Chapter 7, Problem 6CP

Making a Decision as a Financial Analyst: Analysis of the Effect of a Change to LIFO

A press release for Seneca Foods (licensee of the Libby’s brand of canned fruits and vegetables) included the following information:

The current year's net earnings were $8,019,000 or $0.65 per diluted share, compared with $32,067,000 or $2.63 per diluted share, last year. These results reflect the Company’s decision to implement the LIFO (last-in, first-out) inventory valuation method effective December 30, 2007 (fourth quarter). The effect of this change was to reduce annual pretax earnings by $28,165,000 and net earnings by $18,307,000 or $1.50 per share ($1.49 diluted) below that which would have been reported using the Company's previous inventory method. The Company believes that in this period of significant inflation, the use of the LIFO method better matches current costs with current revenues. This change also results in cash savings of $9,858,000 by reducing the Company's income taxes, based on statutory rates, if the Company had remained on the FIFO (first-in. first-out) inventory valuation method, the pretax results, less non-operating gains and losses, would have been an all-time record of $42,644,000. up from $40,009,000 in the prior year.

Required:

As a new financial analyst at a leading Wall Street investment banking firm, you are assigned to write a memo outlining the effects of the accounting change on Seneca’s financial statements. Assume a 35 percent tax rate. In your report, be sure to include the following:

1. 1. Why did management adopt LIFO?
2. 2. By how much did the change affect pretax earnings and ending inventory? Verify that the amount of the tax savings listed in the press release is correct.
3. 3. As an analyst, how would you react to the decrease in income caused by the adoption of LIFO? Consider all of the information in the press release.