Adjustment of Taxable Profits for Inflation
Author: George E. Lent

Financial statements based on historical costs increasingly depart from current values during an inflationary period and have distorting effects on the measurement of business profits. For this reason, periods of rapid inflation, especially following a major war or economic crisis, have been met in some countries by measures for the revaluation of business accounts for purposes of reports to shareholders and the determination of taxable income.

Abstract

Financial statements based on historical costs increasingly depart from current values during an inflationary period and have distorting effects on the measurement of business profits. For this reason, periods of rapid inflation, especially following a major war or economic crisis, have been met in some countries by measures for the revaluation of business accounts for purposes of reports to shareholders and the determination of taxable income.

Financial statements based on historical costs increasingly depart from current values during an inflationary period and have distorting effects on the measurement of business profits. For this reason, periods of rapid inflation, especially following a major war or economic crisis, have been met in some countries by measures for the revaluation of business accounts for purposes of reports to shareholders and the determination of taxable income.

The inflationary aftermath of World War II was accompanied by revaluation measures in a number of major industrial countries, including Austria, Belgium, France, the Federal Republic of Germany, Italy, Japan, and the Netherlands.1 But such provisions did not gain acceptance in Canada, the United Kingdom, the United States, or the Scandinavian countries. Inflation-ridden Latin American countries also recognized that for tax and other purposes there was a need for revaluing business assets and, in some cases, liabilities. These countries include Argentina, Bolivia, Brazil, Chile, Mexico, Peru, and Uruguay. In Asia, Korea and Indonesia, as well as Japan, have authorized similar techniques. Argentina, Austria, Colombia, and Israel have provided for the adjustment of depreciation allowances without, however, requiring a restatement of balance sheet accounts.

This paper reviews the principles of accounting for inflation, including the accounting techniques that have been proposed, and describes their application to the taxation of business profits in some 20 countries for which information is available. This is followed by an analysis of the probable effects of such measures on the economy, equity, and tax administration. Possible alternatives are also examined.

I. Alternative Approaches to Adjustment

Although there is a diversity of views in the accounting profession on how price level adjustments should be reflected in financial accounts, there are two main currents of thought on the principles underlying such adjustments.2 One approach is based on the replacement cost principle, according to which only nonmonetary assets would be valued at their current replacement cost. The other view is based on what may be characterized as the revalorization principle, which calls for the adjustment of all balance sheet items by a general price index. It should be noted that revalued accounts would not necessarily replace conventional financial statements based on historical cost, but would supplement them, in reports to shareholders and the revenue service. In some countries, however, revaluation is reflected in accounts under provisions of company law.

replacement cost approach

Revaluation of business assets at replacement cost is concerned principally with the adjustment of nonmonetary assets, such as inventories, land, and depreciable equipment and structures. From the standpoint of taxation, its implications for depreciation allowances and inventories are of the greatest importance.

Depreciable assets

There is general agreement that the purpose of depreciation accounting is to allocate the cost of a depreciable asset over its useful life in a systematic and rational manner.3 The income tax laws generally provide for “reasonable” allowances based on acquisition costs less estimated salvage value. Guidelines to the useful lives of various categories of depreciable assets are usually provided, and the method of allocating costs over time is usually prescribed, whether on a straight-line, declining balance, or other basis.

During an inflationary period it is clear that the market value (or replacement cost) of depreciable assets progressively departs from their book value and that fixed annual allowances based on the cost of assets acquired in prior years tend to enhance business profits. It is claimed by some that conventional depreciation methods do not fulfill one of their basic functions of accounting for the replacement of plant and equipment. From the point of view of tax policy, it is alleged that the taxation of earnings that does not allow for replacement of assets diverts to the government funds that are necessary to maintain intact the capital of a business—that is, it is a tax on capital.

The most commonly accepted solution to this problem is the revaluation of depreciable assets, such as buildings, plant, and equipment, through appraisal or by the use of an index of construction costs. The revaluation increment is credited to a special reserve account, and current depreciation allowances are based on the appreciated book values. The difference between depreciation based on original cost and on replacement cost is thereby excluded from taxable profits where such revaluation is authorized under the income tax laws.

The revaluation of nonmonetary assets for reporting purposes has gained wide acceptance by the accounting profession in a number of countries, although there is no agreement on the particular measures employed by businesses.4 Support for this practice in the United States was given in 1964 by a committee of the American Accounting Association, which recommended that current cost be adopted immediately as the basis for valuation of land, buildings, and equipment wherever the differences between current and historical costs are significant and the available measures of current cost are sufficiently objective.5

This view is consistent with the economic concept of income that underlies the national income accounts. In measuring net national product, an allowance must be made for the consumption of capital that will keep capital intact. While various interpretations have been given to the concept of “keeping capital intact” in estimating net capital formation, it rests on the condition that the stock of capital will be able to maintain its current rate of production for the future.6 This implies a measure of capital consumption based on current values of capital stock rather than on its historical costs. Universal failure to provide for such an adjustment in national income accounts results in the overstatement of net national product. Similarly, failure to provide for the tax free recovery of capital investment at less than current value overstates taxable income and may result in a tax on capital.

Inventories

Although investment in inventories is subject to gains and losses arising from price changes, replacement of these inventories is on a much shorter time cycle than fixed assets. However, so-called inventory profits (and losses) may be considerable, depending on the relative importance of inventories to total business assets, their rate of turnover, and the rate of change in prices. In reckoning business profits and inventory investment in the national income accounts, such inventory gains and losses are generally eliminated (for example, the inventory valuation adjustment in U. S. accounts).

The conventional method of charging materials to cost of goods sold is the first-in, first-out method (FIFO). According to this method, cost of goods sold is equal to the book value of inventories at the beginning of the accounting period, plus purchases and less the book value (the lower of cost or market value) of goods at the end of the period. During an inflationary period, these historical costs charged to sales are generally less than their market value at the time of sale. The appreciation in the value of the asset carried therefore creates a so-called inventory profit, or windfall gain, which is subject to ordinary income tax.

The replacement cost approach to the elimination of inventory profits calls for the valuation of opening and closing inventories at current market (or net realizable) value; purchases, including cost of manufacturing during the year charged to cost of goods sold, must also be adjusted to their average replacement cost. Other methods include the base stock method, which eliminates inventory profits related to a basic quantity of stock necessary for business operations.

The last-in, first-out method (LIFO) also substantially reduces the effect of price changes on profits. This follows the principle of charging first to sales the cost of the most recently acquired goods. In this way, the gap between the current replacement price and the historical cost of goods sold in an inflationary situation is narrowed and inventory profits are minimized. This technique is used in the United States, where it was first accepted for tax purposes in 1938, but it has gained acceptance in few other countries. It should be noted that LIFO inventories are carried on the books at their earliest acquired costs and that in an inflationary situation their book value is greatly understated. In this respect LIFO does not conform to the principle of reflecting current values on financial statements that is advocated by proponents of price level accounting.

revalorization approach

In contrast to the replacement cost principle, revalorization, or price level accounting, provides for the conversion of historical cost financial statements to monetary units of constant purchasing power. Revalorization differs in two essential respects from the concepts underlying replacement cost: (1) it adjusts all items of the balance sheet—assets and liabilities—for changes in the value of money, and (2) it employs a standard index of changes in the general price level rather than special indices (or appraisal) for particular balance sheet items.7

These models make a distinction between so-called monetary and nonmonetary items in the balance sheet. Monetary items are assets and liabilities, the amounts of which are fixed by contract or statute; they include cash and accounts and notes receivable, as well as short-term and long-term liabilities. Holders of monetary assets lose purchasing power during an inflationary period, whereas debtors gain by a reduction in the real value of obligations payable. In converting from historical cost accounts to current purchasing power statements, monetary items remain unchanged at the current balance sheet date. This is because they represent cash or the contractual amount of claims due and claims payable. However, as gains and losses tend to arise from changes in the general price level, monetary assets and liabilities appearing in financial statements of prior periods are restated in monetary units of constant purchasing power by multiplying each item by the ratio of the current general price index to the index of the earlier period. The net effect of the price adjustment on monetary assets and liabilities is recognized as a gain or loss for the accounting period.8

The effect of price level adjustments on monetary assets and liabilities may be illustrated by the following example, which assumes a 40 per cent increase in the price level over a year:

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The loss in purchasing power of 13,000 on a short-term monetary account is more than offset by the gain of 40,000 in long-term obligations, leaving a net gain of 27,000 which is charged to the profit and loss account.9 While accountants differ on the treatment of gains on long-term liabilities, the British and U. S. accounting associations are in agreement in treating them as part of profits before taxation.

Nonmonetary items such as land, buildings, machinery, and equipment are restated in the current year’s balance sheet at a value adjusted for changes in the general purchasing power of the monetary unit since the time they were acquired; that is, each separate item is adjusted by the ratio of the general price index at the end of the period to the index at the time of its acquisition. A price level adjustment is also made for inventories. Unlike monetary accounts, these items are stated at their price-adjusted values, but no gain or loss is recognized until they are sold or charged to operations in accordance with accepted accounting principles.

The purpose of general price level financial statements is to restate conventional accounting statements to take into account changes in the purchasing power of the monetary unit rather than to reflect the current cost of various assets, as is the case in revaluation statements. Price level accounting is intended to measure real income of a business rather than only to provide a basis for the maintenance of the value of physical assets. In this respect, the book value of assets adjusted for changes in the purchasing power of money may depart significantly in many instances from values justified by the current market value or replacement cost of these assets.

II. Experience with Revaluation After World War II

Revaluation of financial statements in response to the inflationary aftermath of World War II has taken a variety of forms depending on the circumstances and the purposes served. For analytical purposes it is convenient to recognize two separate approaches: (1) one-time or successive revaluations of nonmonetary business assets, and (2) comprehensive revalorization schemes of a permanent nature.

revaluation of nonmonetary business assets

European countries

In the immediate postwar period, several European countries enacted legislation for the revaluation of nonmonetary business assets to correct balance sheet values for the war-induced inflation. A major objective was to adjust taxable income so as to provide greater funds to business for rehabilitation of plant and for other new investment. France, in 1945, was the first country to authorize the revaluation of assets, and revaluation remained in effect on a voluntary basis until 1959, when it was made mandatory for large companies.10 Italy instituted compulsory revaluation schemes in 1946, 1948, and 1951. In 1947, Belgium introduced a one-time voluntary plan substantially limited to industrial assets acquired prior to World War II. Austria enacted legislation annually from 1947 to 1954 that provided for revaluation of inventories as well as of depreciable assets; this culminated in the 1954 plan for revaluation of monetary accounts as well. Following its currency reform of 1948, the Federal Republic of Germany enacted a revaluation plan in 1949 that also took into account the effect of the new deutsche mark on monetary assets and liabilities. In 1950, the Netherlands introduced a voluntary revaluation scheme similar to that of Belgium. Spain’s first revaluation plan was not instituted until 1961; this was followed by similar schemes in 1964 and 1974.

Scope of revaluation. In Austria, Belgium, France, the Federal Republic of Germany, and the Netherlands, all business firms were covered by the revaluation laws, while in Italy and Spain only corporations were affected. Although the need for balance sheet conformity and improvement of investment and other decisions based on financial statements would seem to call for mandatory schemes, especially for larger companies, the majority of schemes adopted were optional. Revaluation was mandatory only in the Federal Republic of Germany and Italy (except in 1952), and for the final provision in France (1959), when companies with a turnover exceeding 5 million francs were required to revalue their financial statements. In Italy, the linking of revaluation with attempts to improve accounting and to reduce tax evasion was a strong argument for compulsion.

Only in Austria and the Federal Republic of Germany was revaluation applied to all balance sheet items (assets and liabilities), because of the need to correct monetary accounts for the new currency. In Italy and France, the revaluation measures embraced inventories as well as fixed assets; Italy also covered licenses and patents, and France covered securities, receivables, and liabilities in foreign currency. Spain’s law included patents, receivables, certain securities, and payables in foreign currency. Spain also provided for the revaluation of assets and liabilities previously excluded from the balance sheet, Belgium and the Netherlands limited revaluation substantially to fixed assets acquired before World War II; Belgium further restricted it to industrial plant and equipment. An additional feature of the optional schemes was that the decision to revalue and the degree of revaluation, within statutory limits, could be decided on an asset-by-asset basis. In Spain, however, a decision to revalue applied to all eligible assets.

Several countries recognized that inflation would be advantageous to firms that financed the purchase of assets with loans. Belgium, for example, limited the degree of revaluation allowed when this type of financing was important.11 In France and Spain, full revaluation was permitted in order to reflect current values in the balance sheet, and a higher tax was placed on the revaluation reserve from loan-financed assets.

Techniques of adjustment. Most of the European schemes represented a response to what was thought to be a limited period of exceptional inflation. The revaluations have therefore been one-time affairs or have taken place at discrete intervals. This is seen most clearly in Belgium, the Federal Republic of Germany, and the Netherlands. In Italy, the adjustment process spanned a longer period, but there was no attempt at a continuous correction for inflation. Spain has also revalued periodically. Of the countries surveyed, France comes the nearest to a system of continual adjustment to a relatively long period of inflation, with measures in force from 1945 to 1959. Revaluation below the maximum allowed in any particular year could be made up in subsequent years.12

Revaluation provisions differed in their adjustment for depreciation that was previously allowed. Clearly, the tax advantage of future depreciation is greater, the less the revalued asset is reduced by previously claimed depreciation. The general rule is to adjust depreciation reserves by the relevant price coefficient for each year’s depreciation. Future depreciation allowances are thus limited to the replacement cost, less revalued depreciation, or to the remaining useful life of the asset. One departure from this rule was the option given by Austria to increase depreciation allowances or to revalue pre-1946 assets still in use even if they were fully depreciated.13

In Belgium, the Netherlands, and the Federal Republic of Germany, revaluation was not linked to any price index but was based on estimated replacement cost within certain limits. Belgium allowed revaluation of assets by the lower of their estimated current value and two and a half times their book value on August 31, 1939, reduced by the degree of physical depreciation. The Netherlands limited revaluation to double the 1949 book value of machinery and short-lived buildings (ten years or less) and ratios declining with the life of buildings beyond ten years. In the Federal Republic of Germany, replacement value was estimated by the individual firm, with declarations for a postwar capital levy providing some curb on the values submitted. All machinery and equipment had to be valued at a minimum of one third of replacement cost, to which was added the remaining two thirds, weighted according to the proportion of the remaining life of the asset.14

In other European countries, depreciable assets were revalued by coefficients issued by the government. These were related to the year of acquisition and applied to the original cost of the asset; a corresponding adjustment was made for each year’s depreciation. The French coefficients were based on the wholesale prices of construction materials, lumber, and steel. In Austria, Spain, and Italy, fixed assets were revalued by coefficients that reflected increases in the wholesale price level.

Different laws limiting the taxation of inventory profits have been in force in France since 1939.15 Between 1952 and 1959, the law was designed to exempt from tax the inventory profits on basic minimum stocks of a permanent investment character. An inventory valuation account could be set up so as to exclude inventory profits from tax; if prices declined, the difference in value was restored to taxable income. The 1959 tax reform replaced the base stock method by a deduction from taxable income of increases in value of all inventories attributable to price increases of 10 per cent or more.16

The revaluation law in the Federal Republic of Germany provided for inventories to be valued at the lower of their replacement costs on August 31, 1948 or August 31, 1949. The Government later enacted a law that allowed inventory valuation deductions on essentially the same basis as the post-1959 French system. Italy, in 1951, authorized valuation profits on “permanent stock,” considered essential to the normal operation of a firm, to be deducted from taxable profits.17

Austria’s inventory adjustment best conformed to price level accounting. Although initially (1947) legislation provided for an arbitrary doubling of beginning inventories, by 1951 the additional deduction was based on 90 per cent of the difference between average unit costs of beginning and closing inventories for different classes of goods, reduced by factors based on turnover.18

Treatment of revaluation surplus. Of these European countries, only France and Spain enacted a supplementary tax on income or on the revaluation surplus arising from the write-up in the book value of assets. During the years 1945–48, French firms choosing to revalue were required to pay profits tax at 28 per cent rather than at the standard 25 per cent. This differential rate was replaced in 1949 by a 5 per cent tax limited to the revaluation gain from assets financed by loans. With the introduction in 1959 of the compulsory measure, a 3 per cent tax was imposed on the reserves resulting from revaluation of depreciable assets, and a 6 per cent tax was placed on reserves for the maintenance of base stock inventories. Spain’s 1961 revaluation law levied three different rates of tax on the revaluation gain: a simple revaluation tax of 1.5 per cent, 8 per cent on assets financed by loans, and 3 per cent on assets not previously entered in the accounts. In 1964, these rates were reduced to 0.15 per cent, 4 per cent, and 1.5 per cent, respectively. The 1974 legislation did not carry a tax.

Several countries placed constraints on the distribution of revaluation gains. Such gains simply reflected write-ups on the books of the enterprise, distribution of which would be inconsistent with a major purpose of the related tax benefits to finance plant rehabilitation and other new investment.

Asian countries

Several Asian countries have also provided for the revaluation of assets for tax and other purposes; these countries include Indonesia, Japan, and Korea.19 The Japanese revaluations, initiated in 1950, were dictated by the postwar inflation that distorted financial accounts and taxable income in the face of urgent needs to rehabilitate plant.20 The other countries have revalued more recently. Korea enacted legislation for the revaluation of assets in 1958 and 1962, in response to a 60 per cent annual rate of inflation prior to the initial measure. Indonesia provided for revaluation of fixed assets following major inflationary episodes in 1953 and 1971. The latter was preceded by more than a hundred-fold price increase beginning in 1965.

Scope of revaluation. With the exception of the 1954 Japanese revaluation and the 1958 measure in Korea, the schemes in these countries were optional.21 The 1954 Japanese revaluation remained optional for small firms, and the 1958 Korean measure was optional for sole proprietors. Indonesia restricted revaluation to corporations.

The measures enacted in these countries generally applied to a range of assets similar to those of the postwar European revaluations, with the exception of inventories. Indonesia restricted revaluation to fixed assets (land, buildings, and machinery) that were acquired between 1960 and 1970. Korea included some intangible assets and shares as well as fixed assets, while the Japanese measures referred to all fixed assets and up to 1953 to shares. The pre-1954 Japanese acts provided for selective revaluation of individual assets and categories of assets (for example, land) up to the limits prescribed by the index.

Techniques of adjustment. None of these countries has provided for a continuous adjustment for inflation. Indonesia’s two postwar revaluations were separated by 18 years, while in Japan and Korea successive measures reflected the lack of impact of the initial acts as well as continued inflation. Japan’s 1950 law had only limited response, and it was extended in 1951 to take account of conditions generated by the Korean conflict; it was amended again in 1953 and a new act was introduced in 1954. In 1957 the 1954 legislation was extended to firms previously excluded.

Japan’s and Korea’s revaluations were linked explicitly to movements in price indices. The technique employed in these countries for depreciable assets was to apply the increase in the wholesale price index from the year of acquisition to the depreciated cost of the asset, following the declining balance method. Separate indices of land values were used. Indonesia provided for the revaluation of the original cost of plant and equipment and each year’s depreciation by means of government-issued coefficients. These coefficients were based on the depreciation of the Indonesian rupiah’s exchange rate with the U. S. dollar, reflecting the fact that virtually all machinery and equipment were imported. The coefficients for buildings and land were calculated on the cost of construction and the estimated value of land.

Treatment of revaluation surplus. Following the recommendations of the Shoup Mission, Japan in 1950 levied a 6 per cent tax on the revaluation gain, payable over three years; this was re-enacted in 1951. The provisions of the tax were eased in subsequent amendments; the 1953 amendment extended the payment period to five years, and the 1954 law cut the tax to 3 per cent, exempting the amount by which the compulsory revaluation exceeded that allowable under the 1951 Act. Indonesia imposed a seemingly heavy tax of 10 per cent of the revaluation gain, payable in eight quarterly installments; in addition, a capital tax of 10 per cent had to be paid at the time of capitalization. In 1958, Korea levied a 1 per cent revaluation tax, which was halved in the 1962 revaluation.

Latin American countries

Since 1942, ten Latin American countries have adopted revaluation schemes for business income tax purposes: Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, and Uruguay.22 While all ten schemes originated in inflationary situations, those of Bolivia (1972) and Mexico (1954) were directly related to currency devaluations that followed a period of rising prices.23 Generally, these schemes were introduced for the purpose of adjusting depreciation allowances to replacement values. The early revaluation provisions of both Brazil and Chile, however, were intended to adjust capital values for excess profits tax purposes and were later extended to the business income tax. Uruguay’s provision for the revaluation of assets accompanied the introduction of its income tax in 1961, but it also applied to the excess profits tax, which was modified at the same time.

Partial systems, calling for the restatement of asset values (Argentina, Bolivia, Mexico, Peru, and Uruguay), will be treated apart from those of Brazil and Chile, which evolved into permanent revalorization systems of a more comprehensive character. Except for Argentina’s 1971 law and Uruguay’s legislation, the plans of these countries provided for a onetime revaluation of fixed assets. Uruguay’s scheme extends to items other than fixed assets, but it is less comprehensive than that of either Brazil or Chile. Colombia’s 1960 scheme provided for price level adjustments to depreciation allowances, rather than for revaluation of assets. Corporations and limited share partnerships were permitted to credit annually to this reserve an additional 15 per cent of the cost of machinery and equipment acquired prior to the 1957 currency devaluation, within specified limits.

Coverage. The revaluation plans of Argentina, Bolivia, Peru, and Uruguay are of general application to all enterprises, while Mexico’s legislation was limited to firms engaged in industrial, agricultural, and fishing activities. All firms covered by the law in Peru and Uruguay are required to revalue fixed assets; Argentina’s provision is mandatory for only large firms. Bolivia’s provisions appear to be optional, as were Mexico’s. Argentina, Bolivia, and Mexico limited revaluation to depreciable assets, Peru covered land as well, while Uruguay provides for adjustments to the value of depreciable assets, land, and inventory (inventory revaluation is optional).

Techniques. Different policies have been followed with regard to both the indices or measures of revaluation for tax purposes and the limits within which they operate. Uruguay, for example, issues maximum and minimum coefficients of price changes from past years (based on general changes in replacement value) that are applied to the original cost of the asset, depending on its year of acquisition; depreciation corresponding to the useful life spent is also revalued. Different coefficients based on cost of construction and land values are applied to real estate. Argentina’s price adjustments have also been based on coefficients issued by the Government. In its 1972 decree, Bolivia distinguished between domestic and imported capital goods, the former being increased by 20 per cent and the latter by 60 per cent, slightly less than the extent of the devaluation. Peru’s 1971 decree provided for a 55 per cent increase in the December 31, 1967 values established by the predecessor Act of 1967, and smaller adjustments for assets acquired in 1968 and 1969; corresponding adjustments were made for accumulated depreciation. Mexico, on the other hand, authorized taxpayers to increase the book value of their assets (unless fully depreciated) on the basis of an appraisal but not by more than 40 per cent of the book value on April 19, 1954. Additional depreciation based on this adjustment was deductible only for the 15 per cent distributable profits tax and not for the schedular taxes.

Of these countries, only Uruguay has authorized adjustment of inventory costs. Initially, opening inventories were revalued at replacement cost, and the excess over cost was excluded from taxable income. Since then, various prescribed percentages of opening inventories have been deductible, provided the amount did not exceed taxable income.

Special reserves and revaluation tax. Since 1960, Argentina has levied a tax ranging from 3 to 10 per cent of one half the increase in book value of the assets, depending on the size of the increment; this tax is deductible for income tax purposes. The revaluation reserve arising from the 1967 and 1971 revaluations of assets in Peru was subject to a 10 per cent tax. Bolivia imposed a tax of 5 per cent on the 1972 revaluation gain transferred to a special reserve; a 5 per cent tax was also authorized under its permanent legislation of 1973. Mexico’s reserve was subject to the same rules as those governing its special 10 per cent reinvestment reserve; the amount could be capitalized and was subject to the distributable profits tax only when the company redeemed its shares or was liquidated. Although Uruguay does not impose a special tax on the revaluation reserve, the higher valuation is subject to its net wealth taxes.

comprehensive revalorization schemes—brazil and chile

The profit adjustment schemes of Brazil and Chile have gradually evolved after years of experimentation with partial adjustment plans.24 In Brazil, the legal provisions and administrative regulations governing the readjustment mechanisms are continually being modified. Chile, until 1974, has had a fairly stable permanent adjustment system, but it has been complicated by successive partial revaluations.

The techniques employed by these two countries have some fundamental similarities. Both systems are based on the concept that income is equivalent to the increase of a firm’s net worth in real terms and that the tax law should take into account the effects of inflation on all items that enter into the determination of net worth—both assets and liabilities. However, neither system conforms to the revalorization model advanced by the British and U. S. accounting professions.

Chilean system

Chile’s scheme for the annual adjustment of profits derives from a provision enacted in 1959,25 which established an optional system of net worth revaluation available to all taxpayers subject to business income taxes. As part of the income tax reform enacted in 1964, this provision was modified in some respects and made mandatory.26 The system has been based on the annual adjustment of net worth for changes in the consumer price level. Until 1975, the total amount of adjustment available to a taxpayer was determined by multiplying the net worth at the beginning of the year by the relative change in the consumer price index during the year. This amount was apportioned first to revaluation of fixed assets, by applying to their net value the same relative change in the consumer price index; any balance remaining could be deducted directly from that year’s profits, but it could not exceed 20 per cent of such profits.

New legislation, effective in 1975, repealed the 20 per cent limitation and made sweeping changes in the revaluation scheme.27 The full amount of the net worth adjustment is now deducted directly from taxable income. Compensating adjustments, however, must be made to taxable income for changes in the value of certain assets and liabilities. The law calls for revaluation of the following accounts: (1) beginning-of-year fixed assets, equity investment, patents, and copyrights; (2) inventory at replacement cost; (3) index-linked monetary accounts; and (4) monetary accounts in foreign currencies. Operating results for the taxable year would reflect the revalued accounts in accordance with accepted accounting principles—for example, depreciation and inventory accounting. Although there is no precedent for taxing unrealized revaluation increases in fixed assets at income tax rates, this effect is mitigated by the net worth adjustment. Moreover, the new law was accompanied by one of Chile’s periodic revaluations, which largely nullified its effect for 1975.

The normal operation of the Chilean permanent profits adjustment scheme has been subject to periodic provisions for the revaluation of assets. The main object of these revaluations has been to escape from the limitations of the permanent system by allowing full revaluation of fixed assets and inventory, generally up to replacement values. Although a special tax is imposed on the resulting reserves, many taxpayers have taken advantage of the revaluation provisions. Chile has thus combined the features of both replacement value and revalorization of financial statements in a way that distorts equity and complicates administration.

Brazilian system

The Brazilian profits adjustment system shares many features with the Chilean scheme but conforms better to the revalorization system advocated by the accounting profession.28 It is composed of two parts: the revaluation of fixed assets and the revaluation of working capital. The first of these is mandatory; the second is optional. A third component, which is closely related to these two, is the treatment of income and expenses connected to index-linked claims.

Brazil provided for revaluation of fixed assets for many years, but until 1964 its use was limited to financial statements and to the valuation of capital for purposes of the excess profits tax. Taxpayers were then allowed to write off the amount of the revaluation of depreciable assets against taxable income. This amount was treated separately at first as a new investment with the same useful life as the original asset, but since 1974 it may be amortized over the balance of the useful life of the asset. Revaluation is based on the index used to adjust indexed treasury bonds, an index which reflects changes in the wholesale price level.

The second component of the Brazilian profits adjustment scheme is the revaluation of so-called working capital by the same price index. This provision was introduced in 1964 for purposes of computing the excess profits tax,29 but in 1968 this system was modified and made applicable to the business profits tax. Working capital is defined as the difference between equity capital and the net book value of fixed assets. Liabilities exclude all debt expressed in foreign currency, or subject to indexation, that is related directly to the acquisition of fixed assets. The resulting adjustment in each year is considered as the amount necessary to preserve working capital intact. If the amount is negative, taxpayers may opt for the adjustment and deduct this amount from their taxable profits.

An important complement of the Brazilian adjustment scheme is the handling of amounts received or paid as “monetary correction”—that is, payments (excluding interest) derived from transactions subject to indexation. The indexed component of loans paid or received by enterprises is treated in a special account. If the total amounts paid exceed those received, the difference may be deducted from profits; if the total amounts received exceed those paid out, the difference is now (since 1974) treated as taxable income.

III. Evaluation of Price Level Adjustments

Too little is known about the experience with the various plans described above to state with any confidence what effects they have had on new investment, economic stability, resource allocation, the distribution of the tax burden, administration and compliance, or indeed, government revenue. Any such analysis must therefore rest largely on theoretical grounds and find support from whatever fragmentary information is available.

allocative effects

It seems clear that the tax benefits of partial revaluation plans vary with the composition of business assets and the degree of inflation. Capital-intensive industries with long-lived assets stand to gain most from the introduction of such a scheme, first, because their fixed assets generally comprise the largest share of total assets, and, second, because of a generally older age distribution of plant and machinery, the replacement cost of which has risen the most (although subject to depreciation already accrued). Industries with heavy inventory investment may also realize substantial benefits, depending on the extent of the price rise in particular commodities. This distribution of tax benefits is consistent with the objective of partial revaluation measures to provide funds for investment. Although the timing of the tax savings may not coincide with a replacement program, except for inventories, greater cash flow is made available for additional new investment, repayment of debt, and other corporate purposes that strengthen the company’s financial position.

Some indication of the relative benefits implicit in partial revaluation plans is provided by an analysis of the 1971 balance sheets of 137 corporations trading on the London market.30 As expected, financial companies including those in banking and insurance were not affected because they owned little or no depreciable assets or inventories. Of the remaining 124 companies, 55 would have received the greatest benefits from revaluation of inventories; these included the tobacco manufacturing, general engineering, merchandising, textile, and food processing industries. Slightly fewer companies (49) would have had the largest benefits from revaluation of their plant and equipment accounts, although many of these would have also benefited greatly from the elimination of inventory profits.

These industries were concentrated in shipping, oil, building materials, and hotels.

The effects on income of the revalorization plan supported by the British accounting profession were distributed somewhat differently, especially because of the offsetting gain on long-term debt. Of the 137 companies in the sample, such inflation accounting would have reduced the reported earnings by about 75 per cent, with reductions up to 200 per cent (one company having a considerably higher reduction). The greatest relative decreases in reported earnings were in electrical manufacturing, shipping, automobiles, textiles, and engineering, with average reductions ranging from 60 to 174 per cent. On the other hand, price level adjustment had relatively little effect on merchandising and banking, but it appreciably increased earnings of breweries, hotels, and insurance and real estate companies because of their relatively large liabilities.

Similar estimates for selected corporations in the United States have been made by Davidson and Weil.31 Using procedures that conform generally to those recommended by the APB Statement No. 3,32 they calculate the effect of price level adjustments on net income in 1973 both before and including the gain or loss on monetary items for 60 major industrial companies and 24 utilities. Adjusted net income before the gain or loss on monetary accounts of industrial companies shows reductions ranging from 7 to 90 per cent of reported income, with a median reduction of about one third. The median reduction for public utilities in 1973 is about 25 per cent.

Inclusion of monetary accounts produces a much wider divergence of price-adjusted income from reported income for industrials, ranging from a reduction of 82 per cent to an increase of 76 per cent. The median change for the 60 companies, however, is very slight, amounting to a reduction of 5 per cent. As could be expected because of their heavy debt structure, the price-adjusted income of every public utility was increased, in several cases by 100 per cent or more. The median increase was about two thirds.

economic stability and growth

All plans for the revaluation of depreciable assets and inventories under inflationary conditions have the effect of reducing business taxable income, and (unless offset by tax on revaluation gains) of reducing business taxes. This results in greater internally generated funds at the disposal of the business. The magnitude of the impact depends, of course, on the particular form of the revaluation, the rate of increase in prices, and the level of business income tax rates. In an inflationary situation the increased cash flow tends to stimulate greater investment and thereby intensifies demand pressures. If the inflation is accompanied by high interest costs, the larger internal funds reduce dependency on the capital market and better enable capital investment programs to be carried out. The reduction in tax revenue, however, may require the government to increase its borrowing and thereby sustain high interest rates that militate against investment in other sectors of the economy—housing, for example—unless corrective action is taken to increase revenues or to reduce expenditures. It may fairly be concluded then that indexation of corporate profits based on the revaluation principle adds to inflationary pressures.

Because of the offsetting effect on taxable income of the indexation of business liabilities, revalorization would result in mixed effects, depending on the composition of assets and capital structure of different businesses. On balance, there would be relatively little effect on revenues and, consequently, on inflationary pressures. Public utilities for example, would suffer higher taxes because of their heavy debt structure.

The longer-range effects of revaluation would depend largely on the trend of prices. If economic pressures and structural changes result in a continuation of past inflationary influences, permanent schemes for revaluation of assets would provide continuing tax relief to business. Unless offset by higher tax rates or by arbitrary limits on the tax benefits, this tax reduction would lower the cost of capital and would increase investment, with the result that a larger share of the gross national product would go into capital formation. The increase in productive capacity could help break supply bottlenecks and thus help contain price increases in certain industries. The adoption of a comprehensive revalorization plan, however, would temper such a trend, depending on the proportion of business debt to revalued assets.

pricing policy

If revalued financial statements were utilized for business planning purposes, the economic effects outlined above probably would be reinforced by upward price adjustments. Replacement costs would be factored into the pricing policies of producers, with the result that administered prices would often follow more closely changes in the market value of inventories and plant and machinery. The extent to which supplemental revaluation statements now prepared by corporations enter into pricing policy is not known, but their general acceptance for tax purposes probably would lend greater support and interest in their use as a management tool in this respect.33 The more revaluation is embedded in internal costing systems, the more it is likely to enter into pricing, depending on the freedom of discretionary action.

effect on capital market

The acceptance by investors of financial statements based on price level adjustments would enable a more realistic appraisal to be made of changes in company earnings over an inflationary period. If reported earnings were deflated for higher replacement costs, they would tend to be reflected in lower share prices. Similarly, revalorization plans would have diverse effects, depending on whether or not price-adjusted earnings were reduced. Lower reported earnings would at the same time cool investors’ expectations for dividends and better enable management to justify greater retention of funds for new investment. Indeed, it could be argued that dividends would not be covered by earnings in many cases.34

While revaluations have been undertaken in a number of industrial countries, no special analysis appears to have been made of the stock market reaction except in Japan, where, as described below, special requirements governing capitalization are believed to have had a dampening effect. The degree to which investors may discount share prices for the effect of permanent inflation accounting on reported earnings seems highly conjectural. In speculating about the probable effect of the proposed British revalorization system on the stock market, Cutler and Westwick concluded that the most likely outcome would be a fall in prices of some company shares and a rise in others, depending on the direction of shift in earnings, with little or no general decline in prices.35

An important issue arises over requirements governing the capitalization of the revaluation reserve by the issuance of capital stock. Such capitalization has been justified under voluntary schemes as an obligation of the taxpayer to retain rather than to distribute corporate assets, consistent with the purpose of revaluation to finance new capital investment. In Japan, however, a larger capital stock account combined with lower reported earnings was believed to depress stock market values and make stock financing more difficult because it compounded the reduction in the ratios of both earnings and dividends to capital. This proved to be a very controversial provision of the Japanese voluntary revaluation schemes and was resolved only by a compromise in the 1954 Act that limited dividends to 15 per cent of capital unless at least 30 per cent of the revaluation reserve was capitalized.36

taxation of revaluation gains

The taxation of revaluation gains may substantially nullify the income tax benefits of asset revaluation and its economic consequences outlined above. The rate of tax, if any, and the provision for its payment thus require a delicate balancing of equity and economic considerations if voluntary revaluation is to gain wide acceptance. Except for Bolivia, France, Japan, Korea, and Peru, mandatory plans have not been accompanied by tax on revaluation gains, and the tax has been reduced under successive voluntary plans in other countries.37

Credit restrictions during inflation generally impair business liquidity and impose constraints on the financing of investment in current, as well as in fixed, assets. While business cash flow may be enhanced by the reduction of tax liabilities attributable to higher depreciation on revalued assets, even a moderate tax on revaluation gains, especially if real estate is covered, may offset income tax savings. For this reason payment of the revaluation tax is sometimes spread over several years.38 Calculations for Japan show that there was a net tax benefit from revaluation of depreciable assets over their useful life, assuming a 10 per cent discount rate, although the benefit was very small for assets with a useful life of 50 years and more.39 At lower discount rates the savings would be greater.40

A revaluation levy, therefore, may greatly restrict the benefits to the economy that are sought through revaluation of assets, especially if there is little or no income tax benefit, as for real estate and certain other assets. Such levies in France may partly explain why only about 12 per cent of all businesses and 32 per cent of corporations assessed on the basis of actual income elected the plan.41 In Japan, the results were also disappointing.

Following the 1951 extension of the 1950 Act, only about 22 per cent of eligible juridical persons revalued, although they accounted for about 72 per cent of the potential amount of revaluation that could be claimed.42 Indonesia’s 10 per cent levy exacted an even higher price for revaluation, and its law expired after two years without any corporation electing its provisions.

equity issues

Substantial differences in the nature of the plans, their conceptual basis, and their application make it difficult to draw any general conclusions about the equity of adjusting taxable profits for inflation. However, as such schemes are limited to price adjustment of business profits, they clearly favor one class of taxpayer over others for which no comparable relief may be provided. Moreover, the distribution of the tax benefits among different businesses may raise serious questions of discrimination. One aspect of this that needs to be considered is the price index that is employed.

Discrimination between business and nonbusiness taxpayers

However well it can be rationalized by accounting principles and economic theory, the revaluation of assets for tax purposes confers a special benefit on most business firms that mitigates the effects of inflation on their tax burden. Without comparable adjustments for other classes of income, it results in a redistribution of income taxes among different income sources. This can be seen most clearly for fixed incomes based on interest, annuities, and pensions, the purchasing power of which is also diminished by inflation. If, however, there is provision for the indexation of debt instruments, as in Brazil and Chile, such discrimination is somewhat lessened.43

The case for discrimination against wage and salary income is less clear. If the level of wages and salaries parallels the rising general price level, personal income taxes increase more than proportionately under graduated rates and fixed family allowances and thus increasingly impinge on the cost of living. Unless income tax adjustments corresponding with those provided for businesses are made, a question of tax equity arises, even though the tax relief is provided on entirely different grounds. Price level adjustments of personal income taxes by indexation of family allowances and tax brackets, as has been done in a number of countries, redresses the imbalances in the distribution of the tax burden that would otherwise arise.44

Discrimination among businesses

Not all revaluation schemes have included all businesses but have been limited to corporations or to certain types of industry. While for reasons of compliance cost and minimal benefits not all businesses may wish to avail themselves of the provision, denial of its possible advantages creates inequities. On the other hand, there is less reason to make revaluation mandatory for all businesses, most of which are small private firms. Compulsory legislation has sometimes been limited to larger corporations (for example, in Argentina, France, and Japan), but in most countries it has been mandatory for all corporations (for example, in Brazil, Chile, the Federal Republic of Germany, Italy, Korea (first plan), Peru, and Uruguay). In some countries revaluation provisions were optional for unincorporated businesses.

Any partial revaluation scheme that is limited to the indexation of particular assets is bound to discriminate between different businesses, depending on the composition of their total assets. Failure to index liabilities, also, so as to give effect to the reduction in purchasing power of money, understates increases in net worth over the taxable year and thereby understates real net incomes. Companies with a heavy debt structure payable in local currency therefore enjoy a relatively greater tax benefit than those with small debt.45 Similarly, if monetary assets are not indexed, earnings are overstated in terms of changes in their purchasing power.

For these reasons, comprehensive revalorization plans that adjust the assets and liabilities of all businesses for changes in the value of money best serve equity for tax and other purposes.46 The theoretical basis for this view is supported by the accounting profession. The permanent indexation schemes of Brazil and Chile come closest to realizing this goal, but the adjustment of net working capital is optional in Brazil.

Within the context of partial revaluation plans, different techniques for adjusting depreciation to current replacement cost during an inflationary period also have widely varying effects on different businesses, depending on the age composition of their depreciable assets. In the introduction of the plan, the theoretically correct principle calls for revaluation of assets by price coefficients based on their year of acquisition; a corresponding adjustment should be made for revaluing accumulated depreciation allowances.47 This is the method most commonly employed in one-time revaluations; succeeding revaluations would reflect price changes from the previous revalued base.

Other plans (for example, Bolivia’s) simply adjust uniformly the book value of all depreciable assets in use at a specified date (and not written off) by an index of change in prices (or decline in the exchange rate) since that date. If prices have been rising, this procedure fails to write up the value of assets acquired before that date to their current values and discriminates against companies with an older age distribution of assets. The revaluation of depreciation allowances, as in Colombia and Israel, has a similar result.

Some firms may be unable to realize the tax benefit of an increase in depreciation allowances because it cannot be absorbed by income. This situation may develop in slow growth industries with heavy investment in fixed assets and low profit margins. Extended loss carry-over provisions may improve this condition, although the present value of the deduction would be reduced.

Revaluation gains and taxation

As has been noted, some countries have imposed a special tax on the write up in book value. As this capital gain is attributable to inflation, a basic question arises as to whether it should be taxed, especially if it is not realized. From an economic point of view, these gains do not reflect real income, and their taxation would appear to be inconsistent with the principles of replacement cost accepted by the government for tax and financial accounting purposes.

From an equity point of view, however, taxation of the gains on assets may find some support in compensating for the benefit that is implicit in the failure to adjust liabilities for inflation. If the revaluation is elective, the tax may be regarded as a charge for the privilege of revaluing. This is especially true if the new value establishes a fresh basis for capital gains tax purposes.48 On the other hand, when revaluation gains arise from revalorization of monetary as well as nonmonetary accounts, their taxation would not seem to be justified.

As has been seen, the level of the revaluation tax is quite arbitrary and has varied from a nominal rate in Korea and Spain to as high as 10 per cent in Indonesia and Peru. There is no relevant criterion other than a standard rate of the capital gains tax itself, which may be so punitive as to defeat the purpose of revaluation. The appropriate rate of tax, if any, and its period of payment must therefore be guided by a proper balance of economic and equity considerations. The 6 per cent rate adopted by Japan was determined after a careful examination of the liquidity position of Japanese companies and their ability to meet payments without jeopardizing new investment.

The choice of an index

Equity considerations are important in the selection of a price index or other measures employed for the adjustment of balance sheet accounts to inflation. The index chosen should, of course, be consistent with the intended objectives of the revaluation. For this reason it is important to distinguish between adjustments to current value under the replacement cost approach and purchasing power indices under revalorization schemes.

Replacement cost. If replacement cost is accepted as a valid basis of accounting for current depreciation and inventories, it is necessary to raise a basic question of what is to be replaced.49 Because of technological improvements, machinery and equipment are rarely replaced with identical assets but rather with assets of greater productivity.50 Therefore, use of replacement cost of existing machinery and equipment would generally provide greater allowances than necessary to maintain the current level of output in the future, and the tax benefits would be unnecessarily enhanced. Varying rates of technological improvement in different industries would be a source of inter-industry discrimination.

One-time revaluations may be based on company appraisal of the market value of assets for their replacement cost (as in Belgium, the Netherlands, and the Federal Republic of Germany), but a permanent plan should be based on more objective measures, such as coefficients that reflect changes in market values. This would, in principle, require the use of special indices related to average price increases experienced for different categories of assets: buildings, machinery and equipment, land, and inventories of particular materials. Unless official coefficients are prescribed, tax avoidance will be invited and administration made more difficult. The unavailability of appropriate indices in many countries has made it necessary to resort to proxies that may not reflect accurately changes in market prices of different categories of assets. When most of the capital equipment is imported, an adjustment based on depreciation in the value of the currency may be appropriate (as in Bolivia and Indonesia), but this would not be suitable for domestic and production costs. In the absence of an index of domestic construction costs, it may be necessary to employ a wholesale price index of non-agricultural goods (as in Argentina). Indexation of the value of real estate, when included, raises special problems either because such an index is rarely computed or, if it is, because wide variation in the appreciation of land values in different areas make any single measure unacceptable for all companies.

revalorization

In accounting for the effect on profits of general changes in purchasing power, it would be desirable to employ a very broad index of price changes, such as the GNP deflator. Yet very few countries have developed a reasonably accurate deflator, and all but these few would be forced to employ a second-best index. Indeed, neither Brazil nor Chile employs this broad measure in its comprehensive revalorization scheme; instead, Brazil uses a wholesale price index and Chile uses the consumer price index.

The question inevitably arises as to how accurately either wholesale price or retail price indices reflect changes in general purchasing power. They are known to have serious weaknesses, especially in developing countries, depending on the accuracy of reported prices, the proper weighting of commodities and services consumed throughout the country, and the statistical bias of the computation. Even so, their uniform application to all businesses would distort taxable profits less than no revalorization at all. Efforts to revalorize accounting statements for tax purposes need not await the perfection of a deflator, provided the available tools are not seriously inaccurate.

administration and compliance

Any major departure from conventional accounting principles is bound to increase the problem of compliance and administration of an income tax. This is especially true of revaluation schemes which superimpose new techniques on existing standards for the determination of taxable income and which frequently require the observance of related rules governing distribution and capitalization of revaluation gains. The effective use of revaluation provisions therefore rests largely on the quality of the accounts that are maintained in the country. Recognition of this fact is seen in the adoption of elective schemes in most countries and, where mandatory, their limitation to corporations or large businesses. While other considerations have influenced the election of revaluation, accounting requirements undoubtedly played a major role in the relatively low proportion of small businesses that opted for the provisions in France and Japan, the only countries for which there are relevant data. On the other hand, it is reported that the 1947 revaluation in Belgium was carried out very smoothly and that virtually every eligible firm took advantage of it.51

Different plans, of course, vary in their complexity, depending on the scope of assets and other accounts covered, on the frequency of revaluation, and on related provisions, such as taxation of revaluation gains and restrictions on their distribution. One-time plans limited to the revaluation of fixed assets pose fewer problems than continuing plans.

Comprehensive revalorization schemes instituted by Brazil and Chile compound the problems of compliance as well as administration. This is especially true when there are introduced refinements related to the nature of debt obligations (as in Brazil) and limitations on benefits (as in Chile). Periodic modifications of the law to meet changing conditions and technical refinements have a cumulative effect on the burden of compliance and administration.

The indexation of inventories presents special problems of enforcement because of the greater opportunities for evasion. It is especially difficult to ascertain the various components of inventories and to be certain that the appropriate price index has been applied. While the base stock inventory method has gained acceptance in European countries, it does not lend itself to businesses with highly diversified goods and high turnover (for example, department stores). The LIFO inventory method substantially eliminates inventory profits and is not difficult to apply once it is established.

Revalorization introduces further complications in the harmonization of income taxes within a common market area such as the European Economic Community, as well as in adjusting to double taxation relief for branches and subsidiaries in countries without a comparable system. Technical problems also arise in the carry-over of losses incurred at a lower price level.52

alternatives to revaluation

In view of the questions and problems raised above on grounds of economic efficiency, equity, and administration, it is important to examine the comparative merits of alternatives to revaluation.

Acceleration of capital allowances

The view that the main purpose of depreciation is to provide funds for replacement of assets is not generally accepted by economists or by the accounting profession.53 Indeed, there is no assurance that even historical costs will be recovered, since recovery depends on whether depreciation charges are covered by revenues. If replacement costs were to be matched by accumulated depreciation charges, during a period of inflation it would be necessary to compensate for the deficiencies of prior years by annual charges based on current replacement values. No official revaluation scheme provides for such retroactive adjustments, which would result in current costs clearly out of line with reality. Even if such charges were made and covered by revenue, comparable funds would not necessarily be retained in the business and invested in replacement of existing assets. Replacement of retired assets at a higher cost would generally be financed from cash flow generated from revenue, including that allocable to both depreciation allowances and earnings, and from outside capital obtained from equity issues or by borrowing.

The traditional view, long honored by the accounting profession, is to treat an expenditure on depreciable assets as a deferred expense and to amortize its cost over its useful life. In theory, its apportionment over time should reflect its rate of decline in value to the firm owing to obsolescence, wear and tear, and inadequacy. As straight-line amortization is commonly employed for tax and business purposes, provision for more rapid recovery of capital investment is frequently advocated as an alternative to asset revaluation.54

Techniques for speeding up the rate of capital recovery take a variety of forms. One generally accepted method provides for the acceleration of depreciation through greater write-offs of the cost of plant and equipment in early years; this may be accomplished either by large initial-year allowances or by a declining balance formula. Its extreme form, so-called free depreciation, gives businesses the privilege of writing off capital investment at their discretion, including full write-off in the year of acquisition. In 1938 Sweden adopted “free depreciation” as the best solution to financial and tax accounting in a period of rising prices.55 While this provision has been popular because of the flexibility it has given businesses in the recovery of investment for tax purposes, the write-offs have intensified investment in boom periods, and in 1952–53 and 1955–57 taxes on new investment were introduced to curb this effect.56 Rapid write-offs in Sweden have also distorted balance sheets and led to a provision that permits the revaluation of assets in financial statements for business purposes. The United Kingdom, which had long provided for substantial initial allowances, in 1972 authorized a 100 per cent write-off of plant and machinery and a 40 per cent write-off of industrial buildings in the first year.

Another method of liberalizing capital allowances is the provision of investment allowances (or investment tax credits) which supplement ordinary depreciation; these generally permit a business to deduct in the year of acquisition a specified percentage of the cost of new capital expenditure, in addition to standard depreciation allowances. While most commonly found in investment incentive codes, investment allowances or tax credits have been provided in the income tax laws of Canada, the United Kingdom, and the United States.57

Accelerated depreciation (other than the expensing of capital expenditures by one-year write-offs) does not, of course, eliminate the effect of price level changes on business profits. Rather, by reducing the lag between the time of acquisition of a depreciable asset and its amortization for tax purposes, the effects of inflation are only mitigated. The magnitude of the differential effect on business profits is illustrated by the results of a careful reconstruction of corporation profits in the United States based on different assumptions of depreciation (Table 1). If straight-line depreciation were used over the 26 years from 1948 to 1973, the adjustment of depreciation for price level changes would have reduced corporate profits before tax by some $174 billion, or 13.5 per cent. It is significant, however, that general use of the double declining balance depreciation method permitted in the United States would have yielded corporation profits of only $83 billion, or 7.4 per cent, in excess of those resulting from price level adjustment of straight-line depreciation.58 Rough estimates indicate a tax saving of about $41 billion that would have been available to corporations over this period for new investment and distribution—slightly less than $1.6 billion a year. This differential would have been closed, however, if the investment tax credits were also employed in lieu of replacement cost. Over the nine-year period 1962–70 such tax credit resulted in annual tax savings averaging $1.8 billion.59

Table 1.

United States: Profits Before Tax of Nonfinancial Corporations, Computed with and without Current Price Depreciation, 1948–73 1

(In billions of U.S. dollars)

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Source: U.S. Department of Commerce, Survey of Current Business, Vol. 48 (May 1968), pp. 22–25 and Vol. 54, Part 1 (May 1974), pp. 19–21.

Profits based on national accounts. Depreciation allowances assume that useful lives declined linearly from 100 per cent of Bulletin F service lives before 1940 to 75 per cent of Bulletin F lives in 1960 and thereafter. Bulletin F service lives are defined in the 1942 edition of U.S. Department of Commerce Bulletin F; they are commonly used in many studies of measures of depreciation.

While this era was beset by periodic bouts of inflation when the corporation profit differential under alternative assumptions widened, the average annual rate of increase in the consumer price index was a modest 2.5 per cent. In periods of rapid inflation the differential tax advantages of price level adjustments would naturally be heightened. The critical rate of inflation that would justify the adoption of such a system is uncertain and depends on a balancing of equity, economic, and administrative considerations of alternatives.

There would be an entirely different distribution of the tax benefits under liberalized capital recovery allowances and revaluation. The latter would be enjoyed mostly by long-established businesses with slow growth, whereas accelerated depreciation would be more readily available to newer firms that are expanding.60 In this respect, accelerated depreciation and especially investment allowances or tax credits, would represent a more positive inducement to capital investment because the tax benefits are a function of new investment. One advantage is the greater flexibility of accelerated depreciation for channeling investment to particular industries by variations in rates.

Liberalized capital allowances would also appear to have a greater destabilizing effect on the economy than revaluation. While revaluation allowances under a permanent system vary with the degree of inflation, the resulting tax savings would not necessarily materialize in new investments; depending on business policy decisions, the additional funds available might be used to acquire existing assets, liquidate liabilities, or pay dividends. Unless modified to meet changing economic conditions, the tax benefits of liberalized allowances based on accelerated depreciation and/or investment allowances tend to vary with fluctuations in investment over a business cycle or longer-term expansions and contractions of the economy. However, one of the virtues of investment allowances or tax credits is that they can be adjusted to changes in economic conditions (as has been so in Canada and the United States). They are, therefore, more flexible tools for the control of new investment to the degree that they are effective.

Accelerated depreciation allowances also have administrative and compliance advantages, as they are not superimposed on existing accounts but are generally incorporated in a firm’s accounting system. Of the various techniques, the investment credit is perhaps the simplest, because it is applied directly to the tax calculated in accordance with tax law based on accepted accounting principles and does not require the alteration of a company’s accounts.61

Inventories

If revaluation is limited to nonfinancial assets, the other major account involved is that covering inventories. When revalued, the difference between the book value and replacement cost of opening inventories at current prices is usually deducted from earnings so as to mitigate the effects of inflation on profits. This technique is best illustrated by Austria’s provisions. Some countries (for example, France and Italy) have followed the base stock method of eliminating profits on a minimum permanent investment in inventories.62 As mentioned in Section I, the LIFO inventory method is perhaps the most sophisticated technique of eliminating inventory gains and losses, but it has won approval in few countries of the world.

While not without problems in application, the LIFO inventory method substantially eliminates inventory gains and losses due to changes in price of goods. One deterrent to its use is the fear that a decline in prices will increase taxable income under adverse business conditions. Another concern is the effect of inventory liquidation on taxable income; if inventories are reduced, goods carried at an earlier book cost are charged to sales, thereby increasing profits. Furthermore, this method is objectionable because balance sheets are distorted by the valuation of LIFO inventories at low historic costs.63

The alternatives set forth above are suitable only for partial revaluation plans. They are not substitutes for comprehensive revalorization of financial statements that adjust business profits for the effects of price changes on monetary accounts as well as on tangible assets.

IV. Summary and Conclusions

Because conventional accounting principles are based on historical costs, financial statements increasingly depart from reality during periods of inflation. Unless they are adjusted for changes in the price level, reported earnings subject to income tax tend to be inflated because costs lag behind prices. For this reason, many countries have provided for the revaluation of business accounts to reflect current price levels, particularly following a war or other national crisis when inflation has become rampant.

nature and scope of revaluations

When adopted, revaluation schemes have usually formed part of a government’s stabilization program and have represented a one-time adjustment to a new price plateau. In some countries, however, they have remained in effect for several years, and in other countries they have been renewed periodically with the resurgence of inflation. In only four countries—Argentina, Brazil, Chile, and Uruguay—have permanent plans been instituted (see Appendix Table 2).

The traditional approach has been based principally on a revaluation of plant and equipment to reflect current market cost. This has the effect of increasing depreciation allowances so as to reduce taxable income and make available greater funds after tax for replacement and rehabilitation of production facilities. (Several countries have simply adjusted depreciation allowances without requiring the revaluation of assets.) Similar measures are intended to eliminate inventory profits attributable to rising prices. More recently, techniques have been advanced by the accounting profession to adjust financial statements, including the profit and loss report, for changes in the general price level. This recognizes the effect of a decline in the value of money, not only on fixed assets and inventories but also on monetary accounts (cash, receivables, and liabilities). Such a revalorization technique, however, has been applied to income taxation in only two countries—Brazil and Chile.

Revaluation has been both mandatory and optional. When mandatory, it has usually applied to substantially all businesses or corporations (as in Brazil, Chile, the Federal Republic of Germany, Italy, Korea, Peru, and Uruguay), although the voluntary plans of Argentina, France, and Japan culminated in compulsory revaluation for large companies. Such general application can be explained by the purpose of achieving comparability in financial reports. When revaluation was optional, businesses usually could select the category of property to be revalued.

Several countries have imposed taxes—ranging up to 10 per cent—on the surplus arising from revaluation. As such a tax partly offsets the tax savings expected to be realized to finance new investment, it is inconsistent with the economic arguments usually advanced for revaluation. However, a tax on revaluation of nonmonetary assets may compensate for the fact that liabilities are not adjusted for changes in their real value.

evaluation

Wide variations in revaluation schemes make it difficult to assess their economic and equity effects. These effects vary with the degree of inflation, income tax rates, and coverage of the law. Capital-intensive industries, and especially those with large inventory investment, tend to realize the greatest tax benefits from revaluation of nonmonetary assets; financial companies are affected relatively little. A general revalorization scheme requiring the indexation of monetary assets and liabilities as well as of nonmonetary assets would result in a substantial redistribution of such benefits, in many cases increasing the income taxes of capital-intensive industries with a heavy debt structure. Partial revaluation plans would add to inflationary pressures, because the tax savings attributable to rising prices would make greater internal funds available to businesses for new investment and would reduce their dependence on the money market. The effect on the stock market is conjectural; however, earnings adjusted for replacement costs would tend to dispel the illusion of high profits attributable to inventory gains and to under-depreciation and would probably result in lower stock market values. Mandatory revalorization of all balance sheet items is likely to be reflected in more stable average market values.

One source of possible inequity is the measure employed for revaluation. While inventory values may be based on market quotations, there is no comparable objective standard for the valuation of plant and equipment. Engineering appraisal is fraught with error and manipulation, and the replacement values of different types of fixed assets diverge over time from any single index of construction costs or prices that is commonly employed. If the revalorization principle is followed and all accounts are adjusted for changes in the purchasing power of money, a general price index should be employed. But in many countries this is deficient because of partial coverage of goods and services or defects in their weighting. However, the introduction of indexation need not await the perfection of an index if the results are tolerably accurate.

The privilege of revaluing assets for business tax purposes would have considerable redistributive effects and appears to discriminate among different income sources. Such discrimination would be reduced under a general revalorization scheme, but inequities would remain unless comparable adjustments were provided for other taxpayers with fixed-income investments in securities and pension plans. The case for discrimination against wage and salary income is less clear, but unless comparable tax relief is provided for rising living costs during inflation a question of tax equity would arise. A number of countries provide for such relief by the adjustment of family allowances and tax brackets, through either indexation or discretionary changes in the tax law.

Revaluation provisions clearly add to the problems of tax administration and compliance. While one-time revaluations may not be difficult to deal with, especially if they are voluntary, compulsory annual indexation may prove to be burdensome. Comprehensive revalorization schemes are especially sophisticated and raise further problems of differentiating between dissimilar classes of monetary assets and liabilities, some of which themselves may be indexed, as in Brazil and Chile.

Despite the increasing acceptance of inflation accounting for financial reporting purposes, other techniques for adjusting taxable business income to inflation may be more suitable on grounds of efficiency, equity, and administration. With regard to inventory investment, one alternative that recognizes higher replacement cost is the last-in, first-out (LIFO) inventory method, which has been accepted in only a few countries. With regard to capital allowances, the adoption of accelerated depreciation and investment allowances has been proposed. The ultimate form of accelerated depreciation is the write-off of capital expenditures in the year made, sometimes provided under so-called free depreciation. This permits full recovery of the cost of plant and equipment at the current price level.

Accelerated depreciation (and/or investment allowances) can be designed to yield substantially the same aggregate tax benefits as replacement cost depreciation. Estimates for the United States show roughly equivalent benefits between 1946 and 1973, when prices rose at an annual average rate of 2.5 per cent. However, the distribution of tax relief and its economic effects would be somewhat different. Both new and established companies would benefit from accelerated depreciation, and during a period of rising prices the timing of the tax relief would be better synchronized with investment plans for replacement and expansion. As a result, accelerated depreciation probably would contribute more to demand pressures than would replacement cost techniques.

The choice of techniques depends largely on the inflationary situation. Revaluation of assets is well adapted to the re-establishment of realistic values following a period of rapid inflation, as part of a broad stabilization program. Periodic revaluations may be necessary if inflation persists at a high rate, but accelerated depreciation and the LIFO inventory method may be more suitable for moderately rising price levels. A permanent revalorization scheme deals more comprehensively with the distortion of taxable profits under conditions of persistent inflation and has appeal on both equity and economic grounds, but it poses greater problems of compliance and enforcement. A major issue also would arise over the taxation of many companies, such as public utilities, whose taxable earnings would be increased.

APPENDIX

Table 2.

Summary of Principal Revaluation Measures of Selected Countries, 1946–75

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Also 1953; details not available.

In 1954, monetary accounts were revalued to reflect currency reform.

1948 currency reform was applied to monetary accounts.

Chile has also periodically provided for voluntary revaluation of depreciable assets, subject to revaluation tax.

Prior to 1975, Chile provided for allocation of net worth adjustment to capital assets first, with the balance to reduction of taxable income, not exceeding 20 per cent of income.

*

Mr. Lent, Senior Advisor in the Fiscal Affairs Department, has been on the faculties of the University of North Carolina and Dartmouth College. He has served as an assistant director of the tax analysis staff, U. S. Treasury Department, and as Consultant to the Organization of American States.

1

For a survey of earlier history, see Taxation and Research Committee, Association of Certified and Corporate Accountants, Accounting for Inflation (London, 1952), pp. 99–144.

2

For good overviews see Patrick R. A. Kirkman, Accounting Under Inflationary Conditions (London, 1974) and R. S. Gynther, Accounting for Price-Level Changes: Theory and Procedures (New York, 1966).

3

“Depreciation accounting is a system of accounting which aims to distribute the cost or other basic value of tangible capital assets … over the estimated useful life of the unit (which may be a group of assets), in a systematic and rational manner. It is a process of allocation, not of valuation.” American Institute of Certified Public Accountants, Accounting Terminology Bulletin, No. 1 (New York, 1953).

4

For an earlier survey of business practice, see E. Cary Brown, Effects of Taxation: Depreciation Adjustments for Price Changes (Graduate School of Business Administration, Harvard University, 1952; reprinted by Maxwell Reprint Company, Elmsford, New York, 1970).

5

Accounting Review, Vol. 39 (July 1964), p. 698. The majority of the members of another committee recommended the use of replacement cost for inventories as the best of several alternative methods.

6

For a thorough analysis of the principles involved in measuring net capital formation under constant prices, see Edward F. Denison, “Theoretical Aspects of Quality Change, Capital Consumption, and Net Capital Formation,” in Problems of Capital Formation: Concepts, Measurement, and Controlling Factors, National Bureau of Economic Research, Studies in Income and Wealth, Vol. 19 (Princeton University Press, 1957), pp. 215–61. The principles and techniques of adjusting for price changes are presented in Allan H. Young, “Alternative Estimates of Corporate Depreciation and Profits: Parts I and II,” Survey of Current Business, Vol. 48 (April 1968, pp. 17–28; May 1968, pp. 16–28).

7

For authoritative statements by the accounting profession in the United States and the United Kingdom on the principles involved, see Accounting Principles Board, American Institute of Certified Public Accountants, Financial Statements Restated for General Price Level Changes (New York, 1969); and Accounting Standards Steering Committee, The Institute of Chartered Accountants in England and Wales, Accounting for Changes in the Purchasing Power of Money, Provisional Statement of Standard Accounting Practice No. 7 (London, May 1974). The accounting institutes of Scotland and Ireland joined with the institute of England and Wales in supporting similar rules before the Inflation Accounting Committee.

8

A question may arise over the validity of adjusting the value of fixed income instruments (the rate of interest on which already reflects the rate of inflation). If, for example, the interest rate is 15 per cent, of which 10 percentage points compensate for an anticipated decline in purchasing power, it might be argued that the holder is already compensated for inflation. However, if the entire 15 per cent interest is taxable at, say, 50 per cent, the 7.5 per cent yield after tax would be negative. It is necessary, therefore, to index the principal amount to avoid taxation of capital. For example, a $1,000 debenture carrying 15 per cent interest would be revalued at $900, so as to protect the investor against taxation of the $100 loss in capital; tax would be limited to $25, and the nominal yield after tax would be 12.5 per cent—equivalent to a real rate of return of 2.5 per cent. The borrower’s interest cost of $150 would be offset by a real gain of $100 on the debt; if deductible at a tax rate of 50 per cent, the real cost would be equivalent to the $25 yield of the investor, that is, 2.5 per cent. See Vito Tanzi, “Inflation, Indexation, and Interest Income Taxation” (unpublished, International Monetary Fund, February 14, 1975).

9

The loss in cash and accounts receivable is calculated at 40 per cent of 60,000, or 24,000, plus 40 per cent of one half of the year’s increase, assuming that the increase has taken place evenly through the year. A similar computation is made for the increase in liabilities.

10

The 1959 tax reform abolished revaluation with respect to price changes occurring after June 30, 1959. Large firms were required to undertake revaluation of their 1959 accounts by December 31, 1963; small firms could elect it by then.

11

E. B. Nortcliffe, “Revaluation of Assets in Belgium,” Accountant (London April 23, 1949), pp. 323–26.

12

Harvard University Law School, World Tax Series, Taxation in France (Commerce Clearing House, Chicago, 1966), p. 325.

13

Felix Kollritsch, “Austria’s Answer to Inflationary Profits and Taxation” Accounting Review, Vol. 36 (July 1961), pp. 439–45.

14

For assets fully depreciated in the books but still in use, the proportion of replacement value taken was lower. M. Peter Holzer and Hanns-Martin Schönfeld, “The German Solution of the Postwar Price Level Problem,” Accounting Review, Vol. 38 (April 1963), p. 379.

15

M. Peter Holzer and Hanns-Martin Schönfeld, “The French Approach to the Post-War Price Level Problem,” Accounting Review, Vol. 38 (April 1963), pp. 384–87.

16

Since 1948, France also permitted deductible inventory reserves to take account of fluctuations in prices of specified basic raw materials acquired in world markets; in 1959, this provision was extended to materials purchased in national territory. See Harvard University Law School, Taxation in France (cited in footnote 12), pp. 315–22.

17

Harvard University Law School, World Tax Series, Taxation in Italy (Commerce Clearing House, Chicago, 1964), Paragraph 6/5.1, p. 383.

18

Kollritsch, op. cit., p. 443.

19

Israel granted additional depreciation allowances for machinery and buildings following the currency devaluations in 1954, 1962, and 1967. The supplementary allowance for assets purchased with foreign exchange was based on the difference between the old and new exchange rates. For domestically financed assets, a lower amount was given, depending on the date the asset was acquired.

20

The initial measure largely followed the recommendations by the Shoup report on the Japanese tax system: Report on Japanese Taxation by the Shoup Mission, General Headquarters, Supreme Commander for the Allied Powers (Tokyo, September 1949), Vol. II, p. 126. An excellent analysis of this experience is given by Sidney Davidson and Yasukichi Yasuba, “Asset Revaluation and Income Taxation in Japan,” National Tax Journal, Vol. 13 (March 1960), p. 46.

21

Despite the compulsory nature of the 1958 Act in Korea, there was widespread failure to comply. See Samuel S. O. Lee, “Korean Accounting Revaluation Laws.” Accounting Review, Vol. 40 (July 1965), p. 624.

22

For a comprehensive survey and analysis, see Arturo E. Lisdero and Luis E. Outeiral, Contabilidad e Inflación: El ajuste integral, Los revalúos legales, contables e impositivos (Cordoba and Buenos Aires, 1973). Argentina’s plans through 1957 are described in Enrique J. Reig, El Impuesto a los Reditos, 5th edition (Buenos Aires, 1970).

23

Bolivia’s 1972 revaluation decree was followed by a new income tax law of 1973, which authorizes a new revaluation when reductions in the exchange rate or increases in prices reach 15 per cent of the level on December 31, 1971 (Decree Law No. 11154 of 1973).

24

For a more detailed history and analysis of these plans, see Milka Casanegra-Jantscher, “Taxing Business Profits During Inflation: The Latin American Experience” (unpublished, International Monetary Fund, April 16, 1975; forthcoming in International Tax Journal).

25

Law No. 13305 of April 4, 1959. A revised plan was made effective in 1975.

26

Ley de Impuesto a la Renta (Law No. 15564), February 14, 1964.

27

Decree Law No. 822, December 31, 1974.

28

The law in effect through 1974 was amended by Decree Law No. 1338, Article 14, July 23, 1974, effective January 1, 1975. See also regulations announced on October 15, 1974, Portaria 544.

29

The excess profits tax was repealed in 1966.

30

R. S. Cutler and C. A. Westwick, “The Impact of Inflation Accounting on the Stock Market,” Accountancy, Vol. 83 (March 1973), pp. 15–24. While relatively few companies were covered, they accounted for about 75 per cent of total stock market values in 1971.

31

Sidney Davidson and Roman L. Weil, “Inflation Accounting: What Will General Price Level Adjusted Income Statements Show?” Financial Analysts Journal Vol. 31 (January/February 1975), pp. 27–31, 70–84; “Inflation Accounting: Public Utilities,” Financial Analysts Journal, Vol. 31 (May/June 1975), pp. 30–34, 62.

32

Accounting Principles Board Statement No. 3, Financial Statements Restated for General Price-Level Changes (1969).

33

See Brown (cited in footnote 4), p. 48.

34

See Cutler and Westwick, op. cit. About eight companies are shown to have made dividends that were not covered by price-adjusted earnings for the year.

35

Ibid., p. 17.

36

Davidson and Yasuba (cited in footnote 20), p. 57.

37

Higher book values are also subject to net wealth taxes in several countries—for example, Argentina, Chile, Peru, and Uruguay. Property tax also applied to revalued assets in Japan, and a capital levy, payable over 30 years, was applied in the Federal Republic of Germany.

38

Japan initially spread payment of its 6 per cent levy over three years and later over five years. Indonesia’s 10 per cent tax was payable in two years.

39

Davidson and Yasuba, op. cit., p. 53.

40

For a mathematical analysis of the revenue effects of a revaluation tax under different conditions, see Armando P. Ribas, “Effects of a Tax on Revaluation of Assets” (unpublished, International Monetary Fund, December 11, 1974).

41

Foreign Tax Policies and Economic Growth, Report of a conference held at The Brookings Institution, December 5–7, 1963, published by the National Bureau of Economic Research (Columbia University Press, 1966), p. 310.

42

Davidson and Yasuba, op. cit., pp. 50–51.

43

For a survey of Brazil’s experience, see Jack D. Guenther, “‘Indexing’ Versus Discretionary Action—Brazil’s Fight Against Inflation,” Finance and Development, Vol. 12 (September 1975), pp. 24–29.

44

See Amalio Humberto Petrei, “Inflation Adjustment Schemes Under the Personal Income Tax,” Staff Papers, Vol. 22 (July 1975), pp. 539–64; Fiscal Affairs Department, “Adjustment of Taxation for Inflation” (unpublished, International Monetary Fund, May 23, 1975).

45

This fact was recognized by France and Spain in imposing a heavier revaluation tax on assets financed by debt.

46

While Edwards and Bell agree that such a system would tend to make the income tax more equitable, they are of the opinion that business policy decisions can be based only on balance sheet adjustments for particular price changes. See Edgar O. Edwards and Philip W. Bell, The Theory and Measurement of Business Income (University of California Press, 1961), pp. 16–28.

47

If the declining value depreciation method is employed, current depreciation allowances are computed on the net value of assets after revaluation of the cost of the asset and the depreciation previously claimed.

48

In countries where corporations and other businesses are subject to net wealth taxes, there would be less justification for a revaluation levy.

49

As is pointed out in Section IV, economists and accountants are by no means agreed that provision of funds for replacement is the proper function of depreciation accounting.

50

Indeed, the assets of a business may not be replaced at all, if business decisions dictate. For example, certain equipment may be leased rather than owned.

51

See Accounting for Inflation (cited in footnote 1), p. 109.

52

These and other implications of revalorization are discussed by M. F. Morley, The Fiscal Implications of Inflation Accounting (London, The Institute for Fiscal Studies and the Institute of Chartered Accountants in England and Wales, 1974), pp. 109–23.

53

Accounting Research Division, American Institute of Certified Public Accountants, Reporting the Financial Effects of Price-Level Changes (American Institute of Certified Public Accountants, New York, 1963), p. 33.

54

See Brown (cited in footnote 4), p. 121; Richard Goode, The Corporation Income Tax (New York, 1951), pp. 176–78; Colombian Commission on Tax Reform (Malcolm Gillis, editor), Fiscal Reform for Colombia (Harvard University Law School, 1971), pp. 82–83; Alan R. Prest, Public Finance in Theory and Practice, 4th edition (London, 1970), pp. 337–50.

55

See Accounting for Inflation (cited in footnote 1), p. 132.

56

These taxes were 10 and 12 per cent, respectively, and were deductible for income tax purposes. On Swedish fiscal stabilization policies, see Assar Lindbeck, “Theories and Problems in Swedish Economic Policy in the Post-War Period,” in Surveys of National Economic Policy Issues and Policy Research, American Economic Review, Vol. 58, Part 2, Supplement (June 1968), pp. 1–87.

57

See George E. Lent, “Tax Incentives in Developing Countries,” Rivista di Diritto Finanziario e Scienza delle Finanze, Vol. 29 (March 1970), pp. 3–19; and George E. Lent, “Tax Incentives for the Promotion of Industrial Employment in Developing Countries,” Staff Papers, Vol. 18 (July 1971), pp. 399–417.

58

The double declining balance method provides for the application of twice the annual rate to the balance of the cost of the asset after deduction of depreciation already allowed.

59

U.S. Internal Revenue Service, Statistics of Income—1970: Corporation Income Tax Returns (U. S. Government Printing Office, Washington, 1974), p. 200.

60

It was partly on these grounds that the Tucker Committee in 1951 rejected revaluation of assets in favor of a system of flexible initial allowances. See Report of the Committee on the Taxation of Trading Profits, Cmd. 8189 (His Majesty’s Stationery Office, London, 1951). The Royal Commission on the Taxation of Profits and Income took a similar view. See Final Report, Cmd. 9474 (Her Majesty’s Stationery Office, London, 1955), p. 115.

61

Proper accounting provides for the deferment of the tax reduction and its prorating over the useful life of the asset.

62

A base stock method seems to have been favored by the British Royal Commission on the Taxation of Profits and Income, op. cit., pp. 477–79.

63

According to Gynther, “A balance sheet using LIFO inventory figures has no meaning at all.’ (Cited in footnote 2, p. 103.) Until recently, companies in the United States could indicate current values in a balance sheet footnote.

IMF Staff papers: Volume 22 No. 3
Author: International Monetary Fund. Research Dept.