Financial Reporting and Changing Prices (Issued 9/79)

Summary

This Statement applies to public enterprises that have either (1) inventories and property, plant, and equipment (before deducting accumulated depreciation) amounting to more than $125 million or (2) total assets amounting to more than $1 billion (after deducting accumulated depreciation).

No changes are to be made in the primary financial statements; the information required by the Statement is to be presented as supplementary information in published annual reports.

For fiscal years ended on or after December 25, 1979, enterprises are required to report:

1. Income from continuing operations adjusted for the effects of general inflation
2. The purchasing power gain or loss on net monetary items.

For fiscal years ended on or after December 25, 1979, enterprises are also required to report:

1. Income from continuing operations on a current cost basis
2. The current cost amounts of inventory and property, plant, and equipment at the end of the fiscal year
3. Increases or decreases in current cost amounts of inventory and property, plant, and equipment, net of inflation.

However, information on a current cost basis for fiscal years ended before December 25, 1980 may be presented in the first annual report for a fiscal year ended on or after December 25, 1980.

Enterprises are required to present a five-year summary of selected financial data, including information on income, sales and other operating revenues, net assets, dividends per common share, and market price per share. In the computation of net assets, only inventory and property, plant, and equipment need be adjusted for the effects of changing prices.

Illustrative formats for disclosure of the required information are included in this Summary as Schedules A, B, and C (pages 32-34 of the Statement).

To present the supplementary information required by this Statement, an enterprise needs to measure the effects of changing prices on inventory, property, plant, and equipment, cost of goods sold, and depreciation, depletion, and amortization expense. No adjustments are required to other revenues, expenses, gains, and losses.

In computations of current cost income, expenses are to be measured at current cost or lower recoverable amount. Current cost measures relate to the assets owned and used by the enterprise and not to other assets that might be acquired to replace the assets owned. This Statement allows considerable flexibility in choice of sources of information about current costs: An enterprise may use specific price indexes or other evidence of a more direct nature. This Statement also encourages simplifications in computations and other aspects of implementation: In particular "recoverable amounts" need be measured only if they are judged to be significantly and permanently lower than current cost; that situation is unlikely to occur very often.

The Board believes that this Statement meets an urgent need for information about the effects of changing prices. If that information is not provided: Resources may be allocated inefficiently; investors' and creditors' understanding of the past performance of an enterprise and their ability to assess future cash flows may be severely limited; and people in government who participate in decisions on economic policy may lack important information about the implications of their decisions. The requirements of the Statement are expected to promote a better understanding by the general public of the problems caused by inflation: Statements by business managers about those problems are unlikely to have sufficient credibility until financial reports provide quantitative information about the effects of inflation.

Special problems arise in the application of the current cost requirements of this Statement to certain types of assets, notably natural resources and income-producing real estate property. The Board will consider those problems further and address them in an Exposure Draft with a view to publishing a Statement in 1980. This Statement gives guidance on the treatment of those assets and related expenses for enterprises that present current cost information for fiscal years ending before December 25, 1980.

This Statement calls for two supplementary income computations, one dealing with the effects of general inflation, the other dealing with the effects of changes in the prices of resources used by the enterprise. The Board believes that both types of information are likely to be useful. Comment letters on the Exposure Draft revealed differences of opinion on the relative usefulness of the two approaches. Many preparers and public accounting firms emphasized the need to deal with the effects of general inflation; users generally preferred information dealing with the effects of specific price changes. The Board believes that further experimentation is required on the usefulness of the two types of information and that experimentation is possible only if both are provided by large public enterprises. The Board intends to assess the usefulness of the information called for by this Statement. That assessment will provide a basis for ongoing decisions on whether or not provision of both types of information should be continued and on whether other requirements in this Statement should be reviewed. The Board will undertake a comprehensive review of this Statement no later than five years after its publication.

The measurement and use of information on changing prices will require a substantial learning process on the part of all concerned. In view of the importance of clear explanations to users of financial reports of the significance of the information, the Board is organizing an advisory group to develop and publish illustrative disclosures that might be appropriate as a guide to preparers in particular industries.