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LIFO liquidation

LIFO Liquidation occurs when a company using the LIFO (Last in, First out) accounting method sells old merchandise.

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LIFO for many companies is the more attractive means of accounting for inventory because of its potential to reduce apparent net income and consequently taxes for the company. This can be completely undone by LIFO liquidation however. A company uses LIFO assuming that when it needs to replace inventory its repurchasing costs will increase. This is a reasonable guess as most years there is inflation present in the economy and usually manifests in goods. The problem arises when a company's backlog of old merchandise piles up, and the company either stats to sell due to unavailability of replacement merchandise or necessity (space in warehouse, need for cash). When selling this older merchandise the company must recognize the old cost but also the new (and presumably higher) sale price, thus increasing net income and negating the tax advantage LIFO accounting can provide.

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