Current cost, Price indexes, PPE, PPI accuracy

The Financial Accounting Standards Board (FASB) is soliciting empirical evidence on the accuracy of price indexes for estimating the current cost of machinery and equipment in compliance with Statement #33. Recent studies indicated that measurement errors in current cost data appear to dominate the potential information content of the Statement #33 disclosures. This study investigates the sign, magnitude, and sources of the potential measurement error in the estimates of current cost generated by alternative levels of specificity of the Producer Price Indexes (PPI). The research method consists of statistical analyses to examine the distributional properties of the PPI estimates compared to the criterion variable of the actual current order price of the assets. The results Indicate that, in general, the measurement error tends to be an overstatement of new current cost. The major sources of measurement error appear to be product mix errors, pricing errors, and inadequate adjustments for quality change. Product mix errors seem to be the dominant factor for Electrical and Miscellaneous Equipment, pricing errors for General Purpose Equipment, and inadequate quality change adjustments for Machine Tools and Special Industry Equipment.

[The Financial Accounting Standards Board (FASB) is soliciting empirical evidence on the accuracy of price indexes for estimating the current cost of machinery and equipment in compliance with Statement #33. Recent studies indicated that measurement errors in current cost data appear to dominate the potential information content of the Statement #33 disclosures. This study investigates the sign, magnitude, and sources of the potential measurement error in the estimates of current cost generated by alternative levels of specificity of the Producer Price Indexes (PPI). The research method consists of statistical analyses to examine the distributional properties of the PPI estimates compared to the criterion variable of the actual current order price of the assets. The results indicate that, in general, the measurement error tends to be an overstatement of new current cost. The major sources of measurement error appear to be product mix errors, pricing errors, and inadequate adjustments for quality change. Product mix errors seem to be the dominant factor for Electrical and Miscellaneous Equipment, pricing errors for General Purpose Equipment, and inadequate quality change adjustments for Machine Tools and Special Industry Equipment.]

Thomas W. Downs, Keith A. Shriver, The Analytical Derivation and Empirical Test of a Tax-Adjusted Fundamental Value Model, Journal of Accounting Research, Vol. 30, Studies on Accounting and Taxation (1992), pp. 77-98

[Prior research has developed some econometric properties of accounting valuation rules as linear aggregations of prices and quantities. This study evaluates these proposed properties using actual price data and published price indexes for industrial machinery and equipment for the time period of 1973-1980. Current order prices for 4,875 new industrial machinery and equipment assets were obtained from commercially published pricing guides. The order prices were then used to construct a set of composite price indexes. The Bureau of Labor Statistics (BLS) Producer Price Indexes were also obtained. Various sized asset portfolios were simulated, and the changes in their values were estimated using both the constructed and the BLS price indexes. The changes in estimated and actual values of the simulated portfolios were compared to generate both Bias and mean-squared-error (MSE) measures resulting from the use of price indexes under various experimental conditions. These error measures were then used to evaluate the econometric properties proposed by earlier studies. In addition, total valuation errors were decomposed into movement and measurement components. Movement error is the valuation error attributable to deviations of the relative weights of assets used in constructing price indexes from those of the firm's asset portfolio. Measurement error is the valuation error arising from pricing errors, substitution bias, and inadequate adjustments for technological or quality changes in constructing price indexes. The main results indicate that (1) movement error Bias is zero, but measurement error Bias is nonzero; (2) both MSE movement error and MSE measurement error decline with the use of increasingly fine index systems and with the holding of more diversified asset portfolios, but increase as the asset holding period lengthens; and (3) measurement error tends to be the major source of total error. These findings are based on an assumption that the order prices taken from the commercial pricing guides are void of significant measurement error. Based on these results, it appears that additional effort should be devoted to enhancing price index construction techniques so that measurement error is decreased. Because portfolio diversification appears to reduce all components of error, asset valuations based on a price-index methodology should, perhaps, be restricted to cases involving larger groups of assets rather than very specialized strata of assets. Also, it may be appropriate to restrict the use of price indexes to assets of certain ages, as the study findings indicate that longer asset holding periods are associated with larger errors.]

Evaluates several analytical results developed in earlier studies and investigates the absolute econometric properties of valuation rules using date from a specific economic environment. Statistical theory of valuation; Effects of valuation error on current cost data; Relationship between portfolio diversification and valuation error.

Reviews the book "FMC Corporation's Use of Current Cost Accounting," by Julie H. Hertenstein.