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Replacement cost profit |
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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
Replacement cost profit, also known as Current Cost of Supplies (CCS) profit, or replacement cost income, is an accounting practice for reporting profits in the oil industry.
To calculate profits, companies must (among other things) subtract the cost of goods sold from the total revenue. However, the cost of goods sold can vary depending on how much the company paid for acquiring the goods.
In the oil industry, the cost of goods sold varies significantly due to fluctuations in the price of oil. The company's income is tied to the cost of goods sold, and as a result can also fluctuate significantly. For example: If Exxon bought some reserves in August 2008, when oil traded for $140 and sold those reserves in October 2008 when oil fell to $65 -- the company would have to report a loss.
Replacement cost profit addresses this problem by allowing oil companies base their cost of goods sold on the current price of oil, rather than the price at the time individual reserves were acquired. In other words, oil companies report profitability based on how much it would cost the company to "replace" the reserves it sells.
In practice, this is very similar to Last in first out accounting -- where costs are based on the last inventory acquisition price. However, replacement cost income would vary from LIFO-based income if there are significant changes in price or inventory levels.
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