[Companies that use commodities as inputs (e.g., crude oil and coffee) often face inventory decisions in an environment of widely fluctuating prices. Under LIFO, the end-of-period decision to replace liquidated LIFO layers (or not) may dramatically affect cost of goods sold for both tax and financial reporting. In this paper, we first model the factors involved in the end-of-period decision to acquire inventory. We then apply this model in the context of the difficult situation faced by the management of the Farmer Brothers (coffee) Company in fiscal year 1977. The events reflected in Farmers Brothers' fiscal year 1977 financial statements reveal many of the economic factors involved in managing inventories recorded on a LIFO basis. The actual end-of-period decision reached by Company management is compared to plausible alternative actions. The analysis focuses on estimates of the effects of these alternative actions on cash flows and reported income as well as other factors that might have influenced management to increase the level of ending inventory in the face of declining prices.]

In recent years, the nonoperating income account, Allowance for Funds Used During Construction (AFC), has become a large percentage of earnings available for common in the electric utility industry. Industry observers have disagreed as to the "quality" of AFC earnings and have linked AFC to depressed common equity values. A cross-sectional equity valuation model is used to operationalize the notion of earnings "quality" and to test empirically the relative impact of AFC and operating earnings on the valuation of electric utility shares. A secondary objective is to improve the specification of prior valuation models. It is concluded that the AFC component is of positive economic value but is generally less valuable per dollar than operating earnings. Evidence is also provided (1) on the extent to which AFC is discounted relative to operating earnings, and (2) on the reduction of specification error in the valuation model.

Based on theory and anecdotal evidence, we argue that ongoing implicit claims between a firm and its customers, suppliers, employees, and short-term creditors create incentives for management to choose long-run income-increasing accounting methods. Variables selected to proxy for the extent to which a firm depends on these implicit claims are found to be significant in explaining cross-sectional variation in inventory and depreciation methods. These variables remain incrementally significant when we include traditional variables found to have explanatory power in prior studies (i.e., leverage, bonus compensation, tax, and regulatory/political exposure variables).

[Current financial reporting practices have traditionally emphasized measures of accrual earnings. On the other hand, the link between future cash flows and firm value is well accepted by financial economists, and recently there has been increased interest in measures of cash flow. This paper provides evidence on the role of accrual (i.e., earnings and working capital from operations [WCFO]) and cash flow measures in an explanatory model of security prices. This issue is first examined by testing for an association between unexpected security returns and unexpected cash flows, after controlling for the relation between unexpected returns and unexpected earnings. We also examine the obverse issue by testing for an association between unexpected security returns and unexpected earnings, after controlling for the relation between unexpected returns and unexpected cash flows. We test these relations in two contexts: in results pooled over the entire ten-year time period studied and in year-by-year cross-sectional regressions. Results for our complete sample are generally consistent with: (1) cash flow data having incremental information content relative to that contained in earnings; (2) cash flow data having incremental information content in addition to that contained in earnings and WCFO; and (3) accrual data (i.e., earnings and WCFO) jointly and separately having incremental information content in addition to that contained in cash flow data. However, the results do not support the hypothesis that WCFO has incremental information content relative to that contained in earnings.]

[In recent years, there has been renewed interest in cash flows. This paper describes empirical relationships between signals provided by accrual earnings and various measures of "cash flow" (CF). We include among definitions of CF both "traditional" measures that include simple adjustments to earnings data (i.e., net income plus depreciation and amortization, and working capital from operations) as well as "alternative" measures that incorporate more extensive adjustments (defined in the paper). Evidence is presented on three issues. First, the correlations among various measures of CF are examined to determine whether the signal provided by a given CF measure differs from the signal provided by others. Second, various measures of CF are correlated with earnings to lend evidence on whether the CF and earnings signals are similar. Third, we provide evidence on the ability of earnings and cash flow measures to forecast one period and two period ahead cash flows and, in so doing, we examine the FASB's assertions that earnings are superior to CF in predicting future CF. Results can be summarized as follows. First, the observed correlations between traditional cash flow measures and alternative CF measures that incorporate more extensive adjustments are low. Second, the correlations between alternative measures of CF and earnings are low while the correlations between traditional measures of CF and earnings are high. These first two results are consistent with earnings and alternative measures of CF that incorporate more extensive adjustments conveying different signals. Finally, for four out of five cash flow variables, the results are consistent with the hypothesis that random walk models predict CF as well as (and often better than) models based on other flow variables. An exception to this general result is that net income plus depreciation and amortization and working capital from operations appear to be the best predictors of cash flow from operations. Overall, these results are not consistent with the FASB's statements that earnings numbers provide better forecasts of future cash flows than do cash flow numbers.]

Until 1974, firms could choose, within GAAP, to capitalize or expense interest costs associated with capital expenditures. The predominant practice had been to treat interest as a period expense. However, in 1974, the Securities and Exchange Commission imposed a moratorium on further adoption of interest capitalization by non-regulated firms. This study empirically examines economic factors potentially influencing firms' decisions to expense or capitalize interest prior to the SEC moratorium. We hypothesize that the choice may be affected by (1) the existence of management compensation agreements tied to reported earnings, (2) debt covenant constraints, and (3) the political costs (for some firms) of reporting higher earnings. When compared to the control group, our findings are that (1) the frequency of explicit management compensation packages was not greater for the interest capitalization group, (2) firms with financial ratios closer to likely debt agreement constraints (on dividends, interest coverage, and leverage) tended to elect interest capitalization, and (3) other than the largest firms in the ‘politically sensitive’ petroleum refining industry, the larger firms were more likely to capitalize interest.

The article reviews the book "Financial Statement Analysis," by Charles H. Gibson and Patricia A. Boyer.

The article reviews the book "Financial Statements: Form, Analysis and Interpretation," by Stewart Y. McMullen.

Robert M. Bowen, Richard P. Castanias, Lane A. Daley, Intra-Industry Effects of the Accident at Three Mile Island, The Journal of Financial and Quantitative Analysis, Vol. 18, No. 1 (Mar., 1983), pp. 87-111

The voluntary use of regulatory accounting principles (RAP) by Savings and Loans (S&Ls) is predicted to be related to ownership structure, proximity to violation of net worth requirements, political factors, and prior use of RAP. We examine the decisions to both adopt and retain the use of several RAP: two ‘cosmetic’ RAP that are relatively independent of other economic decisions and two ‘noncosmetic’ RAP that directly interact with investment or financing decisions. S&Ls using RAP tend to: (a) be mutuals, (b) have low regulatory net worth, (c) be larger (for S&Ls adopting RAP), and (d) have used other RAP in the prior period.