Chapter 7, Problem 7.5CP

Using Financial Reports: Interpreting Effects of the LIFO/FIFO Choice on Inventory Turnover

In its annual report, Caterpillar, Inc., a major manufacturer of farm and construction equipment, reported the following information concerning its inventories:

Inventories are stated at the lower of cost or market. Cost is principally determined using the last-in, first-out (LIFO) method. The value of inventories on the LIFO basis represented about 65% of total inventories at December 31, 2011, and about 70% of total inventories at December 31,2010 and 2009.

If the FIFO (first-in. first-out) method had been in use. ¡memories would have been $2,422 million. $2,575 million, and $3,022 million higher than reported at December 31.

2011.2010. and 2009. respectively.

On its balance sheet. Caterpillar reported:

	2011	2010	2009
Inventories	$14,544	$9,587	$6,360

	2011	2010	2009
Cost of goods sold	$43,578	$30,367	$23,886

Required:

As a recently hired financial analyst, you have been asked to analyze the efficiency with which Caterpillar has been managing its inventory and to write a short report. Specifically, you have been asked to compute inventory turnover for 2011 based on FIFO and LIFO and to compare the two ratios with two standards: (1) Caterpillar for the prior year 2010 and (2) its chief competitor. John Deere. For 2011, John Deere’s inventory turnover was 4.2 based on FIFO and 5.9 based on UFO. In your report, include:

1. 1. The appropriate ratios computed based on FIFO and LIFO.
2. 2. An explanation of the differences in the ratios across the FIFO and LIFO methods.
3. 3. An explanation of whether the FIFO or LIFO ratios provide a more accurate representation of the companies’ efficiency in use of inventory.