By the Numbers

Accounting for inflation

The spring flood of corporate annual reports is now flowing into mailboxes of America's 29.8 million shareholders. Along with the pretty pictures, fancy graphs and carefully chiseled words, many contain the most significant change in accounting procedures in decades. They reflect the effects of inflation on a company's financial performance.

In nearly all cases the new bottom line proves to be lower than almost anyone had imagined. Bethlehem Steel, for example, shows a net income under conventional accounting of $121 million for 1980. But with inflation accounting, that profit turns into a loss of either $176 mil lion or $257 million, depending on which of two methods of calculating is used.

Bethlehem's case underlines the shortcomings of current accounting procedures in an era of high inflation. The company has been setting aside money to replace its existing machinery, but the cost of the equipment was calculated at its old value, not at its inflated new price.

Thus the company has been drastically underestimating what it will have to pay for modern equipment.

When using inflation accounting, other large companies show smaller profits, if not outright losses. Exxon's income dips $560 million to slightly more than $5 billion; Alcoa's plunges from $470 million to $ 144 million. Robert Hampton III, a Price Waterhouse senior partner, says that a survey of 83 companies using inflation accounting last year showed that real profits were about 40% less than those reported on the normal balance sheet. Another survey, by Arthur Young & Co., revealed after adjustments for inflation that airlines, railroads and tire and rubber companies actually lost money. High-technology companies like IBM and Intel were the only sector of U.S. industry to do better on an inflation-adjusted basis. Reason:

technological advances have driven down their costs and accelerated productivity so dramatically that new equipment may actually be cheaper to buy than the machinery it is replacing.

Most worrisome of all was the frightening documentation of what professional investors have long suspected but seldom been able to prove convincingly: many U.S. businesses are beginning to liquidate themselves by paying out to shareholders dividends they cannot afford.

Bethlehem, for instance, paid earnings of $ 1.60 a share last year (a total of $69.8 million) on its phantom profits.

For now, the biggest benefit for corporations of inflation accounting--lower taxes because of inflation-reduced profits --cannot be reaped. Tax liabilities are still based on conventional accounting, and inflation accounting is mainly experimental.

The impetus for the new method goes back to 1977, when the Securities and Exchange Commission began pressing for annual reports that give investors more information about the effects of inflation on a firm's finances. Inflation accounting was finally mandated in 1979 by the Financial Accounting Standards Board, the profession's watchdog. This year the board required inflation-adjusted figures for only the 1,280 largest corporations, those with assets of more than $1 billlion.

Within five years, the new method may apply to all firms.

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