THE YEAR-END LIFO INVENTORY PURCHASING DECISION - AN EMPIRICAL-TEST

Several analytical models of the year-end inventory purchasing decisio n of a LIFO firm have been developed (Cohen and Halperin 1980; Halperi n 1979, 1981; Biddle and Martin 1985).1 This study finds empirical sup port for the prediction of these models that, since only LIFO firms re duce their tax burden by purchasing additional inventory (i.e., ''extr a''inventory) at year-end, LIFO firms are more likely to purchase extr a inventory at year-end than FIFO firms. This research also provides e vidence that high-tax LIFO firms are more likely to purchase extra inv entory at year-end than low-tax LIFO firms. This behavior is predicted because a LIFO firms tax savings from purchasing extra inventory at y ear-end are increasing in its marginal tax rate. Additional evidence o f tax-motivated year-end inventory purchases is offered by tests which find that (1) consistently high-tax LIFO firms accelerated their year -end inventory acquisitions-and thus reduced their taxable income-to a significant degree in the years immediately preceding the reduction i n tax rates mandated by the Tax Reform Act of 1986; and (2) difference s in tax status are not related to differences in fourth quarter inven tory purchasing behavior for FIFO firms. The results of this study ind icate that taxes have a sizable effect on the inventory purchasing pol icy of LIFO firms. For example, (1) the estimated difference in the pe rcentage of annual inventory purchases made in the fourth quarter betw een high-tax and low-tax LIFO firms is equivalent, on average, to $12. 66 million of purchases (3.8 percent of ending inventory); and (2) the estimated decrease in inventory purchases made in the fourth quarter by LIFO firms that move from a high-tax status in one year to a low-ta x status in the following year is equivalent, on average, to $28.89 mi llion of purchases (12.1 percent of ending inventory). These large dol lar amounts lend credence to the concern that year-end LIFO inventory purchases made for tax purposes may lead to inventory management ineff iciencies (Jannis et al. 1980, 186).