What Did Inflation Accounting Tell Us?

Abstract

Financial statements for the period 1977–1983 are reconstructed for a sample of 50 large manufacturing firms using replacement cost (or current cost) data provided by ASR 190 and FASB 33, and market (or fair) values of long-term debt and preferred stock. As expected, these data confirm that historical cost accounting overstates profitability during a period of rising prices. These data also indicate that historical cost–based financial ratios often grossly misrepresent the relative financial strengths of firms. Financial analysis conducted on the assumption that the biases induced by historical cost accounting are similar across firms is likely to lead to false conclusions regarding financial strengths and weaknesses.