Lifo and Fifo
LIFO VERSUS FIFO: UPDATING WHAT WE HAVE LEARNED
Nicole Thorne Jenkins Doctoral Student in Accounting Morton Pincus Associate Professor of Accounting
College of Business Administration The University of Iowa 108 PBAB Iowa City, IA 52242-1000 U.S.A. 319/335-0915 FAX 319/335-1956 morton-pincus@uiowa.edu
September 1998 (version 1.2)
LIFO VERSUS FIFO: UPDATING WHAT WE HAVE LEARNED
1.0 INTRODUCTION The statutory mandate in U.S. tax law that firms using the last-in first-out (LIFO) inventory costing method for tax purposes must also use LIFO for financial reporting purposes makes inventory accounting an especially interesting research and teaching topic. The constraint on managerial discretion imposed by tax--book conformity highlights the tension that can exist between tax minimization, on the one hand, and achieving financial reporting objectives, on the other hand. Trade-offs between tax minimization and other objectives are a major theme in the Scholes and Wolfson [1992] framework for examining taxation in the context of business strategy. Moreover, a researcher typically can quantify the cash flow impact a firm derives by using (or forgoes by not using) LIFO or FIFO, whereas quantifying the cash flow effects of other financial accounting choices is more problematic.1 This is because the cash flow effects of other accounting choices typically are indirect (e.g., through contracting costs). It thus is not surprising that research in the LIFO/FIFO area has a long history. Two reviews of LIFO research have previously been published in the Journal of Accounting Literature. The first appeared in the initial issue of the Journal and examined LIFO-related research as part of a more general review of capital market assessments of alternative accounting methods [Ricks, 1982a]. The second review, published just six year later, focused exclusively on LIFO. It surveyed three main research streams: the effect of LIFO adoptions on security prices; the determinants of
Nicole Thorne Jenkins Doctoral Student in Accounting Morton Pincus Associate Professor of Accounting
College of Business Administration The University of Iowa 108 PBAB Iowa City, IA 52242-1000 U.S.A. 319/335-0915 FAX 319/335-1956 morton-pincus@uiowa.edu
September 1998 (version 1.2)
LIFO VERSUS FIFO: UPDATING WHAT WE HAVE LEARNED
1.0 INTRODUCTION The statutory mandate in U.S. tax law that firms using the last-in first-out (LIFO) inventory costing method for tax purposes must also use LIFO for financial reporting purposes makes inventory accounting an especially interesting research and teaching topic. The constraint on managerial discretion imposed by tax--book conformity highlights the tension that can exist between tax minimization, on the one hand, and achieving financial reporting objectives, on the other hand. Trade-offs between tax minimization and other objectives are a major theme in the Scholes and Wolfson [1992] framework for examining taxation in the context of business strategy. Moreover, a researcher typically can quantify the cash flow impact a firm derives by using (or forgoes by not using) LIFO or FIFO, whereas quantifying the cash flow effects of other financial accounting choices is more problematic.1 This is because the cash flow effects of other accounting choices typically are indirect (e.g., through contracting costs). It thus is not surprising that research in the LIFO/FIFO area has a long history. Two reviews of LIFO research have previously been published in the Journal of Accounting Literature. The first appeared in the initial issue of the Journal and examined LIFO-related research as part of a more general review of capital market assessments of alternative accounting methods [Ricks, 1982a]. The second review, published just six year later, focused exclusively on LIFO. It surveyed three main research streams: the effect of LIFO adoptions on security prices; the determinants of