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  • LIFO vs FIFO Impact on Merrimack Tractors

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    The document discusses the inventory valuation methods used by Merrimack Tractors and Mowers and how changing methods would impact financial performance. Merrimack currently uses LIFO (Last-In First-Out) but rising import costs from China have reduced profits. The company controller suggests switching to FIFO (First-In First-Out) to increase reported income at the cost of higher taxes. Calculations show net income would become positive under FIFO instead of negative under LIFO. While taxes would rise with FIFO, it provides time to address rising cost issues and profits may improve if Chinese wages decrease.

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    Vaibhav Maheshwari Merrimack Tractors 2011pgp926

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    The document discusses the inventory valuation methods used by Merrimack Tractors and Mowers and how changing methods would impact financial performance. Merrimack currently uses LIFO (Last-In First-Out) but rising import costs from China have reduced profits. The company controller suggests switching to FIFO (First-In First-Out) to increase reported income at the cost of higher taxes. Calculations show net income would become positive under FIFO instead of negative under LIFO. While taxes would rise with FIFO, it provides time to address rising cost issues and profits may improve if Chinese wages decrease.

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    Attribution Non-Commercial (BY-NC)
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    836 views3 pages

    LIFO vs FIFO Impact on Merrimack Tractors

    Uploaded by

    studvabz
    The document discusses the inventory valuation methods used by Merrimack Tractors and Mowers and how changing methods would impact financial performance. Merrimack currently uses LIFO (Last-In First-Out) but rising import costs from China have reduced profits. The company controller suggests switching to FIFO (First-In First-Out) to increase reported income at the cost of higher taxes. Calculations show net income would become positive under FIFO instead of negative under LIFO. While taxes would rise with FIFO, it provides time to address rising cost issues and profits may improve if Chinese wages decrease.

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    [VAIBHAV MAHESHWARI, SEC A, ROLL PGP2011926] September 5, 2011

    MERRIMACK TRACTORS AND MOWERS INC.: LIFO OR FIFO? Merrimack Tractors and Movers is a US based company. Earlier it used to assemble mowers in Nashua but after 1980 it stopped manufacturing and assembling operations and started buying its tractors and machines from China. By 2008 imports cost from China was rising because of following reasons: Increased wages and labour costs Strengthening of Chinese currency Consequences Projected net income of year 2008 was below that of 2007 and earlier years External Directors were forcing COO Rick Martino to keep incomes growing else quit Solution: James Colburn, company controller, suggested that they have been following Last-in, first-out (LIFO) method of inventory valuation and have been able to save on taxes because of it but if they changed their method from LIFO to FIFO (Firstin First-out) then they can increase income figures at the cost of increase in the taxes payable. To consider Colburns idea Rick needed detailed financial analysis which is as follows: Valuation of the Inventories for the years 2007 and 2008 on LIFO basis 2007 Cost Per Unit 900 1000 1100 1200 1300 2008 Cost Per Unit 900 1400 1500 1600 1700

    Beginning Inventory Purchases, Quarter 1 Purchases, Quarter 2 Purchases, Quarter 3 Purchases, Quarter 4 Available for Sale Less: Sales Ending Inventory

    Units 1500 0 1000 0 1000 0 1000 0 1000 0 5500 0 4000 0 1500 0

    Cost 1350000 0 1000000 0 1100000 0 1200000 0 1300000 0 5950000 0 4600000 0 1350000 0

    Units 15000 10000 10000 10000 10000 55000 40000 15000

    Cost 1350000 0 1400000 0 1500000 0 1600000 0 1700000 0 7550000 0 6200000 0 1350000 0

    Projected Income Statements for the years 2007 and 2008 based on LIFO method: Income Statement - 2007 67000000 46000000 Income Statement - 2008 70350000 62000000

    Sales Less: Cost of Goods Sold

    [VAIBHAV MAHESHWARI, SEC A, ROLL PGP2011926] September 5, 2011


    Gross Margin Selling and Admin Exp. Income before Taxes Income Taxes (35%) Net Income 21000000 10000000 11000000 3850000 7150000 8350000 10000000 -1650000 0 -1650000

    Evaluation of inventories on FIFO basis (As suggested by Colburn): 2008 Cost Per Unit 900 1400 1500 1600 1700

    Beginning Inventory Purchases, Quarter 1 Purchases, Quarter 2 Purchases, Quarter 3 Purchases, Quarter 4 Available for Sale Less: Sales Ending Inventory

    Units 1500 0 1000 0 1000 0 1000 0 1000 0 5500 0 4000 0 1500 0

    Cost 1350000 0 1400000 0 1500000 0 1600000 0 1700000 0 7550000 0 5050000 0 2500000 0

    For preparing Income statement of year 2008 we need to take following assumptions as case do not provide data regarding them: An increase of 5 %, in sales revenue, is assumed for the year 2008 because the costs are rising and company might have increased its sales price to compensate loss in profits Selling and Administration expenses are still same as that of year 2007 Income tax percentage is also same as that of year 2007 Income Statement on FIFO basis for year 2008 Income Statement 70350000 50500000 19850000 10000000 9850000 3447500 6402500

    Sales Less: Cost of Goods Sold Gross Margin Selling and Admin Exp. Income before Taxes Income Taxes (35%) Net Income

    [VAIBHAV MAHESHWARI, SEC A, ROLL PGP2011926] September 5, 2011


    Inference: After comparing income statements of year 2008 based on LIFO and FIFO methods we can observe a drastic impact it had on NET INCOME. NET INCOME is positive when FIFO method is used and negative when LIFO is used. As per Colburns report, real cost of switching over to FIFO is $ 5.5 million and will lead to immediate tax liability of $ 2 million but still we will be left with $ 3.5 million which will increase the income. Increasing tax burden is a concern but at least it will give Rick some time to see how real problem of rising costs can be solved. Further, after Olympics in China are over there is a possibility that wages and labour costs can come down and dollar may regain strength. Attachments:
    Merrim ack_FIFO_LIF O.xls

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