Merrimack Tractors and Mowers, Inc.

Managerial Accounting and Control LIFO or FIFO Submitted to Prof. A. Kanagaraj

5/9/2011 2011PGP840 S. Shankar (SEC B)

Executive Summary: Merrimack Tractors and Mowers, Inc, located in Nashua, New Hampshire, were started during the World War II by the grandfather of the current President and Chief Operating Officer, Mr. Ricardo Martino. Initially the mowers were manufactured and assembled in their own factory. But by 2008, the company was buying all its mowers and tractors from a contract manufacturer in China, which used to manufacture according to Merrimack s requirements. This decision was justified considering two factors. Firstly the wages in China were very low and secondly the oil prices were comparatively very cheap. So the total cost including the cost of shipping was much less compared to the production in its own plant. In 2008 the situation changes due to the following reasons: 1. The Beijing Olympics in China has made the cost of labour expensive. 2. The strengthening Chinese currency compared the U.S. dollar made the outsourcing costlier. 3. Rising oil charges made the shipping charges to rise by three times. The competitors who did not outsource were not affected much by this price rise. Therefore there was pressure on the Merrimack Tractors and Mowers Inc, to show a positive performance this year. The idea of re-establishing a local plant or outsourcing to another source was not feasible due to time constraints. There was a proposal from James Colburn, the company controller, that they change the accounting method for the inventories like tractors, mowers and parts. The accounting method is changed from LIFO to FIFO to gain the LIFO reserve. The FIFO method has to be consistently applied to all the previous years. The trade-off between the LIFO and FIFO method is Tax versus Net Income.

ENDING INVENTORY IN 2007 USING FIFO:

2007 FIFO method Units Cost per unit Total cost Opening inventory 15000 900 13500000 Purchases Q1 10000 1000 10000000 Q2 10000 1100 11000000 Q3 10000 1200 12000000 Q4 10000 1300 13000000 Available for sale 55000 59500000 Sales Ending inventory 40000 15000 40500000 19000000

We observe that there is a difference between the FIFO and LIFO accounting method in inventory valuation. This difference is called LIFO reserve.

COST OF SALES IN 2008 USING LIFO AND FIFO:

2008 FIFO method Units Cost per unit Total cost Opening inventory 15000 19000000 Purchases Q1 10000 1400 14000000 Q2 10000 1500 15000000 Q3 10000 1600 16000000 Q4 10000 1700 17000000 Available for sale 55000 75500000 Sales Ending inventory 40000 15000 56000000 13500000

In this method the initial inventory method is taken by calculating the ending inventory from the previous year by FIFO. Thereby the initial inventory valuation is more than the normal valuation.

Opening inventory Purchases Q1 Q2 Q3 Q4 Available for sale Sales Ending inventory

2008 LIFO method Units Cost per unit 15000 900 10000 10000 10000 10000 55000 40000 15000 1400 1500 1600 1700

Total cost 13500000 14000000 15000000 16000000 17000000 75500000 62000000 13500000

INCOME STATEMENT FOR THE YEAR 2008:

2008 FIFO 67000000 56000000 11000000 10000000 1000000 350000 650000

Income statement 2008 LIFO Sales 67000000 Cost of goods sold 62000000 Gross Margin 5000000 Admin Expenses 10000000 Income Before Tax -5000000 Income Tax @35% NA Net Income -5000000

Thus the difference of $5065000 is obtained in the two accounting methods. Thus a profit can be shown in the year but they have a tax liability of $2 million when using the FIFO method across the years.