This document analyzes the inventory accounting methods of LIFO and FIFO for Merrimack Tractors and Mowers Inc. given rising costs of imports from China. Using a LIFO analysis, it shows that with LIFO, the company's net income would decrease rapidly over 2007-2009 despite sales increases, due to rising inventory costs. Switching to FIFO in 2008 would increase reported profits that year but likely lead to higher taxes in future years as costs rise. The document considers whether LIFO or FIFO is most suitable for the company given its current challenges meeting costs amid rising import prices from China.

1. Case Study – Merrimack Tractors and Mowers Inc.
Case Study Merrimack Tractors and Mowers Inc.
Submission Date 13-Sep-2009
Class EPGP– 09-10
Subject Financial Reporting and Analysis
Submitted by
 Abhishek Pangaria
 Mandeepak Singh
 Rajendra Inani
 Saravanan Logu
 Tarandeep Singh
 Vivek Edlabadkar
Table of contents
Objectives............................................................................................................................2
Case Background.................................................................................................................2
About the Company.........................................................................................................2
Company’s need...............................................................................................................3
Analysis of current Business Scenario.................................................................................4
Conclusion.........................................................................................................................12
Take the FIFO way........................................................................................................12
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2. Case Study – Merrimack Tractors and Mowers Inc.
Objectives
To analyze suitability of LIFO or FIFO as inventory accounting method in view of the present economic
health of Merrimack Tractors and Mowers Inc.
Case Background
About the Company
Name of the company Merrimack Tractors and Mowers, Inc.
Line of Business Lawn care and maintenance equipment line manufacturing
Business Practice Manufacturing is outsourced to China, only distribution is done with import
Ricardo “Rick” Martino, President and chief operating officer, he took over charge of company from year
1995 after death of his father. This company was founded after World War II by grandfather of Rick at
Nashua, New Hampshire.
Company incorporated in 1980 having 4000 share holders. Its equity traded at NASDAQ. The 25% equity
of this company is retained by Martino family.
By year 2008, the company was buying all of its tractors and machines, manufactured to its specifications,
from a contract manufacturer in China, and it is operating exclusively as a machine and parts designer and
distributor. Low labor cost at China made this company to close its US manufacturing facilities and shifted
manufacturing to China.
Martino thought about expanding beyond their regional base, but in contrast to their competitors who had
developed national and international sales forces, had never done so.
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3. Case Study – Merrimack Tractors and Mowers Inc.
Company’ s need
Change in China’s economy with Beijing Olympics Games increased wages and labor costs, material and
energy costs. Also, Yuan appreciation against dollars and Oil price increase resulting in transportation cost
in comparison to local US manufacturers. The financial health of company was showing that year 2008 Net
income would be below year 2007’s income.
It would be difficult to establish a new vendor for parts supplies within the period of current financial year
to ensure better income for the company. Also, restarting manufacturing back in US would take some time,
but not before end of current financial year.
Company controller James Colburn gave idea about changing method of accounting inventory. (LIFO to
FIFO)
Present inventory accounting method – Matching cash received to the costs required to produce mowers.
As a small, unincorporated business run by the founder of the company, cash flow was considered as
adequate measure of income, and income taxes were paid by family members and employees who received
cash from the company.
With the incorporation of the company in 1980, however, new accounting policies needed to be selected
and applied. Since that time, inventories had been reported at cost and using an assumption of last-in, first
out (LIFO) flows applied on a periodic basis. LIFO had been selected to save on income tax payments so
that the cash saved being used for investments, and about $2 milllion had been saved since 1980.
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4. Case Study – Merrimack Tractors and Mowers Inc.
Analysis of current Business Scenario
Until 2007, Merrimack has accumulated a LIFO reserve of $5.5 million. Considering the current trend of
rising prices, LIFO is a suitable method for computation but as evident from the discussions between the
board members, Merrimack is facing huge challenges in meeting up with the cost and keeping the margins
intact. This is primarily because of the rising cost of imports.
Possible Solutions
1. Continuing with LIFO
2. Moving to FIFO from 2008
As evidenced by Colburn, moving to FIFO will cost the company $2 million on account of additional taxes.
But this tax is unavoidable if the company were ever to liquidate.
Moving into FIFO in 2008 will plug in additional $3.5 million into the financial system and hence bloat the
profit margin for the year.
However, moving to FIFO in times of rising costs is going to be counterproductive in following years. This
is because the company would be incurring higher taxes as the cost of goods in transaction would be lower
than what would have been in LIFO.
Assumptions in analysis
1. Sales remain consistent at 40,000 units each year
2. Selling and administrative expenses remain constant
3. Sales Price increases YoY at a rate of 5%
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5. Case Study – Merrimack Tractors and Mowers Inc.
LIFO Analysis
LIFO Costing Model
LIFO Costing Model Units 2007 Cost Units 2008 Cost Units 2009 Cost
Beginning 15,0 90 13,500,00 15,0 90 13,500,00 15,00 90 13,500,00
Inventory 00 0 0 00 0 0 0 0 0
10,0 1,00 10,000,00 10,0 1,40 14,000,00 10,00 1,80 18,000,00
Purchases,Q1 00 0 0 00 0 0 0 0 0
10,0 1,10 11,000,00 10,0 1,50 15,000,00 10,00 1,90 19,000,00
Purchases,Q2 00 0 0 00 0 0 0 0 0
10,0 1,20 12,000,00 10,0 1,60 16,000,00 10,00 2,00 20,000,00
Purchases,Q3 00 0 0 00 0 0 0 0 0
10,0 1,30 13,000,00 10,0 1,70 17,000,00 10,00 2,10 21,000,00
Purchases,Q4 00 0 0 00 0 0 0 0 0
55,0 59,500,00 55,0 75,500,00 55,00 91,500,00
Available for Sales 00 0 00 0 0 0
40,0 46,000,00 40,0 62,000,00 40,00 78,000,00
Less Sale 00 0 00 0 0 0
15,0 15,0 15,00
$13,500,000 $13,500,000 $13,500,000
Ending Inventory 00 00 0
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6. Case Study – Merrimack Tractors and Mowers Inc.
LIFO Analysis – Income Statement
Income Statement 2007 - LIFO 2008 - LIFO 2009 LIFO
Sales $67,000,000 $70,350,000 $73,867,500
Cost of Goods Sold $46,000,000 $62,000,000 $78,000,000
Gross Margin $21,000,000 $8,350,000 -$4,132,500
Selling and admin exp. $10,000,000 $10,000,000 $10,000,000
Income before taxes $11,000,000 -$1,650,000 -$14,132,500
Income tax(35%) $3,850,000 $0 $0
Net Income $7,150,000 -$1,650,000 -$14,132,500
Profitabilty Margin 10.67 (2.35) (19.13)
From this, we may conclude the following
1. Despite the rise in costs, the inventory holding remains unchanged.
2. YoY, the net income is depleting at a rapid rate. The main contributor
for this change is the increasing COGS.
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7. Case Study – Merrimack Tractors and Mowers Inc.
FIFO Conversion
FIFO Costing Model
Units 2007 Cost Units 2008 Cost Units 2009 Cost Units 2009 Cost **
(increasing
value)
Beginning 15,00 9 13,500,00 5,0 1, 6,000,00 5, 1,6 8,000, 8,000,000
Inventory 0 00 0 00 200 0 000 00 000 5,000 1,600
10,00 1, 13,000,00 10, 1,7 17,000,0 17,000,000
0 300 0 000 00 00 10,000 1,700
Purchases,Q1 10,00 1,0 10,000,00 10,00 1, 14,000,00 10, 1,8 18,000,0 10,000 15,000,000
0 00 0 0 400 0 000 00 00 1,500
Purchases,Q2 10,00 1,1 11,000,00 10,00 1, 15,000,00 10, 1,9 19,000,0 10,000 15,000,000
0 00 0 0 500 0 000 00 00 1,500
Purchases,Q3 10,00 1,2 12,000,00 10,00 1, 16,000,00 10, 2,0 20,000,0 10,000 15,000,000
0 00 0 0 600 0 000 00 00 1,500
Purchases,Q4 10,00 1,3 13,000,00 10,00 1, 17,000,00 10, 2,1 21,000,0 10,000 15,000,000
0 00 0 0 700 0 000 00 00 1,500
Available for 55,00 59,500,00 55,00 81,000,00 55, 103,000,0 55,000 85,000,000
Sales 0 0 0 0 000 00
Less Sale 40,00 40,500,00 40,00 56,000,00 40, 72,000,0 40,000 62,500,000
0 0 0 0 000 00
Ending 15,00 $19,000,00 15,00 $25,000,00 15, $31,000,000 15,000 $22,500,000
Inventory 0 0 0 0 000
** - Indicates the values with curtailed COGS
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8. Case Study – Merrimack Tractors and Mowers Inc.
2009 -
Income Statement 2007-FIFO 2008 - FIFO 2009 - FIFO FIFO**
Sales $67,000,000 $70,350,000 $73,867,500 $73,867,500
40,500,00
Cost of Goods Sold 0 $56,000,000 $72,000,000 $63,750,000
Gross Margin $26,500,000 $14,350,000 $1,867,500 $10,117,500
Selling and admin exp. $10,000,000 $10,000,000 $10,000,000 $10,000,000
Income before taxes $16,500,000 $4,350,000 -$8,132,500 $117,500
Income tax(35%) $5,775,000 $1,522,500 $0 $41,125
Net Income $10,725,000 $2,827,500 -$8,132,500 $76,375
Profitabilty Margin 16.01 4.02 (11.01) 0.10
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9. Case Study – Merrimack Tractors and Mowers Inc.
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10. Case Study – Merrimack Tractors and Mowers Inc.
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11. Case Study – Merrimack Tractors and Mowers Inc.
Conclusion
Take the FIFO way
Considering available options it is evident that the business will run unviable in 2008 if the company does
not move to FIFO method of accounting for inventory.
This however is not the gospel to move company from RED to green. The move will prove to be extremely
wrong if the company does not plan to reduce cost of production/purchase.
Hence this move is to be seen only as a measure to keep the business running under “viable” status for
another year.