ABSTRACT
It can be argued with some strength that, where the business is partly financed by borrowing, the absence of a 'gearing adjustment' would lead to an underestimate of the current economic return to shareholders, though the precise quantification of this is impossible. If future sales revenues rise as the replacement cost of the fixed assets and stocks rises, as it is reasonable to suppose will tend to happen, and if full provision is made in the accounts, as CCA requires, for the replacement of the fixed assets and stocks consumed, then, unless allowance is made for any gearing effect, a full distribution of the reported current cost profit will (where prices have risen) tend to reduce the gearing ratio year by year, i.e. the costs reported will include an element of provision for debt repayment. This arises because borrowing, which partially finances the assets concerned, is fixed in monetary terms. The gearing adjustment takes the form of an abatement of the CCA adjustments for additional depreciation, cost of sales and the MWCA, reducing these in the proportion that borrowing bears to the total long-term finance. The formula for this adjustment has been inevitably a matter of compromise, and no doubt discussion will continue.
