V 108-305. General note.

Aggregate balance sheet and income data for all U.S. corporations combined and for corporations classified by major industry have been published annually since 1926 by the Internal Revenue Service (and its predecessor, Bureau of Internal Revenue) in Statistics of Income, part 2. Data classified by asset-size class are also available since 1931. Series V 108-140 and V 167-196 are based on the materials assembled in Statistics of Income. Other sources provide balance sheet and income data for public utilities, railroads, and commercial banks over considerably longer periods. Data for public utility corporations are presented, in condensed form, in series V 197-212. Data for railroads are presented in chapter Q, Transportation, and for commercial banks in chapter X, Financial Markets and Institutions.

Most of the series shown here include aggregates based on the values reported by corporations in their accounting statements. These book values are seldom, if ever, equal to current market values, nor do they correspond to theoretical values computed by economic analysts (e.g., values arrived at on the basis of the expected revenue streams). When the general price level remains stable, individual differences between the book value and the market value (or between the book value and the theoretical economic value) may largely cancel out in the process of aggregation. In times of a persistent inflation, however, book values show a general tendency to fall below current market valuations, while in times of persistent deflation the reverse is generally true. Some specific valuation problems, arising in connection with different types of business assets, are briefly discussed below.

Physical assets. Physical assets owned by business firms include inventories (both finished goods and goods in process) and fixed assets (land, plant, and equipment).

Inventories are usually shown on the balance sheet at "cost or market, whichever is lower." Consequently, in periods of rising prices, book values tend to be below current market values. In periods of falling prices, however, conservative accounting practices require an adjustment in the book value so as to bring it down to the level of the current market value.

Book charges for inventories used up in production were formerly based almost universally on the "fifo" (first in, first out) method of valuation, but a substantial number of firms have switched to the "lifo" (last in, first out) method. These two valuation methods yield different results with respect to reported costs and profits and also with respect to the book value of the year-end inventory. Under "lifo" procedure, the most recent prices are used for the computation of costs. Consequently, reported profits (and, therefore, income tax liability) are reduced in periods of rising prices, but are increased in periods of falling prices, as compared with the amount that would be reported under "fifo."

On the other hand, the year-end inventories are valued at less recent prices on a "lifo" than on a "fifo" basis. Consequently, in periods of price instability the use of "lifo" tends to widen the gap between the book value and the current market value of the year-end inventories.

Except in special cases, a comparison of year-end inventory values does not provide an adequate indication of changes in the physical volume of inventories. When "lifo" is used, a change in the book value of inventory will correctly indicate the change in the physical volume valued at current prices, as long as the volume is increasing. If the physical volume is decreasing, however, a valuation adjustment is required in order to arrive at the current value of the physical

decrement. When "fifo" is used, a valuation adjustment must be made whether the physical volume is increasing or decreasing.

Since the aggregate inventory values represent a combination of "fifo" and "lifo" inventories (the former being the predominant component), an inventory valuation adjustment is clearly required before any inferences regarding changes in the physical stock are to be drawn from these figures.

Fixed assets include durable capital goods, which are generally entered at cost and are written off gradually over a period of years by means of annual depreciation charges. A detailed balance sheet usually includes (a) the gross amount before depreciation, (b) the depreciation reserve accumulated to date, and (c) the net amount after depreciation, which is equal to (a) minus (b).

If the prices of capital goods remained constant, the gross amount of plant and equipment would equal their replacement cost (the cost of replacing the existing items, which vary in age from almost new to being close to the time of retirement, with brand new items of the same type). During periods of continual price increases, however, the gross amount falls considerably short of the replacement cost; while during periods of continual price declines, the opposite is true.

The net amount of plant and equipment would approach the current market value only if the annual depreciation allowances corresponded to the actual loss of value through wear and tear as well as obsolescence (and, furthermore, if the prices of new capital goods remained constant). This, however, hardly ever happens in actual practice. Most corporations have been using the "straight line" method of depreciation, under which durable equipment has been written off by equal amounts every year during its entire lifetime, irrespective of the actual degree of wear and tear or obsolescence. During and after World War II accelerated writeoffs were allowed in industries working for defense, whereby plant and equipment could be written off over an arbitrary 5-year period. This procedure, coupled with the fact that prices generally rose at a relatively fast rate during the war and the postwar period, has served to further widen the gap between the net book values and the actual market values of fixed assets.

Neither the gross nor the net amount of plant and equipment may be taken to reflect accurately changes in the physical stock of durable capital goods. If prices remained constant, changes in the gross amount would indicate changes in quantity, though not in quality, of capital goods. For example, if a firm owned 100 units of machinery and added 10 new units next year, the gross amount would show a 10-percent rise (assuming no retirements during the year); but the gross amount could not show the decline in quality of the original 100 units through the process of aging. The net amount does reflect the aging of durable equipment but, as stated above, the prevailing depreciation methods do not-and are not intended to-align the book values with changes in the actual market value over time.

Financial assets. Financial assets of corporations represent their claims on other business units, individuals, and government. Current (short-term) financial assets include cash, bank deposit accounts, notes receivable and marketable securities (mostly U.S. Government but frequently including marketable corporate stock as well). Noncurrent (long-term) financial assets consist of bonds, other long-term debt instruments, and nonmarketable securities which are largely permanent holdings of corporate stock. The problem of market valuation does not, of course, arise in connection with cash and bank deposits. If receivables are salable, their market value does not ordinarily deviate from the book amount by more than a moderate