John Deere Case Study

Cases in Financial Reporting – 8th Edition
John Deere

Concepts:
a) There are a number of risks and benefits to holding inventory. The benefits of holding inventory are avoiding lost sales due to backordered goods. Quantity discounts can also be had from ordering inventory in large quantities. The costs of placing orders are reduced, because fewer orders will need to be made. Production runs are more efficient when running large quantities when compared to smaller quantities. There is also less risk in production shortages.
The disadvantages of holding inventory are the large expenses of cash required to purchase the inventory. If the inventory is not sold, the asset may depreciate, or become obsolete which will require a write-off. There are also tax burdens to holding large amount of inventory. Inventory also requires storage space, and storage fees will be likely.
b) Raw inventory would hold the raw materials for production. For example, a manufacturing plant producing engine blocks would likely hold aluminum ingots or raw castings. Work in progress inventory is somewhere between raw and finished. To continue the example, an engine block that has had machining done, but not fully assembled would constitute as work in progress. Finished inventory is product that is ready to be sold to the customer.
c) Companies use cost flow assumptions to value inventory based on the industry they are in. Normally companies will use the same cost flow assumptions as their competitors or nature of the industry they are in. John Deere uses LIFE as their cost flow assumption.
d) The balance sheets of the two companies would differ in the LIFO reserve John Deere must have on the balance sheet. For John Deere, they utilize LIFO, which “stores” the value of the product in inventory more than FIFO. John Deere can keep their inventory stocked with lower priced goods on the balance sheet, when in reality they are moving all the same inventory. If prices are decreasing over time, LIFO is not favorable, as more expensive inventory will be held.

Analysis:
f)
Deere & Company
2012
2011
2010
Net Sales
$33,500.90
$29,466.10
$23,573.20
LIFO cost of goods sold (COGS)
$25,007.80
$21,919.40
$17,398.80
LIFO net income
$3,064.70
$2,799.90
$1,865.00
LIFO inventory from the balance sheet
$5170.00
$4,370.60
$3,063.00
LIFO reserve from financial statement notes
$1,421.00
$1,486.00
$1,398.00
Total assets from the balance sheet
$56,265.80
$48,207.40
$43,366.80

Calculations to convert LIFO to FIFO
2012
2011
2010
FIFO inventory = LIFO inventory + LIFO reserve
$6,591.00
$5,856.60
$4,461.00
FIFO assets = LIFO assets + LIFO reserve
$57,686.80
$49,693.40
$44,664.80
Change in LIFO reserve during year end
-$65.00
$88.00 FIFO COGS = LIFO COGS - Change in LIFO reserve
$25,072.80
$21,831.40 After-tax effect of LIFO methiod = (1 - Marginal tax rate) x Change in LIFO reserve
-$42.25
$57.20 FIFO net income = LIFO net income + After-tax effect of LIFO method
$3,022.45
$2,857.10 Fiscal 2012
Deere & Company
CNH Global As reported
As if FIFO
As reported
Common-size cost of goods sold
74.65%
74.84%
80.13%
Net income
$3,064.70
$3,022.45
$1,142.00
Growth in net income
$264.80
$165.35
$203.00
Common-size net income
9.15%
9.02%
5.88%
Total assets
$56,265.80
$57,686.80
$35,426.00
Inventory
$2,527.80
$3,948.80
$9,514.00
Common-size inventory
7.55%
11.79%
26.86%

g)
Deere:
COGS – $25007.8
Average Inventory – (5170 + 4370.6) / 2 = $4770.3

LIFO:

FIFO:

CNH:
COGS - $15566.0
Average Inventory – (3734.0 + 3662) / 2 = $3698.0

The difference between John Deere’s FIFO and LIFO average inventory hold time is substantially different. When looking in the LIFO perspective, Deere outmatches their competition. In the FIFO perspective, John Deere fares worse. For John Deere, LIFO gives a perspective of doing better than they actually are.

h)
Fiscal 2012
Inventory
Reported Income Taxes FIFO
LIFO
FIFO
LIFO
Net Inventory
$6,591.00
$5,170.00
2,306.85
1,809.50

i)
The primary concerns would be the increased tax rate when converting to LIFO. If the majority of the other business in the same industry are reporting on LIFO it would be beneficial to stay there. Net income would appear to be lower in FIFO because increased income taxes must be paid.