The Steel Industry’s LIFO Problem
In the early 1980s, the American steel industry was experiencing severe financial troubles. An increase in foreign competition as well as advancing technology combined to contribute to the decline of industry profits. The demand for domestic steel was down, and, as a result, many firms laid off workers. However, the use of the LIFO method of accounting for inventory distorted the actual financial position of many firms as illustrated by the following simple example:
USA Steel Co. had the following LIFO inventory layers on January 1, 1982:
Layer 1 (oldest)
6,000 tons @ $10 per ton
5,000 tons @ $15 per ton
Layer 3 (newest)
8,000 tons @ $25 per ton
Assume steel sold for $50 per ton in 1983 and cost $35 per ton to produce. Because of a decrease in demand for domestic steel, USA Steel shut down its production facilities and elected to sell the inventory on hand rather than produce additional inventory.
1. If USA Steel Co. sold 15,000 tons of steel during 1983, what was the gross margin in this simplified example using LIFO?
2. What was USA Steel’s gross margin if the 15,000 tons of steel had been calculated at the current cost of $35 per ton?
3. Does the LIFO gross margin accurately depict the financial situation of USA Steel Co.?