Incomes Policy and the Measurement of Profits

Recently, some old problems have been discussed in the new context of an incomes policy.1 The old problems are two. Should company incomes be measured by accounting profits — revenues less historical costs — or by current incomes — revenues less current costs? Secondly, is profitability better measured by the ratio of accounting profits to the historical-cost book value of assets or by the ratio of current income to the current-cost book value of assets? It has been argued that investment allowances have served to close the shortfall between historical-cost depreciation allowances and current-cost capital consumption as far as the taxable incomes of companies are concerned, but that this shortfall (and the amount of investment allowances received) are ignored in many published accounts. Profits in these accounts are therefore overstated in periods of creeping inflation, with the consequence that the ratio of accounting profits, thus overstated, to the historical-cost value of assets (which is less than their current costs) leads to an overly favourable view of the profitability of companies. Mr Taylor has recommended that investment allowances should be shown in published accounts, together with the fire insurance values of fixed assets, so that more sober and realistic estimates of profits and the rate of return may be made.