Although the FASB has not yet required use of replacement values in the preparation of financial statements, the SEC has ordered their inclusion in the footnotes. Thus it may not be too soon to ask: What does the income figure in a replacement value income statement really mean?

The use of current values separates net income into two components—operating gains (and losses) and holding gains (and losses). The authors prefer to call the operating gains component “distributable income,” arguing that it measures that portion of conventional accounting net income the firm can distribute to stockholders and the tax collector and still be assured of maintaining physical capacity—a measure of importance to security analysts.

Distributable income can be distributed without impairing capacity, the authors argue, because it will decrease (increase) to compensate for rising (falling) asset prices. If historical value is less than current replacement cost (as it usually is during inflation), then income based on depreciation of current values will be smaller and retentions larger. The extra assets will earn a return. As long as the return from these retentions is at least as large as the rate at which replacement cost of the firm’s equity is rising, the net assets retained will be sufficient to maintain capacity.