Real ploughback earnings as an indicator of enterprise performance: FAS no. 33 disclosures revistited

Abstract

Existing and potential investors are vitally interested in the improvement of their wealth prospects. Receipt of cash, whether in the form of cash dividends or capital gains, represents fulfillment of this expectation. Such fulfillment is possible only when an enterprise registers growth in its resource base. Reported income is considered a good indicator of success achieved by an enterprise because it represents increase in available resources. An important link between reported income and stock prices is the link between future earnings and current earnings. This study utilizes data from FAS No. 33 to develop a real ploughback measure indicating a firm's ability to continue its operations successfully and to enhance its future earnings potential. The results of the study show that the market uses sophisticated models in evaluating the signal contained in ploughback earnings I. IntroductionThis paper explores the information contents of real ploughback earnings. The term real ploughback used in this paper is similar to the concept behind the computation of distributable income under replacement cost accounting proposals. The study is motivated by the fact that research findings on the usefulness of FAS NO. 33 disclosures have not been conclusive [for example, see Lev and Ohlson (1982), Bernard and Ruland (1987) and Lev (1989)].In FAS No. 89 (FASB, 1986), the FASB declared that FAS No. 33 disclosures did not achieve the cost-benefit relationship that had been anticipated for them. It is noteworthy that FAS No. 89 did not cite a single theoretical argument that would refute the litany of arguments made in the discussion memorandums and exposure drafts leading up to the issuance of FAS No.33 and the statements in the conceptual framework. Thus, the FASB yielded to the old notion that the criterion for sound accounting practice is the mere fact of general acceptance.Even though FAS 33 primarily dealt with reporting the effect of price level changes, implied in it were notions of profit calculation suggested by Edward and Bell (1961). In fact the FASB had issued FAS No. 33 as a trial balloon to pave way for implementing financial reporting requirements consistent with its conceptual framework. An important goal of FAS No. 33 was to emphasize the importance of identifying a capital maintenance concept that would facilitate assessment of the ability of an enterprise to cope with economic exigencies and the potential for sustaining its level of performance.