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Inventory accounting and earnings/price ratios: A puzzle

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  • CHI†WEN JEVONS LEE

Abstract

. Economic intuition indicates that each dollar of current pretax cash flow should lead to higher accounting earnings, higher tax payments, and lower stock price under the FIFO rather than the LIFO method of inventory costing. Hence, the earnings/price ratios of the FIFO firms should be higher than those of the LIFO firms. However, the empirical study in this paper provides evidence to the contrary. To search for confounding factors, I examine the possible impacts of size, risk, industry classification, other accounting methods, and expectations of future earnings growth. None of these factors seems to affect the conclusion significantly. Because I have not established a complete causal link between accounting information and stock valuation, I refrain from drawing strong inferences and treat it as a puzzle. This puzzle should stimulate more research in this area in the future. Résumé. L'intuition économique veut que chaque dollar de flux d'encaisse actualisé avant impôt doive produire des bénéfices comptables supérieurs, des impôts à payer plus élevés, et des prix plus faibles des actions si l'on utilise la méthode d'épuisement successif (PEPS) plutôt que la méthode d'épuisement à rebours (DEPS) dans l'establissement du coût des stocks. Les ratios cours/bénéfices des entreprises qui utilisent la méthode PEPS devraient done être plus élevés que ceux des entreprises qui utilisent la méthode DEPS. Toutefois, l'étude empirique effectuée par l'auteur l'amène à des conclusions contraires. Cherchant des facteurs qui tendraient à renverser la situation, il examine l'incidence possible de la taille, du risque, de la classification du secteur, d'autres méthodes comptables et de perspectives de croissance éventuelle des bénéfices. Aucun de ces facteurs ne semble influer sur sa conclusion de façon significative. L'auteur n'ayant pas établi de lien de causalité définitif entre l'information comptable et l'évaluation des actions, il s'abstient de tirer des conclusions fermes et aborde plutôt la question sous forme de puzzle. Un puzzle qui devrait éventuellement stimuler la recherche dans ce domaine.

Suggested Citation

  • Chi†Wen Jevons Lee, 1988. "Inventory accounting and earnings/price ratios: A puzzle," Contemporary Accounting Research, John Wiley & Sons, vol. 5(1), pages 371-388, September.
  • Handle: RePEc:wly:coacre:v:5:y:1988:i:1:p:371-388
    DOI: 10.1111/j.1911-3846.1988.tb00710.x
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