[1940] Ch. 32 EXTRAORDINARY LOSSES AND OTHER SPECIAL ITEMS IN THE INCOME ACCOUNT
1 year ago

Summary:
Chapter 32 focuses on the challenges faced in analyzing income accounts, specifically in determining whether certain losses should be classified as extraordinary or not. In the 1930s, businesses experienced significant write-downs in inventories and receivables, although the methods employed varied among companies. Some deducted these losses from their surplus, while others charged them to their earnings statement. The extent of the collapse in inventory values during 1931-1932 can be considered extraordinary.

The chapter also highlights the manipulation of accounting practices, where companies would take sums from their surplus and report them as income, influencing stock prices. Analyzing inventory losses becomes complicated due to the creation of reserves to absorb future losses, which may not be reflected in the income account of any given year.

Examples from companies such as United States Rubber, Goodyear Tire and Rubber, as well as the packing industry's Wilson and Company and Swift and Company, demonstrate the varied accounting practices in managing future inventory losses. Some companies increase reported profits by reducing inventory, while others charge losses directly to operations and transfer reserves to surplus.

The chapter concludes by discussing variations in inventory accounting practices and the standard procedure of valuing inventory at the lower of cost or market. The "cost of goods sold" is calculated by adding purchases and subtracting the closing inventory. Different methods, such as the Last-In, First-Out method and the Normal-stock or Basic-stock Inventory Method, are used to minimize fluctuations in inventory values.

The report also touches on idle-plant expenses, which refer to the cost of carrying nonoperating properties and are charged against income. These expenses should be temporary and non-recurring. Additionally, deferred charges are expenses that apply to multiple years instead of a single period. They include organization expenses, moving expenses, development expenses, and discounts on obligations sold. These expenses are spread out over a period of years, typically five, to avoid affecting reported earnings.

The article criticizes various accounting practices, such as the amortization of bond discounts, which should be written off through annual charges against earnings but have sometimes been charged to surplus. Regulatory bodies have condemned this practice, leading some companies to reverse their approach and charge bond discounts against earnings.

Overall, accurate security analysis is crucial in identifying disparities between intrinsic value and market price. The chapter highlights that relying solely on the market's appraisal is not always reliable due to mob psychology and faulty reasoning. Analyzing accounting practices can be valuable in rectifying errors and ensuring accurate reporting.

No comments yet