An Examination of the Substitution and Supplement Effects of Current Cost Ratios 1

The prior research on the usefulness of current cost data has concentrated on the incremental information content of current cost income measures by adopting a capital market perspective. The present study complements the prior research and focuses on the substitution and supplement effects of current cost balance sheet ratios by utilizing an individual user approach to financial analysis. This paper examines the distributional properties of current cost ratios in order to ascertain whether such properties are similar to the properties of historical cost ratios for firms in the primary manufacturing and retail industries. Furthermore, the relative rankings of the firms based on the current cost ratios are compared with the relative rankings based on the historical cost ratios for various fundamental financial dimensions. The findings indicate that substitution or supplement effects may exist for current cost ratios in both cross-sectional and intertemporal analyses of the financial constructs of firms. These effects are most evident for the leverage dimension on a cross-sectional basis and the profitability dimension on an intertemporal basis. Furthermore, the effects are more prevalent in the manufacturing industry as compared to the retail industry. These results suggest that the usefulness of current cost data may be on a firm-specific basis relative to the average performance of the industry containing that firm. In summary, the findings are consistent with both the predictive ability goal of external financial reporting and the evaluation of managerial performance objective of internal managerial reporting.