Case 6-2: Lewis Corporation

Approach
We have found it useful for students to perform some comparative FIFO/LIFO average cost calculations,
rather than only read about the differences among these methods. This case presents that opportunity,
with an emphasis on the income taxhence, cash flowimplications of the choice of a method. Via
Question 3, the student can see the impact of a sales decline causing a stripping off of LIFO layers with
the result that LIFO reports a lower cost of goods sold, and thus would result in higher income taxes that
year, than would FIFO.
Question 4 introduces the significance of the LIFO reserve. Students can discover that the LIFO reserve is
useful in analyzing financial statements. It can be used to estimate the cumulative tax savings realized by
adopting LIFO; and when trying to compare the financial performance of a company using LIFO to
another using FIFO, the LIFO reserve can be used to adjust the LIFO financial statements to a FIFO
basis. This adjustment will be explored in more detail in Case 6-3
Finally, Question 5 presents the opportunity to challenge the widely held notion that almost all companies
use LIFO (the instructor can update the text footnote on LIFO usage by referring to the latest edition of
Accounting Trends & Techniques and to discuss the reasons for many companies use of FIFO. For those
who wish to do so, this discussion can bring in the Efficient Markets Hypothesis. In our view, one reason
some companies continue to use FIFO in circumstances when LIFO would improve cash flows is that
their managements do not believe that EMH premise that the lower reported earnings from LIFO would
not diminish shareholder value.

Calculations for Questions

Question 1
The approach below reflects how most students perform these calculations. At some point I show them
(to their chagrin) that a lot of effort can be saved if the amount of each years purchases is calculated first,
and then the equation Beg. Invent + Purchases = COGS + End Invent. is applied year-by-year. With the
more detailed approach students take, class time allows showing only a couple of years for FIFO and
LIFO, and one year for average cost.
FIFO:

LIFO:

AVERAGE COST:

COGS

2009
1,840
600
380
2,820

@
@
@
@

$20.00
20.25
21.00

=
=
=

$36,800.00
12,150.00
7,980.00
$56,930.00

Inventory

420
400
200
1,020

@
@
@

21.00
21.25
21.50

=
=
=

8,820.00
8,500.00
4,300.00
$21,620.00

COGS

200
400
800
600
820
2,820

@
@
@
@
@

$21.50
21.25
21.00
20.25
20.00

=
=
=
=
=

$4,300.00
8,500.00
16,800.00
12,150.00
16,400.00
$58,150.00

Inventory

1,020

20.00

$20,400.00

COGS

2,820

$20.456 =

$57,685.92

Inventory
1,020 @
20.456 =
$20,865.12
Note in all three cases that the sum of the cost of goods sold and ending inventory amounts is the same:
$78,550 (slightly different with average cost because of rounding errors), which is the sum of the
beginning inventory and purchases (i.e., available for sale).
FIFO:

LIFO:

2010
420
400
200
700
700
660
3,080

@
@
@
@
@
@

$ 21.00
21.25
21.50
21.50
21.50
22.00

=
=
=
=
=
=

$ 8,820.00
8,500.00
4,300.00
15,050.00
15,050.00
14,520.00
$66,240.00

Inventory

40
1,000
1,040

@
@
@

22.00
22.25

=
=

COGS

1,000
700

@
@

$ 22.25
22.00

=
=

$22,250.00
15,400.00

COGS

880.00
22,250.00
$23,130.00

AVERAGE COST:

FIFO:

700
680
3,080

@
@

21.50
21.50

=
=

15,050.00
14,620.00
$67,320.00

Inventory

20
1,020
1,040

@
@
@

$ 21.50
20.00
20.00

=
=
=

COGS

3,080

$21.509

$66,247.72

Inventory

1,040

21.509

$22,369.36

2011
40
1,000
1,000
700
210
2,950

@
@
@
@
@

$ 22.00
22.25
22.50
22.75
23.00

=
=
=
=
=

COGS

LIFO:

COGS

Inventory
Question 2

2009
2010
2011
2011

880.00
22,250.00
22,500.00
15,925.00
4,830.00
$66,385.00

Inventory

490
700
1,190

@
@

23.00
23.50

=
=

$11,270.00
16,450.00
$27,720.00

COGS

700
700
700
850
2,950
1,020

@
@
@
@

$23.50
23.00
22.75
22.50

=
=
=
=

20.00

$16,450.00
16,100.00
15,925.00
19,125.00
$67,600.00
$20,400.00

20
150

@
@

21.50
22.50

=
=

430.00
3,375.00

COGS

1,190
2,950

$22.547

$24,205.00
$66,513.65

Inventory

1,190

22.547

$26,830.93

Inventory

AVERAGE COST:

430.00
20,400.00
$20,830.00

Check on Calculations
FIFO
$ 56,930
66,240
66,385
27,720
$217,275

LIFO
$ 58,150
67,320
67,600
24,205
$217,275

AVG.COST
$ 57,685.92
66,247.72
66,513.65
26,830.93
$217,278.22

The calculation of the $1,406 tax difference for 2005-07 is shown below. However, this difference is
really irrelevant for deciding what to do in future years.
2009

2010

2011

FIFO
LIFO
Sales .....................................................................................................................................................................
$95,880
$95,880
COGS ...................................................................................................................................................................
56,930
58,150
Gross Margin........................................................................................................................................................
38,950
37,730
Tax Expense .........................................................................................................................................................
15,580
15,092
Net Income ...........................................................................................................................................................
$23,370
$22,638

Sales .....................................................................................................................................................................
$110,110
$110,110
COGS ...................................................................................................................................................................
66,240
67,320
Gross Margin........................................................................................................................................................
43,870
42,790
Tax Expense .........................................................................................................................................................
17,548
17,116
Net Income ...........................................................................................................................................................
$ 26,322
$ 25,674

Sales .....................................................................................................................................................................
$105,462.50
$105,462.50
COGS ...................................................................................................................................................................
66,385.00
67,600.00
Gross Muffin ........................................................................................................................................................
39,077.50
37,862.50
Tax Expense .........................................................................................................................................................
15,631.00
15,145.00
Net Income ..........................................................................................................................................................
$ 23,446.50
$ 22,717.50
Total Tax Expense Savings:
2009
$ 488
2010
432
2011
486
$1,406
An easier approach, which most students will overlook, is to note that the three-year difference in COGS
is $3,515, and 40 percent of this is $1,406. Even easier, but much more subtle, is realizing that the threeyear COGS difference is equal to the difference in 2011 year-end inventories ($27,720 - $24,205 =
$3,515).

Question 3
Purchases for 2012 forecasted at 1,910* cartons @ 24.00
FIFO

COGS

Inventory
LIFO:

COGS

Inventory

490
700
1,510
2,700

@
@
@

$23.00
23.50
24.00

=
=
=

$11,270
16,450
36,240
$63,960

400

$24.00

$9,600

1,910
150
20
620
2,700

@
@
@
@

$24.00
22.50
21.50
20.00

=
=
=
=

$45,840
3,375
430
12,400
$62,045

400

20.00

$8,000

FIFO
LIFO
2012 Sales (2,700 @ $35.75) ..............................................................................................................................................
$96,525
$96,525
COGS ...........................................................................................................................................................................
63,960
62,045
Gross margin ................................................................................................................................................................
32,565
34,480
Tax expense .................................................................................................................................................................
13,026
13,792
Net income ...................................................................................................................................................................
$19,539
$20,688
In 2012, LIFO would cause an increase in tax expense of $766.
Question 4
The LIFO reserve is the difference between inventory calculated under the FIFO method, and inventory
calculated under the LIFO method.
2009
2010

LIFO Reserve
$1,220
$2,300

=
=
=

FIFO Inventory
$21,620
$23,130

LIFO Inventory
$20,400
$20,830

Another way to look at the LIFO reserve is that it represents the cumulative difference between LIFO cost
of goods sold and FIFO cost of goods sold. We can see that in 2009, the LIFO reserve ($1,220) is equal to
the difference between LIFO cost of goods sold and FIFO cost of goods sold ($58,150 - $56,930 =
$1,220). Similarly, in 2010, the LIFO reserve ($2,300) is equal to the sum of the differences between
LIFO and FIFO cost of goods sold for 2009 and 2010, as shown on the next page.

2,700 sales + 400 ending inventory - 1,190 beginning inventory = 1,910.

2009
2010
LIFO cost of goods sold ......................................................................................................................................................
$58,150
$67,320
FIFO cost of goods sold ......................................................................................................................................................
56,930
66,240
Difference............................................................................................................................................................................
$ 1,220 +
$ 1,080 = $2,300
Therefore, if you are given LIFO cost of goods sold and inventory, and you are also given the LIFO
reserve for that year (year X) and the previous year (year X-1), you can estimate the following:
FIFO inventory (year X) = LIFO inventory (year X) + LIFO reserve (year X)
FIFO COGS (year X) = LIFO COGS (year X) - [LIFO reserve (year X) - LIFO reserve (year X-l)]
Tax savings (year X) = [LIFO reserve (year X) - LIFO reserve (year X-1)] *(1 tax rate)
Cumulative tax savings due to the use of LIFO = LIFO reserve (year X)
Companies on LIFO report the LIFO reserve in their financial statements, often in the inventory footnote.
Understanding the significance of the LIFO reserve can be very useful when trying to compare the
financial performance of companies using different inventory accounting methods.
Question 5
See Why Not More LIFO? section of the text, plus comments earlier in this note.