Merrimack Lifo Fifo

Syndicate Case Study

Merrimack Tractors and Mowers, Inc: LIFO or FIFO?

Question 1

Using LIFO, prepare a pro-forma income statement for 2008 assuming that the company sells 10,000 units each quarter at a price of $2,000 per unit with Sales General and Administrative costs the same for 2007.

Answer:

| Units | 2007 (LIFO) Per Unit | Cost (in ’000) | Units | 2008(LIFO) Per Unit | Cost (in ‘000) |

Beginning Inventory | 15,000 | $900 | $13,500 | 15,000 | $900 | $13,500 |

Purchase, Quarter 1 | 10,000 | $1,000 | $10,000 | 10,000 | $1,400 | $14,000 |

Purchase, Quarter 2 | 10,000 | $1,100 | $11,000 | 10,000 | $1,500 | $15,000 |

Purchase, Quarter 3 | 10,000 | $1,200 | $12,000 | 10,000 | $1,600 | $16,000 |

Purchase, Quarter 4 | 10,000 | $1,300 | $13,000 | 10,000 | $1,700 | $17,000 |

Available for Sale | 55,000 | | $59,500 | 55,000 | | $75,500 |

Less Sales | 40,000 | | $46,000 | 40,000 | | $62,000 |

Ending Inventory | 15,000 | | $13,500 | 15,000 | | $13,500 |

Pro Forma Income Statement 2008 (in ‘000)

Sales | $80,000 (4*10000*$2000) |

Cost of goods sold | $62,000 (14+15+16+17) |

Gross Margin | $18,000 |

Selling & Admin Expense | $10,000 |

Income before taxes | $8,000 |

Income Taxes (35%) | $2,800 |

Net Income | $5,200 |

Question 2

Prepare a pro-forma income statement for 2008 assuming that the company switches to FIFO at the beginning of 2008. All the other assumptions remain the same as in Question 1.

Note for this question:

Switching to FIFO at the beginning of 2008 would trigger an adjustment in the dollar amount of inventory. The journal entry for the adjustment in inventory would be

Inventory: Increase by $5.5M (this is the amount of LIFO reserve provided in the case)

Taxes payable: Increase by 1,925,000 (35% of $5.5M

Retained earnings (through Other Comprehensive Income): Increase by $3,575,000

As shown in the journal entry, the adjustment leads to an increase in retained earnings through OCI...