Caterpillar Inc is one of the worlds largest manufacturers o

Caterpillar, Inc., is one of the world’s largest manufacturers of construction, mining, and forestry machinery. The following disclosure note is included in the company’s 2015 financial statements:

Real World Financials

D. Inventories ($ in millions)

Inventories are stated at the lower of cost or market. Cost is principally determined using the last-in, first-out (LIFO) method. If the FIFO (first-in, first-out) method had been in use, inventories would have been $2,498 million and $2,430 million higher than reported at December 31, 2015 and 2014, respectively.

Required: 1. The company reported LIFO cost of goods sold of $33,742 million. Calculate the amount that would be reported for cost of goods sold had Caterpillar used the FIFO inventory method for all of its inventory.

2. Using the cost of goods sold calculated in requirement 1, how much higher (lower) would income before taxes be, if Caterpillar had used the FIFO inventory method for all of its inventory?

Solution

WN-1 : Basic Data

a) Company was following LIFO method for Inventory valuation for the financial year 2014.

b) Value of Closing stock under FIFO method= $ 2498 millions

c) Increase in the value of closing stock due to change in method of valuation= $ 2430 millions

d) Cost of goods sold( COGS) under LIFO method= $ 33742 millions

WN-2 : Change in COGS due to change in valuation

COGS= Opening Stock + Purchases - Closing Stock

( Hint: Since we do not have Opening stock & Purchase figures , we can\'t apply use this formula directly but using this formula we can understand that IF Closing stock increases COGS will decrease and vise verse.)

There fore since there is an increase inthe closing stock by $ 2430 millions, revised value of COGS will be $ 31312 millions ( i.e. 33742- 2430) .

note** : Since the Previous year statements are finalized, changes cannot be made in the same. So opening stock cannot be changed. But we will have to disclose the change in valuation of inventory and the its effect on profitability, in the Financial Statements.

WN-3 : Change Income Before taxes due to change in Valuation.

Profit or Income = (Sales+ Closing Stock)- (Opeing Stock + Purchases+Expenses)

(Hint: From the above formula it is clear that if the Closing stock Increases then Income will increase and vise versa.)

Since Closing stock has been reported higher by $2430 millions , taxable income will be higher by $2430 millions.

Conclusion

Ans 1: Revised COGS (WN-2)= $ 31312 millions

Ans 2: Increase in Taxable Income (WN-3)= $2430 millions