Replacing historic cost

Last year, when the oil companies were making a killing on the back of a rising oil price and politicians and other assorted lefties were falling over themselves to demand windfall taxes of the oil majors and crucifixion of their executives, I pointed out that the whole thing was a storm in a teacup which was due to an accident of accounting rules.

British companies are required by law to state their profits using the historic cost convention. That means you measure the profits on the basis of what you sold something for, less what you paid for it. This is fine for many businesses, but for a company which is experiencing fluctuating raw material prices, the effects of this rule is to make the profits fluctuate wildly.

With all the criticism they took, the oil companies seem to have taken note. Instead of issuing media advisories for its quarterly results on a historic cost basis, BP has started used replacement cost instead. Of course their accounts will still have to be on a historic cost basis, because that's what the law demands, but the media don't look at those - they only cut and paste from the press releases and then only the bits that are written in big letters at the top. So the oil companies can probably steer journalists to the more meaningful replacement cost figures and we can do away with the whole media hysteria cycle that runs alongside the oil price cycle.

Comments

[J. Peden]

Let me try this one out, using approximate figures:

Back when the price of a gallon of gas in the U.S. was $4.00, Exxon reported a quarterly profit of about $12 billion, amounting to less than %10 profit.

What's %10 of $4.00 -- $.40 = 40 cents. So how are Oil Company profits responsible for high gas prices?

Meanwhile the Federal and State taxes on a gallon of gas where I live = 42 cents, and this tax does not vary with price. It's been there all the way up from when gas was below $2.00 per gallon.