Abstract This article discusses the effects of last-in, first-out (LIFO) method of inventory cost determination on balance sheets. Perhaps the greatest limitation of the LIFO method of inventory cost determination is the distortive effects that it may have on a company's balance sheet. Evidence exists that the balance sheet problem posed by LIFO is of immediate concern to the accounting profession. Recognizing that the use of LIFO may produce certain balance sheet distortions, the U.S. Securities and Exchange Commission (SEC) has required since 1972, that companies whose securities trade publicly disclose the excess of replacement or current cost over LIFO value stated on the balance sheet, if material. A frequently-cited argument against LIFO is that the balance sheet valuation of inventory may be unrelated to current conditions. According to this argument, the balance sheet under LIFO is misrepresented by the amount of the LIFO reserve. LIFO liquidations sometimes occur, however, despite the tax incentives that encourage managers to avoid them. In fact, these liquidations are sometimes caused by events beyond management's control such as labor strikes, underforecasts of product demand and high interest rates that may tend to raise inventory holding costs. LIFO liquidations generally decrease the LIFO reserve and thereby reduce the balance sheet distortion caused by LIFO. A concern about the distortive effects that LIFO can have on corporate balance sheets over time has led to the proposed solutions described in the introduction to this paper. Currently, the SEC requires registrants to disclose the LIFO reserve. Yet no empirical evidence has been reported to support the disclosure requirement of SEC. Moreover, the current disclosure requirement applies only to companies whose securities trade publicly.
Reeve et al. (Tue,) studied this question.