Objective: Understanding the effect of inventory valuation assumptions on financial statements.
Assignment summary: You are taking the role of a security analyst who recently started following the Oil and Gas industry. The analyst has a task to draw a comparison of several financial indicators for two industry leaders: Exxon Mobil and Royal Dutch Shell, based on their income statements and balance sheets (attached at the end of this document) as well as the information from the notes to the financial statements summarized below. The two companies appear to be quite similar and are similar in size based on total assets. A private investor notes, however, that some financial ratios appear to be different. Your task is to guide an investor through the basic steps that will help them understand the effect of inventory valuation assumptions on the financial ratios.
The following information is based on Exxon’s and Shell’s 2011 Annual Reports.
Background information. Exxon Mobil Corporation was incorporated in the State of New Jersey in 1882. Divisions and affiliated companies of ExxonMobil operate or market products in the United States and most other countries of the world. Their principal business is energy, involving exploration for, and production of, crude oil and natural gas, manufacture of petroleum products and transportation and sale of crude oil, natural gas, and petroleum products.
NOTES TO FINANCIAL STATEMENTS
Inventories. Crude oil, products, and merchandise inventories are carried at the lower of current market value or cost (generally determined under the last-in, first-out method – LIFO). Inventory costs include expenditures and other charges (including depreciation) directly and indirectly incurred in bringing the inventory to its existing condition and location. Selling expenses and general and administrative expenses are reported as period costs and excluded from inventory cost. Inventories of materials and supplies are valued at cost or less (i.e., lower of cost or market).
The aggregate replacement cost of inventories was estimated to exceed their LIFO carrying values by $25.6 billion and $21.3 billion at December 31, 2011, and 2010, respectively (Convert LIFO to FIFO).