ABSTRACT
The purpose of this note is to show that in a period of rising costs, historical-cost pricing policies mean lower real earning rates than those existing when costs were constant and those which would be obtained with replacement-cost pricing, whether physical sales are constant or rising; to argue that the real earning rates of certain United Kingdom companies 1 fell in the years of the period 1949-53 when costs were rising, even though there is some evidence that the percentage mark-ups on costs were lengthened over the same period, so that apparent earning rates were maintained or increased; and that historical-cost pricing policies could explain these falls. The apparent earning rate is defined as the ratio of accounting profit to the historical cost value of funds employed, that is, the historical cost value of net assets. The real earning rate is defined as the ratio of current income 2 to the current value of funds employed, that is, net assets valued at current replacement prices. If production and investment decisions are based on apparent earning rates, low real earning rates could lead in the long run to misallocation of resources, and distributions based on accounting profit could lead to a deterioration in the financial structures of the companies concerned. 3
