Following the 1990 Iraqi invasion of Kuwait, the price of crude oil soared, as did retail gasoline prices. This led the major U.S. oil companies to try to hold down their reported earnings.

The oil companies were anxious to avoid a repeat of an earlier episode when crude oil and gasoline prices peaked during the 1970 and earnings soared. At that time, the public outrage was so great that the U.S. Congress imposed an excess profits tax, taxing back several billion dollars of excess profits. Warnings of similar taxes were repeated in 1990.

To limit their 1990 profits, the major oil companies did exercise some price restraint to keep prices at the pump from rising as much as they otherwise would have. They also engaged in a number of accounting practices, such as increased provisions for future environmental costs, increased maintenance, and large provisions for legal liabilities.

Required

a. What pricing and accounting policy choices are predicted by the bonus plan and debt covenant hypotheses of positive accounting theory, in response to increasing crude oil prices

b. Use the political cost hypothesis of positive accounting theory to explain why the major oil companies would be the ones most concerned.

c. For a US company, what inventory accounting policy (e.g. FIFO, LIFO, and average cost method) would be most effective in holding down profits?