Bethlehem Steel Corporation - Needing Nerves of the Same

Bethlehem Steel Corporation:

Needing Nerves of the Same

Bethlehem Steel Corporation manufactures steel sheets used primarily by the automotive industry and structural steel shapes and pilings used in the construction industry.  These industries experience cyclical swings in their sales as economic conditions change.  Sales of Bethlehem Steel also reflect these cyclical patterns. The manufacture of steel is highly capital intensive.

This case examines Bethlehem Steel’s choices with respect to its inventory cost-flow assumption.  Bethlehem Steel adopted a LIFO cost flow assumption many years ago but switched to FIFO in Year 23.  Exhibits 1 to 3 present financial statements for Bethlehem Steel for Year 19 through Year 25. Exhibit 4 presents selected other data.

Effects of LIFO

Bethlehem used a LIFO cost-flow assumption for Year 19 through Year 22.  The notes to its financial statements indicate that inventories at current cost (FIFO) exceeded their value under LIFO on December 31 of each year as follows (amounts in millions):  Year 18, $530.1; Year 19, $562.5; Year 20, $499.1; Year 21, $504.9; and Year 22, $472.1.  

a.        Compute the amount of cost of goods sold for each of the years Year 19 through Year 22 assuming that Bethlehem had used a FIFO cost flow assumption.

b.        Compute the cost of goods sold divided by sales percentages for Year 19 through Year 22 using both LIFO and FIFO cost flow assumptions.

c.        Compute the inventory turnover ratio (cost of goods sold divided by average inventories) for each of the years Year 19 to Year 22 using both LIFO and FIFO cost flow assumptions.

d.        Which inventory turnover ratio in part c. more accurately measures the actual inventory turnover rate? Explain your reasoning.

Decision to Switch to FIFO

Bethlehem Steel switched to a FIFO cost flow assumption as of January 1, Year 23.  

Bethlehem’s rationale for switching to FIFO is as follows:

We believe that FIFO method of inventory valuation provides a more meaningful presentation of the financial position of the Corporation since it reflects more recent costs in the balance sheet.  Also, in the current environment of low inflation, higher productivity and lower production costs, the use of LIFO has not had a significant effect on operating results.  FIFO will eliminate the distortions in reported financial results caused by liquidations of inventories which flow through cost of goods sold at lower costs prevailing many years ago.  It will also improve the reporting of interim results by eliminating the requirement to estimate whether liquidations that occur in interim periods will be replaced by year end, which tends to cause liquidations and other LIFO adjustments to be recognized in the fourth quarter.

e.        Evaluate each of the reasons stated by Bethlehem Steel for its decision to switch to FIFO (that is, are the assertions correct and sufficiently material to justify the switch).

f.        Bethlehem Steel made the following journal entry to switch to FIFO on January 1, Year 23.  The income rate is 35 percent.

                Inventories…………………………………472.1

                     Income Taxes Payable……………………                  165.2

                                 Cumulative Effect on Net Income from

                                  Change in Accounting Principles……                               306.9        

Explain the rationale for each account affected in this entry.

g.        Refer to part f. Why might Bethlehem be willing to change to an inventory cost flow assumption with such a high income tax cost?  

Analysis of Profitability and Risk

        h.  Assess the changes in profitability and risk of Bethlehem Steel between Year 23 and Year 25.   The                       following financial statement ratios will assist in this assessment.

Schedule 1

Financial Statement Ratios for Bethlehem Steel Corporation

                Year 23        Year 24        Year 25

Profit Margin for ROAa                .00        2.2%        4.4%

Assets Turnover                .77        .83        .85

Rate of Return on Assetsa                .00        1.8%        3.7%

Profit Margin for ROCE                (.01)        1.7%        3.7%

Capital Structure Leverage Ratio                8.1        6.3        4.8

Rate of Return on Shareholders’ Equity                (5.6)%        8.7%        15.0%

Cost of Goods Sold/Sales                95.1%        94.4%        92.2%

Selling and Administrative Expense/Sales                3.6%        2.9%        2.3%

Accounts Receivable Turnover                9.5        9.4        10.9

Inventory Turnover                4.9        5.2        4.9

Fixed Asset Turnover                1.6        1.8        1.8

Current Ratio                1.7        1.6        1.5

Quick Ratio                .8        .7        .5

Cash Flow from Operations/Current Liabilities                22.5%        39.9%        56.9%