Historical Cost Measurement and the Use of DuPont Analysis by Market Participants

49 Pages Posted: 20 Aug 2010 Last revised: 4 Oct 2016

See all articles by Asher Curtis

Asher Curtis

University of Washington

Melissa F. Lewis-Western

Brigham Young University - Marriott School of Business

Sara Toynbee

University of Texas at Austin

Date Written: July 9, 2015

Abstract

We investigate whether historical cost measurement of assets lowers the usefulness of DuPont analysis for investors. Because firms report assets at modified historical cost under US GAAP, accounting ratios can be biased upward when assets have appreciated. Thus, variation in asset turnover, which is the DuPont ratio most affected by asset measurement, can be due to both economic forces and measurement effects. We assess the extent of measurement effects using the average age of a firm’s assets and find that asset turnover ratios are higher and more persistent for firms with older assets. Forecast errors of asset turnover are associated with the change in asset age, and these forecast errors are positively associated with contemporaneous and future returns. Our results are weaker in non-US samples, in part reflecting deflation and upward revaluations, consistent with our US results capturing biased asset turnover ratios due to historical cost measurement.

Keywords: DuPont Analysis, Forecasting, Historical Cost Bias, Future Returns

JEL Classification: M41, G14

Suggested Citation

Curtis, Asher and Lewis-Western, Melissa Fay and Toynbee, Sara, Historical Cost Measurement and the Use of DuPont Analysis by Market Participants (July 9, 2015). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1660671 or http://dx.doi.org/10.2139/ssrn.1660671

Asher Curtis (Contact Author)

University of Washington ( email )

Seattle, WA 98195
United States

Melissa Fay Lewis-Western

Brigham Young University - Marriott School of Business ( email )

Provo, UT 84602
United States
801-703-8426 (Phone)

Sara Toynbee

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

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