New evidence on the incremental information content of earnings reported using the LIFO inventory method

a r t i c l e i n f o Keywords: Last-in-first-out First-in-first-out Information quality This study extends prior research by comparing the relative information quality of LIFO earnings and non-LIFO earnings using updated data and methodology. Results suggest LIFO earnings are incrementally informative independent of tax reporting implications. In addition to shedding light on why the results of prior studies present conflicting evidence about the relative information content of LIFO, these findings are important in light of international accounting standards convergence efforts, under which LIFO is currently prohibited. The information content of earnings may be assessed according to the impact of its change on stock price, as validated by others in numerous contexts (e. 1 states that the objective of financial reporting is to provide decision-useful information to investors (FASB, 1978); hence, the choice of accounting policies for measuring inventory costs and how these choices affect the information content of earnings are important considerations. The Financial Accounting Standards Board (FASB) reports that an important qualitative objective of financial reports is that they should be relevant and timely (FASB, 1980). Since the last-in, first-out (LIFO) cost of goods sold (COGS) reflects more recent input prices, ceteris paribus, relative to non-LIFO cost flow assumptions, LIFO net income provides a more timely measure of firm performance. Several prior studies have investigated this assumption by evaluating the relative earnings quality and information content of the LIFO method of accounting for inventories. Using LIFO note disclosures to re-cast LIFO into " as if " non-LIFO financial reports, Jennings, Simko, and Thompson (1996) document that LIFO income statements explain more of the cross-sectional variation in equity values than their " as if " non-LIFO counterparts. Carroll, Collins, and Johnson (1991) compare before and after earnings response coefficients (ERCs) for LIFO adopters and find evidence of post-adoption increases, in support of the suggestion that LIFO provides incremental information content. In contrast, Pincus and Wasley (1996) identify post-LIFO adoption decreases in ERCs. Neither of these studies attempt to control for taxes and other factors that have been demonstrated to affect the returns and earnings relation , perhaps contributing to these conflicting findings. Biddle and Ricks (1988) and Hand (1995) investigate excess returns around earnings announcements dates of LIFO adopters. Biddle and Ricks (1988) document a positive bias in earnings forecasts and report negative two-day excess returns. In contrast, after considering the impact of pre-earnings disclosures, Hand …