In March 1976 the Securities and Exchange Commission issued Accounting Series Release 190, requiring a thousand of the largest companies to disclose for the first time the current replacement cost of inventories and productive capacity, as well as the replacement cost of operations. What happens to income, total assets and return on assets when these numbers are calculated using replacement, rather than historical, costs?
Analysis of the published financial statements of over 300 of these companies in 30 key industries demonstrates that differences arising from substituting replacement for historical cost of inventory are generally small. Either companies use LIFO to value their inventories, hence broadly approximate current replacement costs, or they turn their FIFO inventories rapidly. On the other hand, the differences arising in the case of fixed assets can be substantial for capital intensive industries owning relatively old plant and equipment—like the tire and rubber, metals and mining, railroad, and airlines industries—although negligible for industries with rapidly changing technology or relatively new plant—like office equipment and computers, drugs, and instruments.
The combination of reduced earnings and increased asset values has a dramatic impact on return on total assets in such industries as food processing, paper, and textiles and apparel. Four industries—airlines, tire and rubber, steel, and metals and mining—have negative rates of return.
ASR 190 is a significant first step toward the development of comprehensive current value accounting. The replacement cost data that most of the affected companies are now disclosing only in their Form 10-K’s should also be included in their annual reports.