gain is passing the exam. If not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. I do have resources for other accounting courses such as advanced accounting, taxation, governmental audit, intermediate accounting. My CPA supplemental resources are aligned with your Becker, Roger, Gleam, and Wiley. So you can go back and forth between my supplemental resources and your review course and I give you access to all the AI CPA previously released questions. Almost 1,500 of them with detailed explanation. Connect with me on LinkedIn. If you haven't done so, take a look at my LinkedIn recommendation like this recording. Share it with other. Connect with me on Instagram, Facebook, Twitter, and Reddit. So what we are saying here, life will equidation will defeat the whole purpose of LIFO. Why? Because in some periods, units sold will be greater than the number of unit purchased. So in some years, we're going to sell more units than we purchased. And if we sell more units than we purchased, how can we sell more units that we purchased? If we sell more unit than we purchased, see, it means we are tapping into the old inventory because we are starting to liquidate old inventory. Why would that happen? Well, maybe in some years, there is a shortage of that product. We cannot buy it. We cannot buy it to replenish our inventory. Therefore, we're going to be selling old inventory or doesn't have to be old inventory. The cost of the old inventory is cost. As a result, it's going to distort their income and most likely not distort their income. It's going to give us the wrong impression about net income, which is distort their income. And more importantly, it's going to give us a higher income tax bill, which is we were using LIFO to avoid higher tax bill in the first place. The best way to illustrate this is to work an example. Let's assume we were buying wheat or it doesn't matter wheat, coffee, steel, and we bought 6,000 pound in 2001 at $4, just whatever we are buying. And this LIFO cost is 24,000. We're going to call this layer one. So we're going to have different layers of LIFO. You know that. In 2002, we purchased 8,000 pound at $5. We paid 40,000. In 2003, we purchased 11,000 pounds at $9. 2004, we purchased 5,000 pound at $10. Notice the prices are rising. Now, the total is we had 30,000 pound and the total cost to 213,000. And we were buying all these and we were not selling them. In other words, we were not selling more than more buying. So this is what's left in LIFO. Then in 2014, we sold 28,000 pounds, not units, pound. We sold 28,000 pound. And we sold them at $15. Well, if we sold 28,000 pounds, it means we sold all of 2004 because we're using LIFO, right? We're using LIFO. We got rid of this layer, layer 4. We got rid of layer 3. We got rid of layer 2. And we sold 4,000 pounds of layer 1. Because remember, we sold 28,000 unit. So we still have 4,000. We still have 2,000 pound from layer 1, but everything else is sold. So let's compute our gross profit. Well, our current gross profit, if we sold 28,000 unit at $15, that's going to give us sales of 420,000. What is our cost of goods sold? Well, our cost of goods sold is 50,000 for the 5,000 unit, 99,000 for the 11,000, 40,000 for the 8,000 pound, not unit, I call them a pound unit. And for the last purchase, we sold 4,000 unit times 4 at 16,000. So if you add 16,000 to all of those, our cost of goods sold is 205. As a result, our gross profit is 215. And that's 100% accurate. And our gross profit percentage is 51.19. Well, what happened here is this. Our gross profit appears to be not appears. Now, it might appear to be a little bit high. Why? Because let's think about it. Look what's happening to the prices from 2001 to from 20X, 1 to 20X for it went from $4 per pound to $5, then by two years later, the cost per pound double. Well, if the cost per pound double, obviously the selling price is going to increase as well. So here's what's happening. We are looking at recent prices. This is $15 is recent sales, recent prices, recent sales. Then we are matching recent sales with old cost, old cost. And as a result, we have a huge profit. Now, what should be the profit? What should be a more reasonable, more a better picture? This is what it should look like. What it should look like is something like the sales will be the same. And realistically, each unit, if we sold a 28,000 unit, each unit should have a cost of goods sold, approximately $9.50. So the cost should reflect the most recent sales. So if we take 28,000 unit times cost of 9.50, it's going to give us cost of goods sold of 266,000. You could also assume, if you think prices are rising, you could say assume, I would say the cost is really $10. Well, what would that do? Well, that would reduce our gross profit from 215 to 154. It would reduce it by $61,000, and our gross profit percentage is 36.67. Now, why did that happen? Why was our gross profit higher? Well, the gross profit was higher, and the gross profit percentage were higher because we were doing life-full equidation. Now, obviously, the company is not going to be happy with this, with the current sales, because now they have a large tax bill. They're going to have more profit. Therefore, they have to pay higher taxes. And from an investment perspective, you don't want to mislead the investors. You don't want to make them think that your gross profit is 51.19. So what you would do, you will disclose in the notes of the financial statement not to mislead investors, not to mislead users, that your profit is this high. Because starting if everything goes as expected in 20x5, your cost is going to be around maybe $11 to $12, or maybe $14. It doesn't matter. So you're going to have to match your recent sales with your recent cost. So when you match your recent sales with an old cost and your profit increased, not artificially, it's a true profit, but it's not sustainable. Why? Because the result of this was the result of LIFO layer liquidation, because what happened is you did not purchase enough for that 20x4. And 20x4, maybe there was a shortage of this material of wheat, the shortage of wheat. That's bad, right? And you only purchased, you had 5,000 pound available to meet your demand, but there are 30,000 pound of demand. Therefore, you went back and you started to liquidate old layers. And when you liquidated old layers, you got the LIFO liquidation, which in turn showed that you are really making a lot of profit. Well, it's not good from a tax perspective, and it's misleading for investors if they think that's going to be sustainable. So as we talked at the beginning, that LIFO have a lot of issues in a sense that we have to deal with LIFO reserve. We looked at LIFO reserve in the prior session. Now we looked at LIFO liquidation. And the other issue that we have to deal with LIFO is dollar value LIFO. Dollar value LIFO is also an important topic. I will be discussing this next. However, you have to have a good understanding of LIFO before you understand LIFO reserve, LIFO liquidation, and dollar value LIFO. At the end of this recording, I'm going to invite you again to take a look at my website farhatlectures.com. As I said, I don't replace your CPA review course. I'm a useful addition. Keep your CPA review course. I'm a useful addition to your accounting courses. I can help you understand the material differently. 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