The Effects of Changing from FIFO to LIFO on the Stock Market

Paper Summary:

This paper examines the phenomenon of earning surprises by examining ex-post facto and the balance sheets of several companies. In addition the way in which stock prices change, directly correlating to the change in FIFO to LIFO, is also be explored.

From the Paper:

"Most investors assume that it is always the goal of a company to the greatest net income possible. They connect net income directly with profitability. What they do not understand is that there are times when it may be advantages for management to show a smaller net income. In an economic period which is marked by high inflation and rising prices the company can show considerable tax advantages by using the LIFO (Last In, First Out) method of inventory valuation. Using this accounting method, the company values the inventory at the prices, which reflect a higher cost to produce them. In a market of steadily rising prices this will make them show smaller net gains and therefore save on their taxes. In this way smaller net earnings will actually amount in greater profit due to the tax savings which will show up immediately in greater immediate cash flow. Some companies use this method when they wish to temporarily increase their leverage position to borrow capital for business expansions."

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