If Merrimack adopted FIFO as of January 1, 2008, the income statement and balance sheet would reflect a large increase in net income, which would go from $7,150,000 in 2007 under LIFO, to $12,675,000 in 2008 under FIFO. By making this change from LIFO to FIFO, Merrimack would report an estimated earnings growth rate of 77.3%, rather than a sub-par -27.3% by keeping LIFO. The reason for this is that the costs of goods sold is decreased by the usage of FIFO, which increases gross profit margin and thereby also increasing net income. All of this would reflect positively on retained earnings, and would thus raise stockholders equity on the balance sheet. $2 million more income taxes would be owed however, if Merrimack were to adopt the FIFO method, but regardless of this FIFO would still represent an improvement in net income over LIFO. (See Table 3)

Comparing LIFO 2008 to FIFO 2008

Under the FIFO method, assuming that costs are increasing (inflation), the costs of goods sold would be lower because the first items sold are the most expensive; this results in a $50,500,000 in costs of goods sold under FIFO in 2008 compared to $58,000,000 under LIFO in 2008. As a result, the Gross Margin, the Income before Taxes, and consequently Net Income will all be higher using FIFO as of January 1, 2008, with Net Income in particular being substantially improved from $7,800,000 (under LIFO) to $12,675,000 under FIFO. This has a positive effect on the company’s balance sheet by increasing retained earnings and thereby raising the stockholder’s equity. $2,625,000 more income taxes would be owed if Merrimack were to adopt the FIFO method, but regardless of this FIFO would still improve net income over LIFO. (See Table 3)

If Merrimack changes from LIFO to FIFO in 2008, this would impact its cash flows by lowering the Costs of Goods Sold, increasing tax on Net Income, and therefore producing a higher Net Income. The Cost of Good Sold decreased from 58,000,000, with LIFO to 50,500,000, with FIFO. The Tax Increased from 4,200,000, with LIFO to 6,825,000, with LIFO. The Net Income increased from 7,800,000, with LIFO to 12,675,000, with FIFO.