Financial implications of a change to LIFO inventory valuation

Fi e , C.; Mowszowski, N. A icle Financial implica ions o a change o LIFO in en o y alua ion Sou h A ican Jou nal o Business Managemen P o ided in Coope a ion wi h: Uni e si y o S ellenbosch Business School (USB), Bell ille, Sou h A ica Sugges ed Ci a ion: Fi e , C.; Mowszowski, N. (1984) : Financial implica ions o a change o LIFO in en o y alua ion, Sou h A ican Jou nal o Business Managemen , ISSN 2078-5976, A ican Online Scien i ic In o ma ion Sys ems (AOSIS), Cape Town, Vol. 15, Iss. 2, pp. 71-79, h ps://doi.o g/10.4102/sajbm. 15i2.1106 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/217853 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. Sie dü en die Dokumen e nich ü ö en liche ode komme zielle Zwecke e iel äl igen, ö en lich auss ellen, ö en lich zugänglich machen, e eiben ode ande wei ig nu zen. 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Mowszowski G adua e School o Business Adminis a ion, Uni e si y o he Wi wa e s and, Johannesbu g A numbe o Sou h A ican companies ha e, in ecen yea s, changed hei me hod o in en o y alua ion o he las in, i s ou (LIFO) echnique. The implica ions o such a change go a beyond me ely educing epo ed ea nings and in en o y le els. This a icle examines he e ec o LIFO on some key inancial a iables o companies. I also conside s he ex en o which lis ed companies in Sou h A ica ha e communica ed wi h he ma ke in o de o ensu e ha he pe cep ions o such in- e es ed pa ies as sha eholde s, lende s and analys s a e no dis o ed by he di e ing me hods o accoun ing. S. A . J. Bus. Mgm . 1984, 15: 71 - 79 'n Aan al Suid-A ikaanse maa skappye he in die laas e paa jaa hul me ode an in en a is- aluasie na die laas e in, ee s e ui (LIEU)-me ode e ande . Die implikasies an so 'n e ande- ing is eel mee as slegs 'n e minde ing in die ge ap- po ee de e diens e en in en a is- lak e. Hie die a ikel bekyk die e ek an LIEU op seke e belang ike inansiele maa s awwe an maa skappye. Di besp eek ook die ma e waa in gelys e maa skappye in Suid-A ika die konsep aan die ma k e - duidelik he , spesi iek om e e seke da aandeelhoue s, geldskie e s en inansiele anali ikusse die implikasies e s aan. S.-A . Tydsk . Bed y sl. 1984, 15: 71 -79 C. Fi e * and N. Mowszowskl G adua e School o Business Adminis a ion, Uni e si y o he Wi wa e s and, P.O. Box 31170, B aam on ein 2017, Republic o Sou h A ica. "To whom co espondence should be add essed Accep ed Feb ua y 1984 In oduc ion Recen ly, a signi ican numbe o companies ha e adop ed LIFO (las in, i s ou ), as agains FIFO ( i s in, i s ou ), a e age cos o any o he me hod o aluing hei in en o ies. A su ey by a i m o Cha e ed Accoun an s in Sou h A ica (Alex Aiken & Ca e , 1983) disclosed ha wen y-six indus ial companies whose sha es a e lis ed on he Johan- nesbu g S ock Exchange (JSE) changed o LIFO du ing he yea ended June 1983, b inging he o al numbe o indus ial company LIFO use s on he JSE o nine y- wo o 31 OJo o he lis ed indus ial companies. This compa es wi h 120Jo as a June 1981. Companies which a e con empla ing adop ing LIFO (and indeed, companies who ha e al eady done so) a e aced wi h wha is commonly e e ed o as he LIFO dilemma. The e a e wo hypo heses which ha e been pos ula ed, gi ing ise o his dilemma. Acco ding o Counihan and Wa s (1978), hese a e: (i) Fi s ly he s ock ma ke could be misled by he educed ( epo ed] income and ix a [s ock] p ice equal o o lowe han he p esen p ice. This is he ' unc ional ixa ion' hypo hesis. (ii) The second al e na i e is ha he s ock ma ke ecognizes he inc eased alue o he i m (equi alen o he p esen alue o he cash- low bene i s ob ained due o he de e - al o ax] and inc eases he s ock p ice [acco dingly]. This is a consequence o he 'e icien ma ke s hypo hesis'. Fo as long as in la ion is p e alen , his dilemma will exis . In in la iona y imes, one o managemen 's mos u gen asks is o ensu e ha he i m which i is managing has de eloped an adequa e low o cash in o de ha any asse s which a e consumed (ei he h ough he cou se o being used in he p o- cess o p oduc ion o by being sold o cus ome s as a p oduc pe se) can be eplaced, he eby secu ing he su i al and po en- ial g ow h o he i m. This a icle examines he e ec o LIFO on some key inan- cial a iables o companies as well as he ex en o which lis ed companies in Sou h A ica ha e communica ed wi h he ma ke in o de o ensu e ha he pe cep ions o in e es ed pa ies (such as sha eholde s, c edi o s, lende s, in es o s, analys s and compe i o s, bo h cu en and p ospec i e) a e no dis o ed by he di e ing me hods o accoun ing. Flnanclal and comme cial Implica ions The ax and accoun ing implica ions o LIFO a ise a he end o a company's inancial yea . Howe e , he i m ope a es h oughou he yea . The in oduc ion o LIFO by a i m has 72 po en ial impac on many aspec s o i s day o day unning, s emming ei he om he equi emen s o a change o LIFO o om accoun ing o ax implica ions. Each i m mus assess he e ec which each o he ac o s men ioned below could ha e on i s own ope a ions and hen weigh he ad an ages agains he disad an ages be o e a i ing a a decision. The decision is an ex emely impo an one as i canno la e be e e sed wi hou he consen o he Commissione o Inland Re enue (CIR). Consequen ly, i is sugges ed ha he decision should be aken by senio managemen en bloc in o de o ensu e ha e e y depa men which is in luenced by a swi ch o LIFO (e.g. accoun ing, inance, ma ke ing, p oduc ion, pu chasing, wa e- housing, pe sonnel e c.) is equipped o handle i s e ec s and o con ibu e owa ds he op imiza ion o he use o he me hod. Manage s conside ing whe he o adop LIFO will be g ea ly assis ed by o ecas s o he e ec s o LIFO on an icipa ed inancial esul s and cash lows. I he o ganiza ion has d awn up a long- ange plan, he inancial plan should be adjus ed o he e ec s o LIFO and e alua ed. Al e na i ely, whe e LIFO is applied o many ca ego ies o in en o y subjec o di e en a es o in la ion and olume luc ua ions, i may be app op ia e o unde ake a sepa a e exe cise o conside he e ec s o LIFO unde al e na i e condi ions. Key ac o s o be e alua ed in hese o ecas s include: (i) he e ec s o he al e na i e LIFO me hods; (u) al e na i e p ojec ed u u e in la ion a es; (iii) luc ua ions in in en o y olumes; (i ) he ca ego ies o in en o y o be alued on LIFO; ( ) he composi ion o LIFO in en o y 'pools'; ( i) sensi i i y o LIFO esul s o changes in sales olumes and p ices; ( u) b eak-e en sales and ixed cha ge co e age unde LIFO. Sampling echniques may be used o de e mine he po en- ial e ec o LIFO on a ious in en o y ca ego ies o p o ide a guide o u u e alues. Sha e p ice Will he e be an e ec on he sha e p ice i a i m swi ches o LIFO? I he answe is posi i e, will he esul s be an in- c ease in sha e p ice (due o he enhanced cash low) o a dec ease (due o in es o s pe cei ing only he lowe epo ed ea nings)? I sha e p ices we e o be ad e sely a ec ed by a swi ch o LIFO (i.e. sha e p ices lowe han i say FIFO we e used) due o he ope a ion o he unc ional ixa ion heo y, his could lead o an inc eased cos o capi al. Consequen ly, i ms us- ing a discoun ed cash low app oach o capi al budge ing would, because o he use o oo high a discoun a e, ejec p ojec s which hey may o he wise ha e unde aken. Such o egone in es men oppo uni ies will ce ainly no lead o maximiza ion o sha eholde s' weal h. Ho'we e , i in es o s ecogniz.ed he bene i s o a swi ch o LIFO in e ms o in- c eased cash low, hen, ce e is pa ibus, economically iable p ojec s would be unde aken and he e would be no s agna- ion in g ow h o he i m o i s sha eholde s. In a emp ing o answe ques ions such as hese, he issue o ma ke e iciency mus be aised. This has been deal wi h a leng h in nume ous a icles and books ( o example Fama, 1970; B ealey & Mye s, 1981; Gilbe son & Roux 1977· . ' ' Gilbe son & Ve maak, 1982). An in es iga ion in o s ock ma ke beha iou esul ing om a 1n 1's swi ch o LIFO should be examined unde he ca ego y S.-M . I yc.hk . lkc.l y ,I. 1984, 15(2) o he semi-s ong o m o ma ke e iciency. Acco ding o Knigh (1981 ), wo o he implica ions o he e icien ma ke hypo hesis a e ha : (i) in an e icien ma ke , sha e p ices adjus quickly and wi hou bias o new in o ma ion; and (ii) he in o ma ion is e ec i ely impounded in o sha e p ices. Wha is o majo conce n he e is he impac which a change o LIFO will ha e on sha e p ices, no only a he ime o an- nouncemen o a change o he change i sel , bu also on an on-going basis, i.e., is he ma ke unc ionally ixa ed (does i belie e only he ea nings igu es i sees?) o is i e icien (does i ecognize ha accoun ing echniques, only change igu es and no he economic posi ion o a company?) In a Sou h A ican s udy, Knigh and A leck-G a es (1983), concluded ha he announcemen o a swi ch o LIFO has a subs an ial nega i e impac on sha e e u ns which seems o be di ec ly p opo ional o he ex en o which FIFO ea nings a e educed by he LIFO adjus men . They also ound ha he nega i e impac is impounded in o p ices sluggishly. They he e o e sugges ed double ine iciency o he JSE. Ha ing s udied he e ec o swi ches o LIFO by companies up o No embe 1980, hey also ound, howe e , ha he ma ke seems, in he case o he mos ecen changes, o be impound- ing he in o ma ional con en o a swi ch o LIFO much mo e apidly and he nega i e impac has also been less p onounc- ed. They concluded ha he ma ke appea s o be lea ning how o in e p e he change o LIFO. Ano he majo possible consequence o a lowe sha e p ice is ha o he suscep ibili y o ake o e . A i m wi h a sha e p ice lowe han i s ' ue' alue lea es i sel open o being sna - ched up by a p eda o who ealizes wha he ' ue' alue is. This aspec could, o example, ha e p o ound implica ions o i ms whe e con ol is no es ed in one pa y. Ea nings, cash low and asse s The e ec o LIFO is o educe epo ed ea nings and asse alues. Os ensibly cash low, which is usually de ined as ne p o i a e ax plus non-cash i ems such as dep ecia ion, is also educed due o he ac ha o e e y RI educ ion in ne p o i be o e ax, he e is only a 46,2c educ ion in ax, assuming a ax a e o 46,2%. The e o e, o e e y RI educ- ion in in en o y alue due o LIFO, he e is a educ ion in cash low (as de ined abo e) o S3,8c. Howe e , in his sense, he de ini ion o cash low can be said o be allacious i.e., how can cash low ha e educed, ye he e is mo e cash in he bank? Fo e e y RI o LIFO adjus men he ue si ua ion is in ac as ollows: Na u e o e ec Cash low Repo ed ne income Sha eholde s' unds Tax liabili y In en o y E ec Inc eased by 46,2c Dec eased by S3,8c Dec eased by S3,8c Dec eased by 46,2c (equi alen o cash in he bank) Dec eased by 100c The e o e, while epo ed ea nings, cash lows and asse alues a e lowe , he e is no doub ha hese igu es a e o a be e quali y han unde o he in en o y alua ion me hods, in ha he ne e ec is ha he e is mo e cash in he bank. As is discussed la e , his has p o ound implica ions on di i- dend policies. bo owing powe s and gea ing, and liquidi y and S. A . J. Bus. Mgm . 1984, 15(2) p o i abili y a ios, i.e. all he indica o s which a e ex ac ed om he inancial s a emen s on a LIFO basis a e enhanced when compa ed o hose on a FIFO basis, since he e is buil in a ese e equi alen o he p esen alue o he in e es sa - ing as a consequence o he ax de e ed. I is also impo an o no e ha he longe a i m has been using LIFO, he highe he disc epancy be ween LIFO alue o in en o y as e lec ed in i s accoun s and he cu en alue (assuming ha some laye s o in en o y ha e been p esen o many yea s wi hou being o ally e oded). This places LIFO in en o y in a simila class o land and buildings wi h espec o i s balance shee alue, bo h i ems usually s anding in he balance shee a his o ical cos s. The e o e, unless some in- o ma ion is gi en in he no es o he accoun s as o he cu - en alue (ideally eplacemen alue), he en i e no ion o a balance shee becomes meaningless. The concep o cash low, as e e ed o in his pape , is hus aken o mean LIFO p o i a e ax plus he p e- ax LIFO adjus men . P ice educ ions I can be shown ha whe e p ices o a ce ain i em o ca ego y o i ems ha e allen a he han isen, he e ec would be a lowe cha ge o he income s a emen in espec o cos o sales unde he LIFO me hod han unde any o he me hod. Con- sequen ly, epo ed ea nings (bo h o inancial s a emen s and ax) will be inc eased and a highe ax liabili y will a ise. Any i m which is in an indus y whe e his phenomenon is ypical should he e o e s ee clea o LIFO, a leas in espec o hose i ems whe e p ices a e cons an ly alling. Typical examples o such indus ies a e 'high- ech' indus ies such as compu e s, ideo games and digi al wa ches, whe e cu en p ice le els a e ac ional compa ed o hose o se e al yea s ago. Howe e , i p ice educ ions a e empo a y, e.g., es ic ed o one pa icula yea , LIFO should only be swi ched o in he yea ollowing ha in ( hich he p ices a e alling, p o ided i is an icipa ed ha p ice le els will s a ising once again. I mus be bo ne in mind ha he CIR is no likely o ap- p o e a swi ch away om LIFO i he e ec o his will be a educ ion o ax payable. Ca e ul p e-planning and pos - implemen a ion moni o ing is equi ed in o de o ensu e op- imal use o LIFO. This ea u e o LIFO can lead o ola ili y in ax paymen s and mus he e o e be ega ded as one o he ac o s inc eas- ing he isk o in es ing in companies in which i is likely o occu . In en o y managemen and main enance o laye s LIFO pos pones epo ing in en o y p o i s only wi h espec o unliquida ed in en o y balances. I in en o y le els a e educed, olde cos s a e ma ched wi h cu en sales p ices. Du - ing pe iods o in la ion, such olde cos s will be ma ched wi h cu en sales p ices and he in en o y p o i s p e iously pos poned will be ecognized. This means ha he axes on in en o y p o i s which we e pos poned in p io yea s may be ecouped by he go e nmen and all due a one ime. A majo ac o which a ec s a LIFO company is he e o e ha o main enance o in en o y laye s. A empo a y all in in en o y le els leads o pe manen e osion. Yea -end in en o y le els may be educed o a numbe o easons, such as s ikes, sho ages o aw ma e ials, anspo delays, unexpec ed demand, changing ashion, obsolescence, i e o he , and op imiza ion o in en o ies o inancial easons. Howe e once a laye has been e oded i canno be 73 econs uc ed. Any u u e addi ions o laye s will be a cu - en (highe ) cos s. I is he e o e possible ha su plus in en o y would be held pu ely o main ain he laye . I hen becomes essen ial o balance he cos o holding such su plus in en o ies (pe haps only o a sho pe iod, i.e., a leas o e he inancial yea - end - hey can be liquida ed again a he beginning o he new yea ) agains he loss o bene i s which will a ise i a laye (o pa he eoO is e oded. This p oblem has wo main implica ions: (i) The ini ial iming o a change o LIFO should usually coin- cide wi h he base in en o y being 'no mal' and no in- la ed by ecen unusual bulk pu chases in excess o no - mal equi emen s. (ii) The pools (in he case o he and alue me hod) o in- di idual quan i ies (in he case o he speci ic goods me hod) should be closely moni o ed egula ly owa ds he end o he inancial yea . The equi emen o main aining laye s in o de o pe pe ua e he LIFO bene i is, in i sel , an addi ional isk inhe en in some LIFO companies which should be bo ne in mind when e alua - ing he company. Addi ional isks a e ha i e o la ge-scale he s will e ode a laye jus p io o he end o a inancial yea wi hou su i- cien ime being a ailable o eplenish i be o e he yea -end. In such a case, all he bene i p e iously a ising om a LIFO alua ion o such a laye will be los . All he p e iously de e - ed ax will now ha e o be paid. I may be con ended ha such as isk (i.e., o unexpec edly ha ing o pay back p e iously de e ed ax) canno be insu ed agains as no loss will ha e been incu ed, me ely he ac ualiza ion o an exis ing liabili y. Finally, i should be no ed ha LIFO could s ill be bene icial in imes o educing in en o y le els and should no be spumed me ely o he eason ha in en o y le els a e likely o all. Hoyle (1981) concluded ha : (i) assuming p ices do no all, a company should always bene i inancially om adop ing LIFO. E en i all he LIFO bene i s a e la e e e sed, he company has enjoyed cash bene i s om he delayed paymen o axa ion; (ii) ne LIFO bene i s can s ill occu when no mal in en o y le els dec ease. I depends on whe he he LIFO bene i s a ising on he emaining in en o y a e g ea e han he cumula i e LIFO bene i s on he in en o y educ ion; (iii) whe e in en o y le els dec ease, hen he longe he pe iod ha in en o ies ha e been held and he highe he in la- ion a e du ing ha pe iod, he g ea e will be he LIFO disad an age; (i ) a educ ion in no mal in en o y le els may s ill esul in a ne LIFO bene i . Howe e , he ne LIFO bene i would ha e been g ea e i he p e ious in en o y le els had been main ained; ( ) managemen o yea -end in en o y le els becomes an in- c easingly impo an unc ion in he yea s subsequen o he in oduc ion o LIFO. In la ion causes inc easingly la ge LIFO bene i s o accumula e on in en o y le els. The la ge he accumula ion, he g ea e will be he loss o cumula i e LIFO bene i s i in en o y le els all; ( i) a empo a y inc ease in in en o y le els, which is e e sed in he subsequen yea , does no b ing any LIFO bene i s in he subsequen yea when in en o y le els e u n o no mal. Thus, a dec ease in in en o y le els can ne e , in i sel , pu a company in a mo e un a ou able ax posi ion han i would ha e been had i no swi ched o LIFO. The wo s esul o 74 such a dec ease will be a pa ial o comple e e e sal o LIFO ax allowances p e iously claimed. Since hese allowances would no ha e been a ailable o a non-LIFO company in he i s place, i is e iden ha he ea o diminishing in en o y le els is misplaced, as, e en in ex eme ci cums ances, a one- yea de e al bene i will s ill occu . In e im epo ing and managemen accoun ing JSE egula ions, p o isions o he Companies Ac and Gene al- ly Accep ed Accoun ing P ac ice equi e ha in e im inan- cial s a emen s be p epa ed using he same accoun ing p ac- ices u ilized in p epa ing annual inancial s a emen s. This becomes di icul when LIFO alua ion o in en o ies has been adop ed since he ull impac o LIFO is no mally no known un il he yea -end. The e o e, he necessa y in e nal epo ing mus be de eloped o measu e he in en o y olume and p ice le el in o de o es ima e ealis ically, he in e im in en o ies on a LIFO basis. In addi ion, judgemen mus be applied as o whe he dec eases in in en o y le els ep esen pe manen o empo a y liquida ions du ing he yea o which eplace- men ese es should be p o ided. A majo p oblem also exis s wi h ega d o in e nal manage- men accoun ing and con ol. Te ms such as ea nings, e u n on capi al, in en o y, u no e and g oss p o i ma gins mus be accu a ely de ined so ha he pe o mance o hose people esponsible o he unning o he i m can be e alua ed. The de ini ions mus also be clea ly communica ed o hose espon- sible o se ing he i m's ope a ing budge s. A sec o o he i m which can also be a ec ed is ha g oup o people, a po - ion o whose emune a ion consis s o a sha e o p o i s o some o he incen i e bonus based on pe o mance. Once again, clea de ini ions mus be laid down o a oid la e con usion o dissen ion amongs such employees. Also, cash- low o e- cas s de i ed om LIFO-based managemen accoun s may e- qui e adjus men o ake in o accoun he eplacemen alue o in en o ies. Cos o keeping eco ds Keeping in en o y eco ds adequa e o implemen he LIFO me hod may, in some cases, be ex emely cos ly. These addi- ional eco ds mus be audi ed, which will also add o he cos . An e alua ion o all such cos s mus be ca ied ou be o e he swi ch is made, al hough i is ha dly likely ha he o al addi ional cos s incu ed would de e a company om mak- ing he swi ch as he po en ial bene i s a e likely o be subs an- ially g ea e han he cos s. Ne e heless, he company's audi o s, da a p ocessing manage and p ocu emen s manage should be consul ed o es ablish he means by which adequa e eco ds a e o be kep . Ma ke ing Al hough i would seem ha he concep o ma ching cu en cos s agains cu en incomes (yielding cu en ne income) could a ec he de e mina ion o selling p ices o goods sold by he i m, i would be mo e co ec o dis ega d his ac o and se he p ices based on ma ke o ces p e ailing a he ime. Howe e , dis o ion in ma ke selling p ices could occu i no all he i m's compe i o s a e u ilizing a common accoun ing app oach, such as LIFO. This should be e alua ed by he i m indi idually, in consul a ion wi h i s ma ke ing managemen . Also, ca e should be aken ha he ma ke ing plan o he i m is no upse by such ac o s as accele a ed sales (a he begin- ning o a inancial yea in o de o educe he bu den o main- aining a laye a he end o he p e ious yea ) o decele a ed S.-A . Tydsk . Bed y sl. 1984, 15(2) sales ( owa ds he end o he yea wi h a iew o main aining a laye ). Ra es o axa ion A de e men o ax which esul s om he adop ion o LIFO is subjec o e mina ion (i.e. ax becomes payable) i and when ce ain e en s occu . These e en s a e: (i) an e osion o all o pa o a laye o in en o ies alued on LIFO; and/ o (ii) a all in he p ice le els o in en o ies alued on LIFO. In bo h hese cases, he cu en cos cha ged o he income s a emen will be lowe and axable income will be highe han i any o he me hod had been used. I ax a es change, he ques ion a ises as o wha will be he di e ence be ween he ax ecouped and ha o iginally de e ed? In addi ion, cognizance should be aken o he ime alue o money. Fo example RI ,20 payable in yea IO could s ill, on a p esen alue basis, be cheape han RI ,00 payable in yea I. Each i m should make an e alua ion o he possible impac o u u e changes in ax a es on i s p ojec ions o LIFO bene i s. I could also be con ended ha as mo e i ms swi ch o LIFO and ake ad an age o o he ax bene i s, his will esul in a cos o he iscus which will hus be o ced o aise he o e all a e o ax in o de o ensu e ha i s e enue does no diminish. Unde hese ci cums ances, FIFO companies would be subsi- dizing LIFO companies, i.e., no only would hey be paying highe a es o ax, bu he a e would also be applied o a highe axable income. An in e es ing obse a ion is ha i all i ms swi ched o LIFO, ax a es would ha e o ise and all i ms would p o- bably be in a simila ax si ua ion o wha hey we e p io o LIFO being in oduced -al hough he e would be ce ain edis ibu ion o ax liabili y. Di idends Due o he lowe epo ed ea nings, such ac o s as di idend co e and p o i a ailable o dis ibu ion will be a ec ed. The ques ion a ises as o whe he a di idend policy which was e - ec i e p io o swi ching o LIFO could be main ained, ce e is pa ibus. I may be a gued ha since he di idend co e (on a LIFO basis) will be educed, he di idend i sel should be educed in o de o main ain he co e . This is a aul y a gumen in ha i any hing, a lowe di idend co e may be o a highe quali y unde LIFO han a highe co e unde FIFO me ely due o he ac ha he addi ional cash which would o he - wise ha e been paid as ax has now been e ained in he business. The conclusion is, he e o e, ha i he e a e wo companies, one o which is on FIFO and he o he on LIFO, bo h eco d- ing he same FIFO ea nings, he LIFO company would be in a s onge posi ion om a cash- low poin o iew o pay a di idend. The FIFO company could e en be paying di idends ou o capi al in a highly in la iona y pe iod. I is sugges ed he e o e ha a be e measu emen o di idend co e would be ha o cash low (as de ined abo e) o di idend. Bo owings The e a e wo aspec s which need o be conside ed he e: (i) he need o bo ow money, (ii) he abili y o bo ow money. As a esul o imp o ed cash low due o ax de e men , i is likely ha a LIFO i m's equi emen s o bo owing will S. A . J. Bus. Mgm . 1984, I 5(2) be less han i FIFO was being used. Howe e , when he LIFO company does equi e o bo ow unds, di icul ies could a ise due o cons ain s imposed by i s A icles o Associa ion, loan o lease ag eemen s, o exchange con ol egula ions (in he case o companies which a e mo e han 25% o eign owned). In each o hese cases, he cons ain s could e e o ce ain balance shee s uc u es such as sha eholde s' equi y, deb o equi y a io, wo king capi al, o income s a emen ela ed ma - e s, such as e u n on in es men , in e es co e , e c. One way o o e coming his p oblem would be o adop he so-called lip- lop me hod o accoun ing (Mowszowski, 1983) hus ensu ing ha he e would be no change in he sha eholde s' equi y. Fu he mo e, any loan ag eemen s can be s uc u ed o e lec he company's equi y based on he ac- coun ing policies in ope a ion a he ime he ag eemen was concluded. Ra ios Va ious a ios ela ing o gea ing, p o i abili y and ac i i ies o he company can be dis o ed i LIFO is adop ed possibly causing con usion amongs sha eholde s, lende s, c edi o s, e c. The mos impo an p inciple o bea in mind when a ios a e examined is ha hey should no be looked a in isola ion, bu a he as a means o compa ison agains p io pe iods and agains o he companies in he same o simila indus ies. Su - icien in o ma ion should be p o ided o enable analysis o a ios o be done on a common basis. An analysis o he e ec s o LIFO on quo ed companies The annual inancial s a emen s o 12 companies o he yea s 1980, 1981 and 1982 we e analysed wi h a iew o illus a ing some o he e ec s discussed abo e. O hese, se en companies had adop ed LIFO by 1982 and i e companies had no . (Adop ion implies ha all o a subs an ial p opo ion o he company's and/o i s subsidia ies' in en o ies we e alued us- ing LIFO.) The LIFO companies we e selec ed on he basis ha hei inancial s a emen s con ained su icien in o ma ion o enable he analysis o be ca ied ou . O he wel e companies chosen, en comp ised o pai s o companies om i e di e en sec- o s on he indus ial boa d o he JSE. An a emp was made o ma ch hese companies wi hin hei espec i e sec o s as closely as possible so as o allow o assump ions o simila in la ion a es and ading pa e ns wi hin a pa icula indus y. The o he wo companies, bo h LIFO use s, we e chosen wi hou co esponding non-LIFO companies. In he case o one o hem, all simila companies had adop ed LIFO and in he case o he o he , no sui able ma ching company could be ound. In bo h cases, howe e , ce ain in e es ing obse a- ions we e made which illus a e some o he p inciples con- ained in his pape . The companies selec ed a e lis ed in Table I . Da a we e ex- ac ed om hei inancial s a emen s. In he case o he non- LIFO companies, no ional accoun ing was in oduced on he basis ha LIFO had been used o 80% o he 1980 and subse- quen yea s' in en o ies. In la ion a es we e applied using in- dices ob ained om SA Rese e Bank Qua e ly Bulle ins and Uni e si y o S ellenbosch Bu eau o Economic Resea ch publica ions en i led 'T ends -A S a is ical Analysis o Economic T ends'. P e ailing in e es a es (p ime o e d a ) we e used o discoun inc emen al LIFO cash lows wi hou ega d o possible changes in isk due o adop ion o LIFO. In he case o he LIFO companies, no ional accoun ing was in oduced on he basis ha LIFO had no been adop ed. The 75 Table 1 Yea o JSE Sec o LIFO Company swi ch Non-LIFO Company S o es Edga s S o es L d 1980 Hepwo hs L d (EDGARS) (HEPWORTHS) Mo o Toyo a Sou h A ica 1981 Dan Pe kins L d (TOY OT A) Holding L d (DANPERK) Elec onics, Sco ish Cables L d 1979 Abe da e Cables Elec ical & (SCOTTISH) A ica L d Ba e y (ABERDARE) Consolida ed Clo hing, Roma ex L d 1979 Tex ile Mills Foo wea & (ROMA TEX) In es men Co p. Tex iles L d (CONTEX) S eel & Allied The Union S eel 1980 (All s eel Co po a ion o SA companies on he L d (USCO) JSE ha e adop ed LIFO) Chemicals & AECI L d P e-1979 Sen achem L d Oil (AECI) (SENTRACHEM) Enginee ing S ewa s & Lloyds 1979 No sui able ma ch o Sou h A ica L d (S & L) non-LIFO igu es o he LIFO companies di e om epo ed non-LIFO esul s because, o his exe cise, cognizance was aken o he addi ional in e es which would ha e been payable on la ge bo owings due o highe ax. The da a shown in Table 2 we e ex ac ed o each o he wel e companies. The o al cumula i e cash- low bene i as a 1982, including in e es o da e on ax de e als, was calcu- la ed o LIFO companies. Simila ly, he o al cumula i e cash- low bene i , including in e es he eon om 1980, o egone by he non-LIFO companies was calcula ed. (Tax was assumed o ha e been payable on he las day o he inancial yea .) The e ec s on cash low and sha eholde s' weal h In he case o he LIFO companies, he di e ence be ween ac ual ne deb a 1982 and he calcula ed deb , had LIFO no been adop ed, ep esen s he o al cash which he company has e ained which would o he wise ha e been emo ed om i s co e s. I is made up o wo componen s i.e., he ax de e - ed and he cumula i e a e - ax in e es sa ing on he de e - ed ax o he end o i s 1982 inancial yea . The i s compo- nen is a liabili y which could one day become owing (al hough, o example, EDGARS ea s he ax de e ed as equi y in p esen ing i s FIFO s a e o a ai s). The second componen ep esen s genuine ne inc eased sha eholde s' weal h - i is pe manen , i.e., i is e lec ed in he inc eased equi y and i is money in he bank. In he case o he non-LIFO companies, he di e ence be- ween ne deb a 1982 ( he ac ual posi ion) and wha he bo - owings would ha e been had LIFO been adop ed in 1980 ep esen s he cash which he company has paid ou , bu which could ha e been e ained had LIFO been adop ed. Once again, he e a e wo componen s i.e. he empo a y(?) cash sa ing o he ax de e men and he pe manen cumula i e a e - ax in e es sa ing on such de e ed ax. Those companies which ha e no adop ed LIFO chose o gi e up hese bene i s, and ha e consequen ly o egone an inc ease in hei sha eholde s' 76 Table 2 Non-LIFO LIFO-Companies Companies (ROOO's unless (ROOO's unless Elemen o da a s a ed) s a ed) (a) P o i be o e ax - Non-LIFO FFS* & adjus ed" FFS & adjus ed (b) P o i be o e ax -LIFO FFS No ional (c) Tax -Non-LIFO FFS & adjus ed FFS & adjus ed (d) Tax -LIFO FFS No ional (e) P o i a e ax -Non-LIFO a-c a-c ( ) P o i a e ax -LIFO b-d b-d (g) Cash low (as de ined on p. 73) a-d a-d (h) Deb (ne o cash esou ces) FFS & adjus ed FFS & adjus ed (i) Equi y -Non-LIFO FFS -no ional FFS & adjus ed lip- lop pe o med (j) Equi y -LIFO FFS No ional (k) In en o y -Non-LIFO FFS FFS (I) In en o y -LIFO FFS No ional (m) Ea nings pe sha e (cen s) -Non-LIFO FFS & adjus ed FFS & adjus ed (n) Ea nings pe sha e (cen s) -LIFO FFS No ional (o) Cash low pe sha e (cen s) g g No. o sha es No. o sha es (p) Di idends pe sha e (cen s) FFS FFS (q) Di idend co e ( a io) m _!!L -Non-LIFO p p ( ) Di idend co e ( a io) _n_ _n_ -LIFO p p (s) Di idend co e ( a io) _Q_ _Q_ -Cash Flow p p ( ) Ne asse alue -Non-LIFO _i_ _i_ pe sha e ( cen s) No. o sha es No. o sha es (u) Ne asse alue • LIFO _j_ _j_ pe sha e (cen s) No. o sha es No. o sha es "The e ms 'adjus ed' and 'no ional' ela e n: Ci) in he case o he LIFO companies, he non-LIFO igu es a 1e adjus men1 o addi1ional in e es which would ha e been paid i LIFO had no been adop1ed. (ii) in 1he case o he non-LIFO companies, 1he no1ional silua1ion i LIFO had been adop ed wi h espec 10 800/ o in en1o ies a e adjus menlS o in1e es1 sa ins on ax de e ed. • FS -F om Financial S alemen s weal h. The esul s a e summa ized in Table 3. In he case o he LIFO companies, he sa ing and de e - men ( he o al o he wo oge he ep esen s he di e ence in ne deb ) we e achie ed, whils in he case o he non-LIFO S.-Al . ~d,k . lkd ~ hi. 1984, 15(2) Table 3 a Cumula i e Di e ence a e - ax LIFO/ in Ne Deb Tax de e men in e es sa ing Non-LIFO Company ROOO's ROOO's 0/o o a ROOO's 0/o o a LIFO EDGARS 10 131 9 698 95,7 433 4,3 Non-LIFO HEPWORTHS' 173 166 96,0 7 4,0 LIFO TOYOTA 19 408 18 660 96,1 748 3,9 Non-LIFO DANPERK 447 422 94,4 25 5,6 LIFO SCOTTISH" I 034 895 86,6 139 13,4 Non-LIFO ABERDARE I 313 I 240 94,4 73 5,6 LIFO ROMATEX 7 319 6 653 90,9 666 9,1 Non-LIFO CONTEX 2 303 2 141 93,0 162 7,0 LIFO AECI 32 622 28 478 87,3 4 144 12,7 Non-LIFO SENTRACHEM 21 382 20 281 94,9 I IOI 5,1 LIFO S& L 18 634 16 632 89,3 2 002 10,7 LIFO usco 8 215 7 597 92,5 618 7,5 (i) In addi ion, an assescd los., o R432 (IX) would ha,e been a,ailable o educe u u e axable income. As he oompany paid R286 (IX) ax in i s nex inansial ye,, , hi, could ha e been educed b 46.2'1 o R432 (IX) = R200 CXXJ. (ii) This is he only company analysed "'hich. in any o he yea unde e lC . paid hack any lax i.e. i s 1980 LIFO ax ex e:ded whal he non-LIFO a, would ha e been b R2l,O CXXJ. companjes, hey ha e been o egone. I is signi ican ha he cumula i e a e - ax in e es sa ing ep esen s a ela i ely small componen o he o al di e ence in ne deb . This is because he LIFO companies ha e only been on LIFO o a ela i ely sho pe iod and he assump ion o he non-LIFO companies is ha hey only adop ed i in 1980. I is no a di icul ask o each i m o ca y ou his exe - cise on i s own inancial igu es whe he i has adop ed LIFO o no in o de o asce ain he e ec LIFO has/would ha e had on i s cash posi ion and ne inc ease in sha eholde s' weal h. The e ec on di idends Table 4 con ains a compa ison o he di idend co e s. I has been illus a ed ha in almos all cases, he numbe o imes by which di idends ha e been co e ed by cash low is sub- s an ially g ea e han he adi ionally measu ed di idend co e , i.e. ea nings pe sha e (LIFO o non-LIFO) di ided by di idends pe sha e. This leads o he conclusion ha di idends decla ed by LIFO companies ha e a measu e o 'quali y' which he non-LIFO companies lack. Viewed om a di e en angle, he LIFO companies could ha e decla ed addi ional di idends ( equi alen o he di e ence in ne deb ) wi hou being in a wo se cash posi ion han hey would ha e been had hey no adop ed LIFO and no decla ed such addi ional di idends. Hence LIFO companjes can a o d o inc ease di idends, and acco dingly, educe he co e , wi hou he inc eased isk o addi ional deb . Thus hey could dis ibu e cash paymen s o hei own sha eholde s a he han o hi d pa ies (i.e. he CIR o ax and lende s o in e es ). The e could ha dly be a mo e clea cu de ini ion o c ea ion o sha eholde s' weal h han his. The e ec o in en o y p o i a io An examina ion o he esul s e eals ha he g ea es bene i s a e ob ained by hose companies whose in en o y/p o i a io is high. Al hough his is no he only de e minan o he impac S. A . J. Bus. Mgm . 1984, 15(2) 7· Table 4 Di idend co e Di idend co e Di idend co e -Non-LIFO --LIFO --Cash low - Company A e age; Range;; A e age; Range;; A e age; Range;; EDGARS 2.5 2,5- 2,6 HEPWORTHS 9,6 9,1-10,I TOYOTA 7,2 5,3- 9,3 DANPERK 2,4 1,7- 2,9 SCOTTISH 1,5 1,3- 1,6 ABERDARE 2,3 1,8- 3,0 ROMATEX 2,1 1,7- 2,4 CONTEX 10,2 9,5 - 10,8 AECI 1,9 1,7- 2,2 SENTRACHEM 2,3 2.2- 2,3 S&L 2,8 2,8- 2,9 usco 4,1 3,7 -4,8 (ii A i hme ic mean o 1980. 1981 and 1982 CO'< s (ii) Range o co e s be ween 1980, 1981 and 1982 o LIFO on epo ed ea nings (o he ac o s such as a e o in en o y inc ease, a e o in la ion, e c. all in e ac ), he g ea e he in en o y/p o i a io, he g ea e he di e gence be ween epo ed LIFO and non-LIFO ea nings. Communica ion A b ie analysis was made o he e e ences o LIFO in he annual epo s o he LIFO companies ( om chai man's s a e- men , no es, di ec o s' epo , e c.). Table 5 con ains a synopsis o such e e ences. Communica ion was gene ally ound o be lacking. Com- panies seem o ha e igno ed he LIFO dilemma wi h which hey a e aced. In o he wo ds, hey ha e adop ed LIFO and ob ained he cash- low bene i s, bu hey ha e gene ally no made su icien a emp o communica e he consequences o he change o hei publics. O he nine y- wo LIFO use s quo ed in he JSE indus ial sec o s, six p o ided so li le in- o ma ion in hei la es annual epo s ha he e ec o LIFO on ea nings, ax o sha eholde s' equi y could no be de e - mined. No able excep ions a e S & L and EDGARS, who go ou o hei way o achie e he bes o bo h wo lds, i.e. o ob ain he cash- low bene i s, and also o ensu e ha hese a e posi i ely impac ed in he p ices o hei espec i e sha es. Finally he ollowing obse a ions we e made a e a s udy o media announcemen s and edi o ials consequen upon publica ion o he esul s o companies using LIFO: (i) In no ins ances was he concep o cash low u iliz.ed. (ii) Compa isons o pe o mances o LIFO and non-LIFO companies a e o en con used. An example o his is con- ained in Appendix 1 which is an ex ac om a supple- men o he Financial Mail o 18 No embe , 1983. No men ion was made, ei he in he compa ison o in he ac- companying analysis and in e p e a ion, o he ac ha Anglo Alpha and PP Cemen a e LIFO use s and Blue Ci cle is no . (iii) The JSE Da a Bank which is published in he newspape s e lec s ea nings yields and/ o p ice-ea nings a ios only on he basis adop ed by he company. A cu so y glance a a newspape could he e o e be o ally misleading o a he e y bes , incomple e. Conclusions The e ec o LIFO on JSE quo ed indus ial companies is only 2,1 6,2 5,0 2,1 1.5 2.2 2,0 8,9 1.8 2.0 2,1 3.0 2.0- 2,2 2.9 2,8- 2.9 4,1- 8,3 10,8 10,6- 10,9 3,1- 6,9 9,1 7,5- 10,6 1,3- 2,6 2,7 1,9- 3,3 1.5- 1,5 1,5 1,3- 1,7 1.7- 2,9 2,4 2,0- 3,1 1,6- 2,4 2.2 1,8- 2,5 8,2- 10,0 11,3 11,0-11,8 1,6- 2.0 2.0 1,8- 2,3 1,9- 2,2 2,5 2,4- 2,5 1,9- 2,3 3,5 3,3 -3,6 2,8- 3.2 5,1 4,3- 6,7 Table 5 Re e ences o LIFO in inancial s a emen s o companies lis ed on he JSE Company Re e ence USCO FIFO alue o in en o y is e lec ed. The e o e, LIFO ese e asce ainable. EPS in i e yea e iew on LIFO and FIFO. O he a ios in i e yea e iew in LIFO on- ly. No indica ion o LIFO e ec on ea nings o yea (excep EPS and he ac ha i is asce ainable by compa ing LIFO ese e wi h ha o p e ious yea ). SCOTTISH Ve y ske chy in o ma ion. Chai man's s a emen con- ains e e ence o e ec o LIFO on yea 's ading. No cumula i e e ec shown. No men ion made in i e yea pe o mance cha s, di ec o s' epo o in e im esul s s a emen s. TOYOTA Discloses e ec o LIFO on ea nings. Re lec s LIFO and FIFO esul s and asse alues since adop ion o LIFO in en yea e iew including EPS and di idend co e . Cumula i e LIFO ese e no di ec ly e lec ed bu asce ainable by adding oge he each indi idual yea 's LIFO di e ence. AECI No e ec o LIFO on ea nings is e lec ed. The only igu e e lec ed is he cumula i e LIFO ese e and by compa ing wi h ha o p e ious yea , e ec can be asce ained. I is in e es ing o no e, howe e , ha in he i e yea e iew, e u n on asse s is calcula ed on he basis o in en o ies a FIFO. EDGARS Excellen disclosu e. Full i e yea e iew on bo h LIFO and FIFO. Full income s a emen e lec ed on LIFO and FIFO bases. Chai man alludes o he im- p o emen in quali y o ea nings and inc ease in cash low. The i e yea e iew is FIFO epo ed, and i ans e s he ull amoun o he FIFO ese e o Non- dis ibu able Rese e ( equi y) wi hou p o iding o de e ed ax he eon. ROMATEX Fi e yea e iew e lec ed in LIFO only, e.g., cash lows, EPS, e u n on a e age sha eholde s' und e c., al hough ne asse alue is e lec ed in LIFO and FIFO. LIFO adjus men o yea is shown, he e o e he LIFO ese e can be calcula ed. Howe e , unde asse s, in en- o y is e lec ed a LIFO only. Ce ain a ge a ios ex- p essed in LIFO, o he s in FIFO. s & L Excellen awa eness o need o communica e wi h sha eholde s wi h ega d o e ec o LIFO. Ini ially sen ou b ochu e on adop ion o LIFO. The LIFO ese e is shown in i e yea e iew, as a e LIFO and FIFO compa isons o ea nings, EPS and di idend co e . I is in e es ing o no e ha ne asse alue is ex- p essed a FIFO only. 78 now beginning o ake on meaning ul p opo ions. Wi h he passage o ime and he high in la ion a es expe ienced in Sou h A ica, he cumula i e e ec o ising LIFO ese es and ax de e men s will ha e a subs an ial in luence on co - po a e cash lows and sha eholde s' weal h. Communica ion, howe e , ends o lag and companies will need o imp o e his aspec i hey a e o maximize he bene i s a ainable h ough an adop ion o LIFO. I is also in e es ing ha a company such as SENTRACHEM is enligh ened enough o disclose in- o ma ion such as NOPAT (ne ope a ing p o i a e ax), COPAT (cash ope a ing p o i a e ax) and FCF ( ee cash low) along he lines o he Economic Ea nings Model, ye i has no adop ed LIFO in o de o gain eal cash- low bene i . I is in iguing ha no many mo e companies ha e adop ed LIFO. In he case o companies quo ed on he JSE, by June 1983, only 310/o o indus ial companies had adop ed LIFO. In he case o p i a e companies, he p opo ion is minimal. Mann ( 1982) conduc ed a su ey o 350 p i a e companies and o he nine y- wo esponden s, only i e had adop ed LIFO, se en we e ully awa e o LIFO bu had ejec ed i , wo had hea d o LIFO bu had no conside ed i in dep h, i e had hea d o LIFO bu we e unawa e o wha i is o can do, and se en y- h ee had ne e hea d o LIFO. I is clea ha he e is inadequa e communica ion di ec ed a companies (pa icula ly p i a e companies) wi h he aim o educa ing and demons a ing he bene i s a ailable om LIFO adop ion. Wha o he a ionale can exis o he ac ha , o i e o he JSE LIFO companies analysed in his pape , he e a e companies ope a ing in he same indus y, unde he same economic en i onmen and in ce ain ins ances, e en hand- ling iden ical p oduc s, ye LIFO had no been adop ed? Pe haps sha eholde s o non-LIFO companies should equi e managemen o ad ance hei easons o non-adop ion. I is also e iden ha he e is a wide spec um o pa ies which equi e u he educa ion wi h espec o LIFO bene i s. These include audi o s, analys s, in es men ad ise s, s ock- Appendix I Deb Shon- e m (Rm) Long- e m (Rm) Deb equi y a io Sha eholde s in e es In e es & leasing co e Deb co e Re u n on capi al (0/o) Tu no e (Rm) P e-in e es p o i (Rm) P e-in e es ma gin (0/o) Ea nings (cen s/sha e) Di idends (cen s/sha e) Di idend co e Ne asse alue (cen s/sha e) Figu es a la es yea end Anglo-Alpha Yea ended 31.12.82 9,1 95,9 0,30 0,60 7,5 0,96 12,1 2S2,9 70,2 26,1 90,4 42 2,1 I 139 •P e o ia Ponland Cemen . A co po a e epo . Supplemen o Financial Mail No embe 18 1983, p.31. S.-A . Tydsk . Bed y sl. 1984, 15(2) b oke s, banke s and in es o s. I all hese pa ies we e made o be acu ely awa e o he po en ial bene i s, i is belie ed ha many mo e companies would adop LIFO. Ne e heless, he al eady exis ing body o LIFO adop e s is known o be a wo y o he e enue au ho i ies. M Mickey an de Wal , he CIR, speaking a he 1983 Financial Mail In es men Con e ence in Johannesbu g, c i icized he exploi a- ion o ax concessions. Wha he was e e ing o when he used he e m 'exploi a ion' is no qui e clea , bu i seems ha he was alluding o companies who adop ed LIFO pu ely as a mechanism o ob ain ax elie a he han hose who genuinely belie ed ha LIFO is he mos sui able me hod o aluing in- en o ies o he ac ual business conduc ed. I also lends su~ po o he hypo hesis ha i all i ms adop ed LIFO, ax a es would ha e o be inc eased and ha un il such ime as his occu s, non-LIFO companies a e, in e ec , subsidizing LIFO companies. No wi hs anding ha he e a e con lic ing conclusions ab oad ega ding he e ec o LIFO adop ion on sha e alues (al hough he mo e ecen s udies end o a ou he cash- low hypo hesis a he han he unc ional ixa ion hypo hesis), i is con ended ha u he esea ch should be conduc ed in Sou h A ica o asce ain whe he he end e e ed o by Knigh and A leck-G a es (1983) is con inuing i.e. is he ma ke becoming mo e awa e o he LIFO bene i s and i so, is such awa eness being impac ed posi i ely in o sha e p ices o in- dus ial companies on he JSE? Pending such esea ch, companies which ha e adop ed, o a e con empla ing he adop ion o LIFO, should ha e li le ea ha nega i e impac on sha e p ice will esul , p o ided ha he communica ion and educa ion p ocess con inues, i.e., p o ided he ma ke is ully in o med o he company's cash lows, and media such as newspape s, JSE handbooks, inan- cial publica ions, s ockb oke s' bulle ins and he like, a e designed o p o ide ull in o ma ion o LIFO and non-LIFO si ua ions and cash lows. A mos impo an inal p o iso is How hey compa e* Blue Ci cle PP Cemen Yea ended Yea ended 30.11.82 30.9.82 28,4 3,3 61,4 21,9 0,56. 0,11 0,47 0,61 2,5 28,6 0,43 3,2 10,7 21,3 30S 270,7 34,2 83,1 11,2 29,8 86,2 247,6 38,5 64 2,2 2,9 728 288 PP Cemen Yea ended 30.9.83 290,7 88,7 31,0 264,9 70,0 3,8