KW Steel Corp. uses the LIFO method of inventory valuation. Waretown Steel, KW’s major competitor, instead uses the FIFO method. The following are excerpts from each company’s 20X1 financial statements:

KW Steel Corp. Waretown Steel ($ in millions)
20X1 20X0 20X1 20X0
Balance sheet inventories $797.6 $692.7 $708.2 $688.6
LIFO reserve 378.0 334.9
Sales 4,284.8 4,029.7 3,584.2 3,355.8
Cost of goods sold 3,427.8 3,226.5 2,724.0 2,617.5

Required:
a. Compute each company’s 20X1 gross margin percentage and inventory turnover using cost of goods sold as reported by each company. Restate KW’s cost of goods sold and inventory balances to the FIFO basis. On the basis of its adjusted data, recompute KW’s gross margin percentage and inventory turnover.
b. Restate KW's cost of goods sold and inventory balances to the FIFO basis. On the basis of its adjusted data, re-compute KW's gross margin percentage and inventory turnover. Explain how the revised figures alter your earlier comparisons.

Answer:

KW Steel Corp. and Waretown Steel

LIFO and FIFO Inventory Valuation Methods:

a. Computation of each company's 20X1 gross margin percentage and inventory turnover:

                                         KW Steel Corp.           Waretown Steel

                                         ($ in millions)                ($ in millions)

                                        20X1         20X0           20X1         20X0

B/sheet inventories      $797.6      $692.7         $708.2      $688.6

LIFO reserve                   378.0        334.9

Sales                            4,284.8     4,029.7         3,584.2     3,355.8

Cost of goods sold     3,427.8     3,226.5         2,724.0      2,617.5

Gross margin               $857.0     $803.2          $860.0      $738.3

Gross margin %             20%                                24%

Average Inventory =  $745.15                         $698.4        

Inventory Turnover    4.6 ($3,427.8/$745.15)  3.9  ($2,724.0/$698.4)

b. Restatement of KW's cost of goods sold and inventory balances to FIFO:

                                     KW Steel Corp.           Waretown Steel

                                       ($ in millions)                ($ in millions)

                                     20X1         20X0           20X1         20X0

Sales                         4,284.8     4,029.7         3,584.2     3,355.8

Cost of goods sold $3,805.8  $3,561.40

Gross margin             $479.0     $468.3          $860.0      $738.3

Gross margin %           11.2%                                24%

Inventory Turnover    9.8 ($3,805.8/$388.75)  3.9  ($2,724.0/$698.4)

c. The performance of KW Steel worsened with the reinstatement of the LIFO reserves.  Before the reinstatement, KW Steel was running closely behind its competitor, Waretown Steel.  But after the reinstatement, Waretown gave KW Steel more gap in performance.  This reinstatement shows that when the performances of two companies are compared based on different criteria, the financial analyst will likely arrive at a wrong conclusion.

Explanation:

a) Data and Calculations:

                                         KW Steel Corp.           Waretown Steel

                                         ($ in millions)                ($ in millions)

                                        20X1         20X0           20X1         20X0

B/sheet inventories      $797.6      $692.7         $708.2      $688.6

LIFO reserve                   378.0        334.9

Sales                            4,284.8     4,029.7         3,584.2     3,355.8

Cost of goods sold     3,427.8     3,226.5         2,724.0      2,617.5

Gross margin               $857.0     $803.2          $860.0      $738.3

Gross margin %             20%                                24%

Average Inventory =  $745.15                         $698.4        

Inventory Turnover    4.6 ($3,427.8/$745.15)  3.9  ($2,724.0/$698.4)

c.

                                     KW Steel Corp.           Waretown Steel

                                       ($ in millions)                ($ in millions)

                                     20X1         20X0           20X1         20X0

B/sheet inventories   $797.6      $692.7         $708.2      $688.6

LIFO reserve                378.0        334.9

FIFO balance             $419.6      $357.8

Cost of goods sold  3,427.8     3,226.5         2,724.0      2,617.5

LIFO reserve               378.0        334.9

Average Inventory =  $745.15                         $698.4

New Average Invt.      388.75      

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12
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Balance Sheet Data Income Statement Data
Cash $600,000 Accounts payable $720,000 Sales $12,000,000
Accounts receivable 1,200,000 Accruals 240,000 Cost of goods sold 7,200,000
Inventory 1,800,000 Notes payable 960,000 Gross profit 4,800,000
Current assets 3,600,000 Current liabilities 1,920,000 Operating expenses 3,000,000
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Total liabilities 4,320,000 Interest expense 403,200
Common stock 720,000 EBT 1,396,800
Net fixed assets 3,600,000 Retained earnings 2,160,000 Taxes 488,880
Total equity 2,880,000 Net income $907,920
Total assets $7,200,000 Total debt and equity $7,200,000
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