Can I have an increase in inventory and still have a decrease in LIFO reserve?

Although it seems contrary to logic, the answer to the question is yes, the reserve can decrease despite increasing inventory levels. The reason is that the key to a LIFO computation is the level of inflation in inventory costs, not the quantity of the inventory. For example:

Assume your business has 100 units in inventory for the first year, and they are equally priced at $10,000. Also, assume inflation for the year is 5%. Each unit would have a LIFO benefit of about 5% of its cost, or $500. The total LIFO reserve for the 100 units is $50,000.

The next year the inventory increases to 110 units (still equally priced at $10,000 each), but this year there is deflation at the rate of 3%. This means that each of the remaining units from the first year (100) has a LIFO benefit of 2% (5% - 3%), or $200. The additional ten units have a negative LIFO benefit of 3% each, or negative $300. This makes the total LIFO reserve for the second year $17,000, a decrease of $33,000, despite the increase in inventory.

Obviously, this is a simple example but it illustrates the principle that inflation (or deflation), not quantity of units, is the most important factor in a LIFO computation.

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