Hey all, Suppose an integrated oil company’s accounting technique for inventories is FIFO and they are adjusting their upstream and downstream segments according to the replacement cost method (it approximates the LIFO method). Since the price of oil was on its highest levels in the 3Q2008, I would expect these adjustments to lower the adjusted operating income. Could anyone please help me? Thanks in advance.
fifo means FIRST in FIRST out. and lifo means LAST in FIRST out. let me know if you have any other questions.
Yeah I understand the concept of LIFO & FIFO. What I don’t understand is the following. Suppose an integrated oil company is using FIFO method. The price of oil goes up. Their selling price reflects the current price, while COGS reflects the old price for raw materials. So, to be comparable with the companies using LIFO (case of US companies - GAAP) and to reveal true income, the company adjusts the income statement for the LIFO method. So the COGS should be higher and the income should be lower. Is my reasoning correct? Can anyone help me with it? Cheers
Because Q3 2008 was in times of rising prices, LIFO will give you a higher COGS, and lower income, while FIFO will give you a higher inventory.
This is what I thought as well. But the company after adjustments gave a higher operating and net income. Weird. One of my and my Co. biggest positions. I wrote to Investor Relations, but no answer from them. I might call them! Does anyone have any suggestions why this could be the case? Thx
which O&G company? maybe there were other adjustments
It’s a French Co. Total with market cap around 130 billion USD. Ticker for ADR is TOT US. No I don’t think there were other adjustments. In their quarterly report they state that due to adjusting FIFO for replacement cost method (almost identical to LIFO) 3Q08operating income and net income are higher for 1193 million EUR and 752 million EUR. Actually in the 2Q08 the adjustment for FIFO method lowered the operating income and net income. Should be the same in the 3Q2008 since oil price was even higher, shouldn’t it be? Thx
LIFO = Less Income for Organization LIFO = Less Inventory for Organization (that little mnemonic helped me immensely at Level 1) However, that assumes a rising price environment. Reverse it for a falling price environment.
Thanks, but this doesn’t help me since I understand the method. I need help with a real life example. As you said LIFO method should give lower income in case of rising prices. Just that in my case the opposite is true. I am trying to figure out why? Either the Co. made a mistake or I don’t understand something. Any help would be appreciated?!
If this company is selling at a rate faster than the rate they are taking on inventory while using LIFO, they could dip into FIFO (in rising prices), causing income to be higher.
The challenge is that prices were rising, and then falling, so your inventory might have more expensive oil in it or cheaper oil. If the inventory cycle (365*(Inventory/COGS)) is relatively short, then your inventory is likely acquired closer to the peak and you are in more of a price falling environment. If the number of days in the inventory cycle is longer than the time since the oil peak, then you might going to have some oil that was more expensive and some that was less. If the price of oil is falling and you’re using LIFO, then your balance sheets are going to show more inventory than otherwise. The cost of replacing inventory is going down, so COGS is declining over time, net income is going up. Also, if this inventory was acquired through forward or futures contracts, that can mess things up, since COGS was not acquired at market prices, but at whatever prices were current when the contracts were entered into.
All else being equal, if prices increase and you switch to LIFO, your costs will be higher, decreasing your operating profit. Is this confusing ?
m_bomba0004 Wrote: ------------------------------------------------------- > Thanks, but this doesn’t help me since I > understand the method. I need help with a real > life example. As you said LIFO method should give > lower income in case of rising prices. Just that > in my case the opposite is true. I am trying to > figure out why? Either the Co. made a mistake or I > don’t understand something. > > Any help would be appreciated?! there are some things that were mentioned that could account for the high net income. potential liquidation. its just not LIFO that would make the change, you have to read the footnotes for other adjustments. its not that simple.
Thanks guys. This makes much more sense now. I don’t know how I haven’t thought about it alone. Thanks a lot. Really appreciated.