Accounting methods and management decisions - the case of inventory costing and inventory policy

Abstract

This study investigates whether associations consistent with LIFO-FIFO tax incentives exist between management choices to adopt or not adopt the LIFO inventory costing method and characteristics of firms' year-end inventories. Both pre- and postchoice characteristics are ex- amined. Because the LIFO-FIFO choice is voluntary, a postchoice association would be consistent with managers both anticipating future inventory characteristics when making a LIFO-FIFO choice and changing inventory management policies in response to that choice. Evidence consistent with the hypothesis that LIFO adoptions are associated with changes in inventory management policies would have important macroeconomic implications. Zarnowitz and Moore [1977] have argued that a failure to recognize the major shift in inventory costing methods which occurred in 1973 and 1974 (primarily FIFO to LIFO) resulted in an underestimation of inventory accumulations by the U.S. Department of Commerce. This underestimation resulted from the different procedures used under LIFO and FIFO to assign costs to inventory units. While this effect of LIFO-FIFO choices can bias macroeconomic measurements and forecasts, an associated change in inventory management policies by a large number of firms could directly affect underlying macroeconomic stocks and flows.