Aurora Borealis
1 March 1977 Financial Analysts Journal Volume 33, Issue 2

Replacement Cost Accounting: What Will Income Statements Based on the SEC Disclosures Show?—Part II

  1. Angela Falkenstein
  2. Roman L. Weil

The SEC is requiring disclosure of replacement cost data for 1976 annual reports. The authors provided estimates of these data for the Dow Jones Industrial companies in Part I of this article. They found that distributable income for those companies was about 40 per cent of conventional income for 1975. Payout ratios were over 100 per cent of distributable income and income taxes were about 80 per cent of pre-tax distributable income. Of course, the effects of translation from historical to replacement cost were far from uniform across these 31 firms: The distributable incomes of companies with relatively new plant, or using LIFO cost flow assumptions for inventories, tended to diverge little from conventionally reported incomes.

Part II explains how to estimate replacement cost disclosures for both inventories and fixed assets, using the General Electric Company as an illustration. Companies calculating the replacement cost of goods sold are likely to use some standard cost approach and develop indexes based on internal cost records. But some may resort to indexes published by government and trade groups, such as the Bureau of Labor Statistics Wholesale Price Index (WPI). Although WPI classifications are broad, the indexes are readily available to the analyst seeking to estimate replacement cost of goods sold.

In some cases the analyst can identify the dominant commodity in a company’s inventories and use its price series. And in certain cases the company provides a company-wide price index for the relevant period. Although such company-wide indexes are currently unusual, they may become much more common: The SEC requires companies to disclose the assumptions employed in developing their replacement cost estimates.

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