Inventory valuation, FIFO, LIFO, Tax payments

A model for estimating the change in the economic value of a firm due to the adoption and use of last in, first out (LIFO) under conditions of certainty has been presented. The model requires single-point estimates of three parameters: the marginal tax rate, the cost of the basic inventory and the ratio of the cost of capital of the firm to the anticipated rate of inflation. In estimating the effect of LIFO on the economic value of the firm, the analysis has been limited to the net present value of future cash flows. Any additional risk that the firm may have to bear due to uncertainty in the future rates of inflation and, therefore, in the effect of LIFO on the firm has not been considered. Indeed, there is some empirical evidence available to indicate that the adoption of LIFO is accompanied not only by an increase in the market value of the firm, but also by an increase in the market risk of its ownership shares. The critical assumptions of the model are that the physical quantity of inventory remains constant and the rates of price change, discount and taxation are known deterministically.

The article focuses on properties of accounting numbers in costing in petroleum industries. Financial reporting and accounting practices used in the petroleum industry differ both among firms within the industry and also from practices of other industries in several respects. One area of difference is accounting for prediscovery costs. Because such costs are relatively large and because a large degree of uncertainty is associated with the potential benefits sought by incurrence of such costs, this area has provoked many practices; most can be grouped either as successful-efforts costing or full-costing practices. The practice of capitalizing only those prediscovery costs, which are directly identifiable with discovery of a commercial reserve and treating all other costs as operating expense is referred to as successful-efforts costing. On the other hand, the practice of capitalizing all prediscovery costs irrespective of their result is called the full-costing method. The study described in the paper is an attempt to analyze the effect of using the alternative methods on various accounting variables.