Philip G. Cottell

LIFO Layer Liquidations: Some Empirical Evidence

The LIFO inventory valuation method has received a great deal of attention as a means of postponing taxes. At the same time the tax consequences of a LIFO inventory liquidation have been virtually ignored. This research indicates that LIFO layer liquidations do occur and can, therefore, cause cash flow problems for corporations in the form of higher federal income tax payments. A hypothesis that LIFO layer liquidations is specific to certain cyclical industries was tested and affirmed. A survey indicated that two factors, cost of capital and income tax expense, were the more critical in the LIFO layer liquidation decision.

Auditor Selection: Impact of Audit Committees

This article reports the results of a study designed to measure whether an SEC rule requiring audit committees might have an anticompetitive impact on auditor selection. Despite concerns expressed by the American Institute of Certified Public Accountants and others, the results of this study do not substantiate the contention that such a rule would favour Big‐Eight auditors. Rather, the results suggest that while movement toward Big‐Eight auditors is prevalent among NASD‐listed companies, the existence of an audit committee does not explain the displacement. It appears that such an SEC rule would not unfavourably impact the competition for audit services.

A Simulation of the Future Economic Impact of Pension Rate Reductions

Pension rate estimates are important because they provide information to the market, and because they are useful in estimating future cash flows or for other analytical purposes. This is especially true now, because the economic environment has deteriorated to a point that many investors perceive increased uncertainty with respect to pension plans and the effect they have on future income. In fact, several authors in the popular financial press have speculated on the impact of such fundamental changes in pension assets, liabilities, and estimates. Often, however, these articles are sensational, and do not appear to appreciate fully the complexities of pension accounting. In order to model the economic impact of pension rate declines, we develop a two‐period analytical model of pension cost, which allows us to simulate future pension expense and its associated earnings impact using a triangular distribution of rate estimates. In addition, we model the incremental cash contributions required under these estimates in order to maintain the ratio of pension assets to liabilities at 100 percent. Our results indicate that while the pension expense effect is large in both periods across firms with small, mid‐sized and large pension plans, firms with large plans show the greatest increase in pension expense. Interestingly, however, the earnings impact is the smallest for firms with large plans in both periods. In addition, all firms face significantly increased cash funding requirements in order to prevent funding ratios (plan assets scaled by pension liabilities) from deteriorating. These results suggest not only future earnings reductions from pension rate declines, but also a potentially significant cash flow impact as well.