The Valuation Effect of LIFO’s Repeal on High Pricing Power Firms

• In Event: Financial Accounting and Reporting V

Abstract

Recent impetus towards the abolishment of Last-in-First-Out (LIFO) accounting includes its prohibition under the prospective implementation of International Financial Reporting Standards (IFRS) and proposed changes to U.S. tax law. Since the prohibition of LIFO requires firms to retroactively realize past LIFO related tax deferrals, its repeal could have significant financial consequences for firms with large LIFO reserves. This study investigates the potential effect of the repeal of LIFO on the value of the firm. Introduced in October of 2007, Bill H. R. 3970 mandated repeal of LIFO for tax years beginning after the date of enactment. Although no action was taken, this bill marked the beginning of domestic political initiatives to repeal LIFO, which continue to this date. Results of this study generally show a post 2007 negative relation between a LIFO’s firm market value of equity and the magnitude of the LIFO tax obligation conditional on the pricing power of the firm. We interpret these results to show that while the increasing likelihood of LIFO’s repeal has negative valuation consequences, this effect is reduced for high pricing power firms that are able to recapture LIFO related tax payments.

Keywords: LIFO, FIFO, Pricing Power, Firm Value

Authors

• Robert Houmes, Jacksonville University

• Inga Chira, Oregon State University