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
[email protected]
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
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Research findings now strongly suggest that (a) there is not really much of a LIFO
puzzle, (b) the capital market reaction to LIFO adoptions is more complex than the
analysis of the traditional tax benefits versus functional fixation hypotheses
suggests, and may not yield a meaningful assessment of the impact of LIFO on
share prices, and (c) the implications of LIFO use for the security price earnings
relation are less straight forward than what one might expect. In this review, we
survey the research that has helped to update our beliefs about the LIFO/FIFO
choice and its impact. We organize the review into the sections that represent
major research thrusts (i.e., questions) over the past 10 15 years. The research
thrusts are capital market reactions to LIFO adoptions, theoretical and empirical
explorations of non tax explanations of the LIFO puzzle, the Kang [1993] model
and subsequent capital market research on LIFO adoptions, share price effects
associated with LIFO s entry into the tax law, the impact of inventory methods on
the price earnings relation and firm value, and income smoothing. We discuss the
research as it evolved in roughly chronological order within research areas as well
as across areas. We begin several sections by summarizing research previously
examined in more detail in earlier LIFO reviews. Note: the italicized parts of the text
contain the more