Question

Part B

The following details are for questions 16–20. Each individual question will appear below the details.

Caterpillar Inc (CAT) has the following excerpts from their financial statements:

Interest Period	December 31, 2016	December 31, 2015	December 31, 2014
Inventory (in $ Millions)	9,615	9,700	12,205
Net Income (in $ Millions)	(67)	2,512	2,452

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 60 percent of total inventories at December 31, 2016 and 2015.

If the FIFO (first-in, first-out) method had been in use, inventories would have been $1,639 million and $2,498 million higher than reported at December 31, 2016 and 2015, respectively.

Assume a corporate tax rate of 35%.

Question

If CAT had used FIFO method instead of LIFO method...

The amount CAT’s 2016 net cash from operations would change by (rounded to the nearest million):

Group of answer choices

$301 Million increase

$126 Million increase

$76 Million decrease

No change in cash from operations

If CAT had used FIFO method instead of LIFO method...

Net profit (loss) CAT would report in 2016 (rounded to the nearest million) is:

− $300 Million (loss)

+ $359 Million (profit)

+ $200 Million (profit)

− $625 Million (loss)

The cumulative amount of income tax savings that CAT generated through 2016 by using LIFO instead of FIFO (rounded to the nearest million) is:

Answer 1

All amounts are in $

1)

If FIFO if followed, then net cash flow changes in 2016

Change in opening inventory = 2,498 million increase

Change in closing inventory = 1,639 million increase

So decrease in operating profit for current year = 859 million

Increase in tax savings = 859 million x 35% = 300.65 million

This leads to increase in Cashflows by 300.65 million (becuase tax savings increased due to higher loss)

So option A - $301 million increase

2)

The change in operating income if we follow FIFO will be $859 million (calculated in above point)

Tax savings in such income = $301 million

Net Income change if we follow FIFO = -$859 million + 301 million = -558 million

So new Profit will be = (67) + (558) = $625 million loss

Option D : 625 million loss

3)

Income tax savings if we use LIFO in 2016 = [67/(100-35)] x 35 = $36 million (rounded off)

Income tax savings if we use FIFO for 2016 = $36 million + $301 million = $337 million

Note :

To find the tax expenses/ tax savings of 2015 we need opening balance of invetory of 2015 as per FIFO. We only ave closing balance of 2015 inventory as per LIFO but we don't have openings balance as per FIFO. If we take the opening balance of 2015 inventory doesn't change under FIFO then

As the closing balance under FIFO is high by $2,498 million and opening balance is assumed to be same, the profit will increase by $2,498 and tax will increase by $874 million in FIFO. So Cashflows saved in 2015 will be $874 by following LIFO and $331 million incurred in 2016 by following LIFO

So Cummilative amount of income tax savings incurred by following LIFO is $543 million ($874 million - 331 million)