merrimack tractors and mowers - bhavesh

8/3/2019 Merrimack Tractors and Mowers - Bhavesh

1/3

Ankita Aggarwal

PGP2011517

SECTION B

Merrimack Tractors and Mowers, Inc.: LIFO or FIFO?

Ricardo Rick Martino, the President and Chief Operating Officer of Merrimack Tractors and

Mowers, Inc., was faced with a situation where he had to make up his minds whether to change the

current inventory accounting system.

Originally Mowers were manufactured and assembled in workshop and factory in Nashua. However,

by 2008 company was buying all of its tractors and machines; manufactured to its specifications,

from a contract manufacturer in China, and was operating almost exclusively as a machine-and-parts

designer and distributor. About 25% of the shares of the company were held by the members of the

Martino family.

However, there were a number of factors due to which the projected net income of 2008 was less

than that of 2007 and earlier years. Its strategy of outsourcing to China due to the following reasons:

a) Beijing Olympic Games increased the labour costs in the Chinese Marketb) Chinese currency has appreciated against the U.S. Dollarc) A rise in oil prices had also increased the costs of shipping finished mowers to the United

States

Rick Martino was facing tremendous pressure from outside directors to keep earnings growing or

face the possibility of being replaced by professional manager who was not a Martino family

member.

Company management dismissed the idea of re-establishing manufacturing operations in Nashua, as

there is no way of doing so before the end of 2008 or even 2009 if the companys profit trends and

growth were to be maintained.

Changing the Method of Accounting:

The company controller, James Colburn, gave the idea of that inventory accounting bechanged to FIFO assumption

This could report a higher income figure in 2008 than it had reported for 2007 However increase in income will come with increase in taxes payable


2/3

Ankita Aggarwal

PGP2011517

SECTION B

QUESTION OF DISCUSSION

How does the change in accounting methods for inventory have an effect on reported income?

The company has been following LIFO method for the last 27 years, i.e. since its incorporation.

Because of the selection of LIFO there was under valuation of stock and hence over valuation of Cost

of Goods sold. This resulted in a cumulative undervaluation of $ 5 million over the years. This will

lead to cumulative increase in the value of closing inventory.

The company decided to change its inventory accounting method due to the following

reasons:

1. Increase the profit by reduction in valuation of Cost of Goods Sold.2. Inventory valuation will increase and hence the cost of goods sold will decrease. This will

lead to a higher projection of profit of $ 5.5 million.

The only drawback of this method is that they will have to pay an extra tax of $ 2 million.

The effect of changes in inventory of the past period has to reflect in the current year-2008.

That is why there is a drastic increase in the revenue of the current year.

According to the 2007 data, the Closing inventory valuation by FIFO method is 19000

Therefore current year Opening inventory value = 19000

IfFIFO method is followed in 2008 also, then

Cost of goods sold[Amount in $000] Closing Inventory[Amount in $000]

Beginning inventory 15000 units @ 1266.67 =19000

Purchases, Quarter 1 10000 units @ 1400 =14000

Purchases, Quarter 2 10000 units @ 1500 =15000

Purchases, Quarter 3 5000 units @ 1600 =8000 5000 units @ 1600 =8000

Purchases, Quarter 4 - 10000 units @ 1700 =17000

Total 56000 25000


3/3

Ankita Aggarwal

PGP2011517

SECTION B

IfLIFO method is followed in 2008

Cost of goods sold[Amount in $000] Closing Inventory[Amount in $000]Beginning inventory - 15000 units @ 900 = 13500

Purchases, Quarter 1 10000 units @ 1400 =14000 -

Purchases, Quarter 2 10000 units @1500 =15000 -

Purchases, Quarter 3 10000 units @ 1600 = 16000 -

Purchases, Quarter 4 10000 units @ 1700 = 17000 -

Total 62000 13500

Change in profit due to change in inventory valuation =

Difference in the cost of goods sold, i.e. 62000- 56000 = 6000

(Or) Difference in the closing inventory, i.e. 25000-13500-5500=6000

Here 5500 is the last years LIFO adjustment

Increase in profit due to change in accounting method from LIFO to FIFO for reel mowers =

$6,000,000

merrimack tractors and mowers - bhavesh

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