LIFO charge

An accounting adjustment that increases cost of goods sold when inventory costs are rising under the Last-In, First-Out method.

A LIFO (Last-In, First-Out) charge is an accounting adjustment made by companies that use the LIFO inventory valuation method. When the costs of acquiring or manufacturing inventory are rising due to inflation, the LIFO method assumes that the newer, more expensive inventory is sold first. This increases the Cost of Goods Sold (COGS) on the income statement and reduces reported net income, which in turn lowers the company's tax liability. To calculate this adjustment, companies track a "LIFO reserve," which is the cumulative difference between inventory valued under the First-In, First-Out (FIFO) method and the LIFO method. The LIFO charge represents the year-over-year change in this reserve. If inventory costs are rising, the reserve grows, resulting in a positive LIFO charge that is added to COGS. For investors, a rising LIFO charge indicates that the company is experiencing inflation in its supply chain. While it reduces reported profitability in the short term, it actually improves cash flow because the company pays less in corporate income taxes. Conversely, during deflationary periods, this charge can reverse (becoming a LIFO credit), which boosts reported margins but can increase tax obligations.

Company A starts the fiscal year with a LIFO reserve of $50 million. Due to rising wholesale prices during the year, the calculated value of its inventory under FIFO is $152 million higher than it is under LIFO at year-end, meaning the ending LIFO reserve is $152 million. The company must record a LIFO charge of $152 million - $50 million = $102 million on its income statement, which directly increases COGS and reduces pre-tax income by $102 million.