The University of Chicago Financial Accounting 30000

Booth School of Business

Dow Chemical Company

Inventories

Dow Chemical Company is a manufacturer and supplier of products used primarily as raw
materials in the manufacture of customer products and services. Its product lines include
chemicals, advanced materials, agro-sciences and plastics businesses. Attached are the
excerpts from Dow Chemical’s Annual report for 2012. Based on the information in the
financial statements and footnotes, please, answer the questions below. Assume a tax rate of
35%.

1. Which cost flow assumptions does Dow Chemical use to value its inventories? What
is the value of inventories that Dow Chemical values at LIFO basis as of December
31, 2012?

2. Suppose that Dow Chemical had used first-in, first-out (FIFO) as a cost flow
assumption for all of their Inventories.

Would the book value of Inventories at December 31, 2012 be higher than, lower
than, or the same as the amount currently recorded? If different, by how much?

Would Total stockholders’ equity at December 31, 2012 be higher than, lower than,
or the same as the amount currently recorded? If different, by how much?

Would Income before income taxes in fiscal year 2012 be higher than, lower than, or
the same as the amount currently recorded? If different, by how much?

What amount would the Dow Chemical have reported as cost of goods sold in fiscal
2012 if it had always used the FIFO method for measuring the cost of inventories for
which it uses LIFO method?

3. Companies often cite income tax considerations as a primary reason for favoring
LIFO over other cost flow assumptions.

Did Dow Chemical save income taxes cumulatively over the years since inception (up
to December 31, 2012) by not using FIFO as the cost flow assumption for all of their
inventories? If so, how much? If not, why?

Did Dow Chemical save income taxes in fiscal year 2012 by not using FIFO as the
cost flow assumption for all of their inventories? If so, how much? If not why and
how much more taxes they paid?

If you were a Chief Financial Officer of Dow Chemical and the LIFO conformity
rule had been repealed by Congress. What inventory method would you
recommend for 1) financial reporting and 2) for tax reporting purposes? Why?
4. Did physical inventory levels valued on a LIFO basis increase or decrease during
2012 for Dow Chemical? How do you know?

If inventory decreased, how did this affect the LIFO reserve as of December 31,
2012?

What factors might explain Dow Chemical’s decision to reduce certain inventories?

5. Suppose that Dow Chemical has no inventory left at the end of NEXT year (i.e.,
fiscal year 2013).

Would Retained earnings at the end of fiscal year 2013 under their existing
accounting policy for inventories be higher than, lower than, or the same as what it
would have been had they used FIFO as a cost flow assumption for all of their
inventories? If different, by how much? Explain.

How would your answer to above change if purchase prices for Dow Chemical’s
inventories are expected to increase by approximately 50% in fiscal year 2013?

6. International Financial Reporting Standards do not permit the use of LIFO as a

cost flow assumption for inventory valuation. What are the potential
disadvantages of the LIFO method that might have caused the International
Accounting Standards Board to prohibit the use of LIFO as a cost flow
assumption?