Inflation Accounting: The SEC Proposal for Replacement Cost Disclosures

Abstract

On August 21, 1975, the Securities and Exchange Commission (SEC) entered the inflation accounting arena with a proposal that might be called revolutionary.' This article examines the implications of that proposal for the analysis of financial statements. The SEC proposes requiring disclosure affecting both the balance sheet and the income statement. For the balance sheet, the disclosures would provide the current replacement cost of both inventory and those plant assets used in operations at the balance sheet date(s). For income statements the required disclosures would tell the replacement cost of goods sold computed at the times of sale and depreciation charges for the year based on the average replacement costs of plant during the year. The SEC does not propose requiring supplementary financial statements based on the new disclosures, only the disclosures themselves. As is often the case, the SEC requires supplemental disclosure of financial information without requiring that income or financial position be measured in a way different from that currently considered generally acceptable by the accounting profession. That is, the SEC is often content to have financial statement readers informed of important information without requiring that alternative financial position and income amounts be shown.2 In the case of the new proposed replacement cost disclosures, the SEC may have refrained from specifying that supplementary financial statements be issued because there is still considerable argument among theorists about how income should be measured in replacement cost terms. There are at least three measures of income that emerge from the use of replacement cost information. Later in this article we discuss each of these concepts of income and how the analyst might view them.