A case presented in Winter 2007 about a fictitious company dealing with the difference between FIFO and LIFO inventory accounting.

1. Morgan Manufacturing Presented by: Mark Bundang, B.Sc and Mohammed Abdo, B.Eng, M.Eng, PhD, CSSA, PMP

2. Morgan Manufacturing Agenda Introduction Situation Analysis Conclusion

3. Morgan Manufacturing Agenda Introduction Situation Analysis Conclusion

7. Pre-tax Return on Sales

8. Pre-tax Return on Assets Key Fact

9. Morgan Manufacturing Agenda Introduction Situation Analysis Conclusion

10. Morgan Manufacturing Inventory Costing Methods EInv = BInv + Purchases – COGS

11. Morgan Manufacturing Inventory Costing Methods: FIFO and LIFO

12. Morgan Manufacturing FIFO and LIFO: Goods Available for Sale Current year purchases Beg. Inventory cost COGS FIFO (Pipe) (Bin) LIFO

13. Morgan Manufacturing The LIFO Reserve: What‘s Left in Inventory ? Current year purchases Beg. Inventory cost End. Inventory (Bin) LIFO FIFO (Pipe) Ending Inventory (FIFO) Ending Inventory (LIFO) “LIFO Reserve” = EInvFIFO – EInvLIFO

14. Morgan Manufacturing Using the LIFO Reserve: Income Statement EInvFIFO = BInvFIFO + Purchases – COGSFIFO EInvLIFO = BInvLIFO + Purchases – COGSLIFO Subtracting these two equations yields: EInvFIFO – EInvLIFO = BInvFIFO–BInvLIFO– (COGSFIFO–COGSLIFO) EInvFIFO– EInvLIFO– (BInvFIFO–BInvLIFO) = COGSLIFO–COGSFIFO End LIFO Reserve – Beg. LIFO Reserve = COGSLIFO–COGSFIFO  Change in LIFO Reserve = LIFO-FIFO difference in COGS

15. Morgan Manufacturing Accounts Affected by the Inventory Costing Method Income Statement Cost of Goods Sold Income Gross Margin Change in LIFO Reserve Inventory Retained Earnings Balance Sheet

16. Morgan Manufacturing Key Parameters to Assess Operating Efficiency Calculation Meaning Ratio Gross Margin Percentage How well is the business’ ability to generate a return at the Gross Profit level. 1 Pre-tax Return on Sales (ROS) How well the business is managing its operating expenses. 2 Pre-tax Return on Assets (ROA) How much income (before taxes) is derived from every 1 dollar in assets. 3 Inventory Turnover How quickly inventory turns over in a given period of time. 4 Days’ Inventory How many days needed to turn inventory over completely. 5

17. Morgan Manufacturing Financial Statements: Morgan and Westwood Based on LIFO Based on FIFO **All figures are in $ millions

18. Morgan Manufacturing Initial Comparison Before LIFO/FIFO Conversion Based on LIFO Based on FIFO 2006 Comparison: Difference Westwood Inc. Morgan Manufacturing Ratio -0.5% 45.0% Gross Margin Percentage 44.5% 1 -0.5% 15.0% Pre-tax Return on Sales (ROS) 14.5% 2 -0.03% 13.39% Pre-tax Return on Assets (ROA) 13.36% 3 +4.6 times 6.5 times Inventory Turnover 11.1 times 4 -23.5 days 56.4 days Days’ Inventory 32.9 days 5

19. Morgan Manufacturing Inventory Gross Margin EInvLIFO=$100 LIFO Reserve (2006)=$70 EInvFIFO=EInvLIFO+ LIFO Reserve EInvFIFO= $170 $950 (Increase from $890 LIFO amount) Income Before Tax $350 (Increase from $290 LIFO amount) Conversion of Accounts from LIFO to FIFO Morgan year ended December 31, 2006 COGS COGSFIFO=COGSLIFO+ ΔLIFORes ΔLIFORes= - $60 COGSFIFO=$1,110 + ($10-$70) COGSFIFO=$1,050 LIFO to FIFO Comparison enabled

20. Morgan Manufacturing Effect of Inventory Method: Morgan Manufacturing COGS GM IBT TaxesLIFO < TaxesFIFO Inventory Assets R/E **All figures are in $ millions

21. Morgan Manufacturing Financial Statements: After LIFO to FIFO Conversion COGSM < COGSW GMM > GMW IBTM > IBTW InvM = InvW AssetsM = AssetsW REM > REW **All figures are in $ millions

22. Morgan Manufacturing Comparison After LIFO to FIFO Conversion 2006 Comparison: Difference Westwood Inc. Morgan Manufacturing Ratio +2.5% 45.0% Gross Margin Percentage 47.5% 1 +2.5% 15.0% Pre-tax Return on Sales (ROS) 17.5% 2 +2.2% 13.39% Pre-tax Return on Assets (ROA) 15.6% 3 -0.3 times 6.5 times Inventory Turnover 6.2 times 4 +2.5 days 56.4 days Days’ Inventory 58.9 days 5

23. Morgan Manufacturing Profit After LIFO to FIFO Conversion Calculation Meaning Ratio Profit Margin Percentage How well is the business’ ability to generate profit. 2006 Comparison: Difference Westwood Inc. Morgan Manufacturing Ratio +1.5% 9.0% Profit Margin Percentage 10.5%

24. Morgan Manufacturing Agenda Introduction Situation Analysis Conclusion

26. Based on the operating efficiency parameters calculated after conversion of LIFO figures into FIFO, comparison of Morgan Manufacturing ratios to those of Westwood Inc. was made possible.