Optimal Inventory Ordering Policy with Tax Payments Under FIFO and LIFO Accounting Systems

This paper considers the impact of tax liabilities on optimal inventory policy through the medium of FIFO and LIFO tax valuation schemes in a stochastic environment. The relationship between inventory policy and changes in either the rate of inflation or the corporate tax rate is investigated. By using recent results from the field of perishable product inventory systems, closed from expressions for expected profit are generated for both FIFO and LIFO. An extensive analysis of die one period problem indicates the impact of each valuation scheme on inventory ordering. Optimal policies are derived for the multi-period problem where prices, costs and demand distributions vary with time. In the case of FIFO a nonstationary optimal myopic policy is generated. In the case of LIFO optimal order policy is nonstationary and nonmyopic. The paper concludes with an example which illustrates the dynamic response of order policy under both schemes. The example indicates that the cost of ignoring taxes in optimizing order levels can be substantial, and that policy obtained under FIFO may be a reasonable approximation to the LIFO policy. The benefit of switching from FIFO to LIFO is also quantified.