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MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
H
ave you ever heard someone say, “I am leery of
LIFO”? The inventory cost flow system last-in,
first-out (LIFO) assumes the cost of the
newest merchandise sells first, leaving the cost
of the oldest merchandise remaining in ending
inventory. In this manner, the income statement expenses
the most recent costs, and the balance sheet warehouses
the oldest costs. In times of rising prices, this minimizes
the value of inventory on the balance sheet and maximizes
the cost of goods sold (COGS), which, in turn, minimizes
taxable income and the associated cash outflow for income
taxes. Sometimes the inventory costs that remain on the
balance sheet could be as much as 70 years old.
1
To b e
sure, that old inventory is no longer physically in inventory,
yet its costs appear in part on the balance sheet. The
result: underreporting the value of actual inventory held.
For this very reason, LIFO is not even a permitted cost
flow assumption under International Financial Reporting
Standards (IFRS). But it is permitted under U.S. Generally
Accepted Accounting Principles (GAAP).
There are three benefits to using LIFO—one is theoreti-
cal, another is practical, and the third is based on improving
cash flow. The theoretical argument is that LIFO “expenses”
the most recent costs on the income statement, providing the
highest-quality income statement based on historical costs.
Should You Be Leery of LIFO?
EXECUTIVE SUMMARY
Based on 10 years of data, this study
finds no reason to be leery of last-in,
first-out, or LIFO. You should, however,
be cautious. LIFO ratio analysis pro-
vides good signals for time series
analysis and for most profitability
ratios. When analyzing ratios between
companies that may not be using
LIFO, the data should be transformed
using the LIFO reserve information.
By Kay Zekany, Ph.D., CMA
12
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
Since the income statement is arguably the most impor-
tant financial statement in the United States, LIFO is
the theoretically preferred method on this basis. The
practical argument is that companies that have histori-
cally used LIFO may wish to continue to do so based
on comparability with prior periods. Finally, with
respect to cash flow, LIFO’s tax savings ability is
another factor. Since the Internal Revenue Service
(IRS) only permits companies that also use LIFO for
financial reporting purposes to do so for tax purposes,
this is another reason for a company to choose LIFO as
its inventory cost flow assumption.
Because of this disparity as well as the differences
between LIFO and its alternative—first-in, first out
(FIFO)—the question arises whether it is possible to
validly conduct financial statement analysis of LIFO
companies without converting LIFO numbers to FIFO
numbers given the potential bias produced. For this
reason, this study examines:
● What types of companies still use LIFO,
● The extent to which its use distorts ratios in finan-
cial statement analysis on profitability, productiv-
ity, and financial leverage both over time and
between companies,
● If the directional signals sent, regardless of distor-
tions in magnitude, are true, and
● If LIFO earnings more closely correlate with cash
from operations than do FIFO earnings to measure
representational faithfulness.
This research is both quantitative and qualitative to
both statistically measure the impact of LIFO on calcu-
lations and to visualize the practical impact.
DATA
This study collected annual financial statement data
directly from XBRL (eXtensible Business Reporting
Language) corporate annual reports on the EDGAR
(Electronic Data Gathering, Analysis, and Retrieval) sys-
tem of the U.S. Securities & Exchange Commission to
calculate financial statement figures and financial ratios
with and without LIFO numbers. Panel data for a
10-year period came from financial statements from
2018-2019 back to 2009-2010, or for as long as the corpo-
ration existed, for the 19 largest corporations currently
using LIFO. All the data was collected in millions of
dollars, regardless of how the actual financial statements
presented them. Collecting data by hand allowed for
checking and correcting errors, so the analyzed data
should truly represent the underlying financials.
Initially, the data came from 10-K documents for all
companies in the Fortune 100, including the company
name, industry, and Standard Industrial Classification
(SIC) code, and LIFO reserve for the current year and
the year prior, if any, to find LIFO companies.
Corporations that use LIFO must disclose the
amount of the excess of the replacement cost or current
cost over the LIFO value if this amount is material.
This requirement results in the LIFO reserve. Hence,
the study considered LIFO companies as those with
nonzero LIFO reserves in the most recent fiscal year
ended prior to August 2019. This nonzero LIFO
reserve rule is consistent with prior literature.
2
The data from the 19 companies showed each used
LIFO. Table 1 lists alphabetically by SIC code LIFO
companies that come from a variety of industries rang-
ing from petroleum refining, other heavy manufactur-
ing, wholesale, and retail to miscellaneous other
industries. Data from LIFO companies come from the
financial statements: one year of data from the income
statement and statement of cash flows and two years of
data from the balance sheet. This study’s data include
the following: year-end date, sales, cost of sales, earn-
ings before interest and tax (EBIT), income tax
expense, net income, accounts receivable, LIFO inven-
tory, total assets, accounts payable, total equity, net cash
inflows from operating activities, and LIFO reserve.
3
This study assumes the statutory tax rate to be 21%
because it was the statutory tax rate in 2019. Using the
same rate throughout the study avoided inserting
unnecessary variability into the data.
The LIFO reserve permits the calculation of non-
LIFO figures and ratios from the given LIFO figures.
4
1. LIFO inventory + LIFO reserve = FIFO
inventory
2. LIFO total assets + LIFO reserve = FIFO total
assets
3. LIFO total liabilities + (LIFO reserve x tax rate) =
FIFO total liabilities
4. LIFO total equities + (LIFO reserve x (1 – tax
rate)) = FIFO total equities
13
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
5. LIFO COGS – increase in LIFO reserve = FIFO
COGS
6. LIFO EBIT + increase in LIFO reserve = FIFO
EBIT
ANALYSIS AND RESULTS
Comparing LIFO to FIFO figures and ratios permits
the measurement of the distortions from the choice of
the inventory cost flow assumption. Statistical analysis
that uses a two-sample t-test of the differences in
inventory figures and inventory-related ratios indicates
indeed a statistically significant difference when calcu-
lating these ratios using LIFO vs. FIFO (see Table 2).
With this sample of Fortune 100 LIFO companies, the
average difference:
● In LIFO ending inventory vs. FIFO ending
inventory was $1.6 billion, with a p-value of less
than 0.01,
● In COGS was $86 million (LIFO COGS is less
than FIFO COGS), with a p-value of 0.20 showing
no statistically significant difference,
● In the two gross profit calculations was $86 million,
with a p-value of 0.20 showing no statistically sig-
nificant difference,
● In the two EBIT calculations was $78 million,
with a p-value of 0.21 showing no statistically sig-
nificant difference,
5
● In the days sales in inventory ratios was -9.4 days,
with a p-value of less than 0.01 where days sales in
inventory ratio is calculated as 365 5 average
inventory/COGS,
● In the cash operating cycle was -9.7 days because
the inventory system affects both days sales in
inventory and the days in payables calculation,
with a p-value of less than 0.01 where the cash
operating cycle is calculated as days sales in inven-
tory plus days sales in receivables less days pur-
chases in payables,
● In the total asset turnover was 0.07 times, with a
p-value of less than 0.01 where total asset turnover
Archer Daniels Midland SIC: 2070 - FATS & OILS
DuPont de Nemours SIC: 2821 - PLASTICS, MATERIALS, SYNTH RESINS & NONVULCAN ELASTOMERS
Merck SIC: 2834 - PHARMACEUTICAL PREPARATIONS
Chevron SIC: 2911 - PETROLEUM REFINING
ConocoPhillips SIC: 2911 - PETROLEUM REFINING
Marathon Petroleum SIC: 2911 - PETROLEUM REFINING
Phillips 66 SIC: 2911 - PETROLEUM REFINING
Valero Energy SIC: 2911 - PETROLEUM REFINING
Deere SIC: 3523 - FARM MACHINERY & EQUIPMENT
Caterpillar SIC: 3531 - CONSTRUCTION MACHINERY & EQUIP
Honeywell International SIC: 3724 - AIRCRAFT ENGINES & ENGINE PARTS
Berkshire Hathaway SIC: 4900 - ELECTRIC, GAS & SANITARY SERVICES
AmerisourceBergen SIC: 5122 - WHOLESALE-DRUGS PROPRIETARIES & DRUGGISTS' SUNDRIES
Cardinal Health SIC: 5122 - WHOLESALE-DRUGS PROPRIETARIES & DRUGGISTS' SUNDRIES
CHS SIC: 5150 - WHOLESALE-FARM PRODUCT RAW MATERIALS
Costco Wholesale SIC: 5331 - RETAIL-VARIETY STORES
Kroger SIC: 5411 - RETAIL-GROCERY STORES
Publix Super Markets SIC: 5411 - RETAIL-GROCERY STORES
Walgreens Boots Alliance SIC: 5912 - RETAIL-DRUG STORES AND PROPRIETARY STORES
Table 1: LIFO Companies and Industries Included in Study
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MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
is calculated as sales/average total assets,
● In the gross profit margin ratio was -0.001 (0.1 per-
centage point), with a p-value of less than 0.01
where gross profit margin is calculated as sales –
COGS/sales,
● In the return on sales was 0.001 (0.1 percentage
point), with a p-value of less than 0.01 where
return on sales is calculated as EBIT/sales,
● In the return on assets was -0.002 (0.2 percentage
points), with a p-value of less than 0.01 where
return on assets is calculated as EBIT/total assets,
● In the financial leverage ratio was 0.44, with a
p-value of less than 0.01 where financial leverage
is calculated as total assets/total equity, and
● In the return on equity ratio was 0.045 (4.5 per-
centage points different), with a p-value of less
than 0.01 where return on equity is calculated as
EBIT/total equity.
Note that while a statistically significant difference
exists between inventory figures under LIFO vs. FIFO,
no such statistically significant difference exists with
COGS, gross profit, or EBIT. This is because the fluc-
tuations in the increase in LIFO reserves over time
hover around zero. Figure 1 shows the LIFO reserve for
one year and the prior year over time, as well as the
change between the two. The data appear over time in
this figure, as well as all the figures in this article, by
companies listed by size, with the largest Fortune 100
firms appearing first.
Those engaged in financial statement analysis expect
to find statistically significant differences in the ratio
calculations. The mere detection of statistical differ-
ences, however, provides little evidence of the practical
significance of these differences. To inform analysts and
others of the practical importance (or not) of going
through the trouble to adjust the reported numbers to
value the impact of the inventory cost flow assumptions
in assessing profitability, productivity, and financial
leverage, one must conduct further analysis.
Of great interest is the representational faithfulness
of the inventory figures and the impact on ratios and
other calculations. In “Comparing LIFO and FIFO: An
Empirical Test of Representational Faithfulness,”
Brock Murdoch and Paul Krause state Sir Richard John
Hicks gives us the most well-established definition of
representational faithfulness.
6
Hicks asserts that income
is the maximum amount a company can distribute to
owners to still leave the company as well off as it was at
Table 2: Testing the Statistical Differences, LIFO vs. FIFO
Mean LIFO Mean FIFO
Mean
Difference
One-tailed
p-value
Ending inventory* 6,308,000,000$ 7,928,000,000$ -$1,600,000,000 8.203 E-29
Cost of goods sold 63,427,000,000$ 63,514,000,000$ -$86,000,000 0.200665
Gross profit calculaon 17,722,000,000$ 17,636,000,000$ $86,000,000 0.200665
Earnings before interest and taxes 6,329,000,000$ 6,251,000,000$ $78,000,000 0.208153
Days sales in inventory* 46.1 55.6 -9.4 days 1.685 E-33
Cash operang cycle* 25.7 35.4 -9.7 days 0.00018
Total asset turnover* 1.97 1.84 0.07 mes 3.236 E-37
Gross profit margin rao* 23.8% 23.7% 0.1% 5.898 E-35
EBIT return on sales* 7.6% 7.7% -0.1% 3.198 E-18
EBIT return on assets* 8.4% 8.2% 0.2% 1.080 E-39
Financial leverage rao* 3.76 3.31 0.44 2.640 E-44
EBIT return on equity* 31.6% 27.1% 4.5% 4.994 E-17
* significant differences at α = 0.01 level
15
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
the beginning of the period. Thus, the measure of
income that best correlates with cash from operations is
the most representationally faithful. Murdock and
Krause studied data from 1985 through 2004 to compare
companies that used LIFO with companies that used
FIFO and found that LIFO is more representationally
faithful than FIFO. In contrast, this present study looks
exclusively at LIFO companies using both LIFO and
FIFO numbers and finds a slightly different result.
Both LIFO and FIFO numbers strongly correlate
with cash provided by operations at 85% correlation
(see Table 3). Thus, both LIFO and FIFO produce
equally representationally faithful results. As Table 3
shows, a slight difference exists in correlations when
you get to the thousandths place favoring FIFO. That
miniscule difference, however, makes the correlations
distinguishable. Since this finding contradicts Murdock
and Krause’s results that found LIFO to be more repre-
sentationally faithful, the field needs more research.
Arguably, the present study uses a stronger research
design that pulls data from the same set of companies
under two separate sets of calculations.
On the other hand, Murdock and Krause’s results
could differ due to inflation from 1985 through 2004 vs.
the period in this study of 2008 through 2019. Inflation
rates clearly impact the LIFO vs. FIFO results. During
the period between 1985 and 2004, inflation ranged from
a low of 1.6% per year to a high of 5.4% per year, with an
overall average of 3.0%. During 2008 through 2019, infla-
tion ranged from a low of -0.4% to a high of 3.8%, with
an average of 1.8%. Another possible explanation of the
difference is that Murdock and Krause’s sample included
Figure 1: LIFO Reserve and Change in LIFO Reserve
-$10,000
-$8,000
-$6,000
-$4,000
-$2,000
$0
$2,000
$4,000
$6,000
$8,000
$10,000
LIFO Reserve this year (million) LIFO Reserve Prior Year (million) Increa se in LIFO Reserve
Table 3: Correlation Matrix
Cash
provided by
operations
LIFO
earnings
before tax
FIFO
earnings
before tax
Cash provided
by operations
1.00000
LIFO earnings
before tax
0.84600 1.00000
FIFO earnings
before tax
0.84861 0.89963 1.00000
16
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
more companies and smaller ones. Importantly, though,
both results indicate operations provided a strong rela-
tionship between LIFO earnings and cash flows.
Now that the statistical analysis is complete, consider
the graphical findings to better understand the practical
differences. Figure 2 shows that LIFO ending-
inventory figures are clearly different from FIFO
ending-inventory figures. For some years and some
Figure 2: Ending Inventory, LIFO vs. FIFO
$0
$5,000
$10,000
$15,000
$20,000
$25,000
End. LIFO Inventory End. FI FO Inventory
Figure 3: Cost of Goods Sold, LIFO vs. FIFO
17
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
Figure 4: Gross Profit, LIFO vs. FIFO
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
Gross Prot LIFO Gross Prot FIFO
Figure 5: Earnings Before Interest and Taxes, LIFO vs. FIFO
-$20,000
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
LIFO EBIT FIFO EBIT
18
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
companies, that difference is large; and for some years
and some companies, the difference is small. This
implies that LIFO ending inventory is not a good surro-
gate for FIFO ending inventory.
Figures 3, 4, and 5 show what Table 2 identified—
COGS LIFO vs. FIFO, gross profit LIFO vs. FIFO,
and EBIT LIFO vs. FIFO are virtually the same and
nearly indistinguishable from each other. Notice that
Figure 5 shows additional data (the first “mountain” of
data points is added) from Figure 4. This is because
Berkshire Hathaway does not report COGS in the face
of its income statements.
Figure 6 shows that LIFO days sales in inventory are
clearly different from FIFO days sales in inventory at a
variety of magnitudes. The LIFO measures are almost
uniformly lower than the FIFO figures, with at least
two small exceptions. Recall that the ratios were statisti-
cally different. Thus, the financial analyst would want
to convert a LIFO days sales in inventory ratio to the
FIFO measure before comparing FIFO and LIFO val-
ues of the number of days it takes on average to sell
inventory to avoid bias.
A measure of the cash flow cycle efficiency, the cash
operating cycle is days sales in inventory plus days sales
in receivables less days purchases in payables. Figure 7
shows that the LIFO cash operating cycle is typically
lower than the FIFO cash operating cycle, with only a
short series of exceptions. This is another example of
an instance when the analyst would want to convert the
LIFO values to FIFO values before relying on this sta-
tistical signal. This is because the data are both statisti-
cally and practically different from each other.
Thus far, a similarity appears in each LIFO vs. FIFO
graph. This is no surprise because the LIFO and FIFO
data are paired data from the same companies during
the same period, with the only difference being the
inventory cost flow calculation. The similarity continues
in many of the subsequent graphs to the point that the
LIFO line graph is almost indistinguishable from the
FIFO line graph. Remember that in all subsequent
cases, these line graphs differ statistically in a signifi-
cant way, despite the similarity. The question you need
to answer is whether the differences are unique on a
practical level.
Figure 8 shows that the LIFO total asset turnover
line graph has higher peaks than the FIFO total asset
Figure 6: Days Sales in Inventory, LIFO vs. FIFO
0
50
100
150
200
250
Days Sales in Inventory LIFO Days Sales in Inventory FIFO
g
Days Sales in Inventory
LIFO vs. FIFO
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MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
Figure 7: Cash Operating Cycle, LIFO vs. FIFO
-150
-100
-50
0
50
100
150
200
250
Cash Operating Cycle LIFO Cash Operating Cycle FIFO
g
Cash Operating Cycle
LIFO vs. FIFO
Figure 8: Total Asset Turnover, LIFO vs. FIFO
-
1.00
2.00
3.00
4.00
5.00
6.00
7.00
Total Asset Turnover LIFO vs. FIFO
Total Asset Tur nover LIFO Total Asset Tur nover FIFO
Figure 8
Total Asset Turnover LIFO vs. FIFO
20
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
turnover line graph, but the lines converge throughout
most of the graph otherwise. Also notice that in all
cases, the “signal” sent by both ratios is similar. This is
because the distortion in earnings from LIFO vs. FIFO
is partially offset by the distortion in total assets. The
similarities in the two lines of this graph demonstrate
that despite statistical significance, there is no practical
difference between the two lines. Granted, differences
appear during the early half of this graph, but the lines
are otherwise so close together that no white space can
be seen between the two lines. Thus, both LIFO and
FIFO send for the most part equally useful signals. It
appears there is no need to recast the total asset
turnover ratio from its original LIFO basis to a FIFO
basis since the bias in inventory is very small when
compared to the bias in total assets.
Figure 9 shows that the LIFO gross profit margin
line graph highly converges with the FIFO line graph.
To be sure, the differences are small and idiosyncratic,
with no clear visual pattern to the distortion. As
reported earlier, the average difference is just 0.1%, one
tenth of one percentage point. Since the impact on
COGS relative to sales is small, the impact from the
LIFO vs. FIFO calculation is very slight. Again, there
appears to be no benefit in transforming the LIFO
measure of COGS to a FIFO basis.
Figure 10 tells a similar story in that the EBIT earn-
ings relative to sales LIFO line graph converges with
the FIFO line graph, with only a few idiosyncratic
observations. The average difference is, again, less than
one tenth of a percentage point. So, on a practical level,
the very slight difference means recasting LIFO calcu-
lations of EBIT return on sales to a FIFO basis pro-
vides no particular benefit.
Figure 11 tells a similar, yet slightly different story.
The LIFO EBIT return on assets line graph converges
with the corresponding FIFO ratio in some of the com-
panies but is visually separate from it in other compa-
nies. Even in the cases when the line graphs diverge,
the directional signal sent for financial statement analy-
sis is generally representative. Specifically, when LIFO
return on assets increases, the corresponding FIFO ratio
typically increases as well. And when the LIFO ratio
decreases, the corresponding FIFO ratio typically does
as well. For this reason, the LIFO ratio of return on
assets is fine for use in an overtime basis but not as
Figure 9: Gross Profit Margin Ratio, LIFO vs. FIFO
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Gross Prot Margin LIFO vs. FIFO
Gro ss Prot Margin LIF O Gross Prot Margin FIFO
Figure 9
Gross Profit Margin Ratio LIFO vs. FIFO
21
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
Figure 10: EBIT Return on Sales, LIFO vs. FIFO
-40.0%
-20.0%
0.0%
20.0%
40.0%
60.0%
80.0%
Return on Sales NIBT LIFO vs. FIFO
Return on Sales LIFO NIBT Return on Sales FIFO NIBT
Figure 10
EBIT Return on Sales LIFO vs. FIFO
Figure 11: EBIT Return on Assets, LIFO vs. FIFO
-20%
-10%
0%
10%
20%
30%
40%
50%
Return on Assets NIBT LIFO vs. FIFO
Return on Assets LIFO NIBT Return on Assets FIFO NIBT
Figure 11
EBIT Return on Assets LIFO vs. FIFO
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MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
Figure 12: Financial Leverage, LIFO vs. FIFO
-
5
10
15
20
25
30
35
40
45
50
g
Financial Leverage LIFO Financial Leverage FIFO
Figure 13: EBIT Return on Equity, LIFO vs. FIFO
-100%
-50%
0%
50%
100%
150%
200%
250%
300%
350%
NIBT Retu rn on Equ ity LIFO NIBT Return on Equity FIFO
Figure 13
EBIT Return on Equity LIFO vs. FIFO
23
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
good in a between-companies basis.
Financial leverage is calculated as total assets divided
by total equity to measure the impact of the ownership
structure on return on equity relative to return on
assets. Figure 12 shows that the LIFO financial lever-
age graph line mostly converges with the corresponding
FIFO ratio. The divergences are typically small, except
for the single tall spike that results from an exception-
ally large change in total equity. Hence, under normal
circumstances, only a small difference appears between
LIFO and FIFO financial leverage.
Figure 13, however, tells a different story with return
on equity. Both the statistical difference and the practi-
cal difference make it worthwhile to recast LIFO num-
bers into ones comparable to FIFO before relying on
them for comparative purposes. That is, the impact on
both the numerator and the denominator make it
impractical to compare LIFO results to FIFO results.
The comparative line graphs on return on equity, EBIT
earnings relative to stockholders’ equity, show two dis-
tinctly separate lines that rarely converge, with an aver-
age difference of 4.5 percentage points. Notice also that
the signals sent by both line graphs, in terms of the
directions of the line slopes, are very similar, with the
big exception being the tall spike previously noted in
reference to Figure 12 wherein the company purchased
a large amount of treasury stock. The smaller the
denominator, the greater the magnitude of change that
results from a change in the numerator.
CONTRIBUTIONS OF THIS RESEARCH
This study’s findings contribute to the discussion of
whether the Financial Accounting Standards Board
(FASB) should retain LIFO as a valid inventory cost
flow assumption. Currently, the U.S. is the sole holdout
country to permit its companies to use LIFO, and, in
fact, 19% of the Fortune 100 choose to do so. The data
tell us that both LIFO and FIFO EBIT are equally cor-
related with cash provided by operations, so both LIFO
and FIFO numbers are equally representationally faith-
ful. Before this study, accountants relied on the concep-
tual analysis that LIFO is a better predictor of cash
flows. With this study, along with the results of
Murdock and Krause, companies will be able to rely on
data, not just a conceptual argument, to determine the
benefits and pitfalls of LIFO.
7
Specifically, this research supports the validity of
LIFO to redirect cash flows and perform some ratio
analysis. On a statistical level, measurable differences
show up between LIFO vs. FIFO ratio calculations.
And while on a practical level, LIFO does distort most
activity and most liquidity ratios, it has typically indis-
cernible effects on most profitability ratios including
gross profit margin ratio, return on sales, and return on
assets. Because the cost flow assumption affects the
financial leverage ratio, the return on equity ratio is
affected as well. Despite the sometimes distorted
across-companies results, on an over-time basis, the
directional signals show remarkably similar patterns.
Hence, this research supports the continuation of LIFO
as a valid inventory cost flow assumption given the foot-
note LIFO reserve disclosure.
With respect to financial statement analysis over
time, LIFO calculations generally send similar signals,
such that there appears to be little benefit to transform
the data to a FIFO basis. Yet, when conducting finan-
cial statement analysis between companies, when one
or more of the companies uses a non-LIFO inventory
cost flow assumption, best practices would require the
company to transform the data to a FIFO basis for com-
parative purposes. Otherwise, it introduces inherent
bias into activity and leverage ratios.
This research also offers the ability to illustrate which
major companies still use LIFO, as well as gives
accounting instructors and financial statement analysts
the opportunity to illustrate the impact LIFO has on
financial ratios to interested students, investors, and
others.
The 10-year period for this study poses limitations
because this was a time when crude oil prices were gen-
erally trending lower over time. While the sample was
not made up completely of oil-related companies, the
oil trend may have biased some of the results. To allevi-
ate this potential problem, a longer data window was
considered; the practical issue, however, is the XBRL
data that facilitated the data-collection process was not
available for the earlier period.
So, to answer the question “Should you be leery of
LIFO?” The answer is no; being leery of LIFO is not
well-founded. LIFO provides good signals for financial
24
MANAGEMENT ACCOUNTING QUARTERLY FALL 2020, VOL. 22, NO. 1
statement analysis over time. Caution, however, to
those who want to conduct a careful analysis between
companies such that an inventory adjustment is war-
ranted, especially since the adjustments necessary are
straightforward. ■
Kay E. Zekany, Ph.D., CMA, is an assistant professor of
accounting and the holder of the Capital One Bank
Endowed Professorship at McNeese State University. She
can be reached at (419) 516-3184 or [email protected].
ENDNOTES
1 Paul B.W. Miller and Paul Bahnson report that the IRS began
permitting LIFO for tax purposes in 1939. “The Spirit Of
Accounting: Fortress LIFO is crumbling: It’s about time,”
Accounting Today, January 2008, pp. 13-14, www.accounting
today.com/news/the-spirit-of-accounting-fortress-lifo-is-
crumbling-its-about-time.
2 Frances Ayres, Christine Bauman, Mark Bauman, and Yun Fan,
“Inventory Accounting After LIFO,” Commercial Lending Review,
September-October 2008, pp. 17-24.
3 EBIT is the best measure of earnings because it ignores inter-
est, income taxes, discontinued operations, and previously
recorded extraordinary items.
4 Peter Easton, Robert Halsey, Mary Lea McAnally, Al
Hartgraves, and Wayne Morse, Financial & Managerial Accounting
for MBAs, Cambridge Publishing House, Belmont, Ill., 2018.
5 Berkshire Hathaway did not disclose COGS on the face of its
income statement. Therefore, more data were available to cal-
culate the EBIT than the gross profit and COGS. Hence, this
explains the difference in results from COGS and gross profit
vs. EBIT.
6 Brock Murdoch and Paul Krause, “Comparing LIFO and FIFO:
An Empirical Test of Representational Faithfulness,” Conflict
Resolution & Negotiation Journal, March 2013, pp. 104-110; Sir
Richard John Hicks, Value and Capital, University Press, Oxford,
U.K., 1939.
7 Murdock and Krause, 2013.