VI. THE PRODUCTION ACCOUNT
D. The measurement of market output
| 6.53. | Five uses of market output were distinguished in paragraph 6.45 above. The ways in which these uses should be recorded are described in the following sections. |
1. Recording of sales
| 6.54. | The times at which sales are to be recorded are when the receivables and payables are created: that is, when the ownership of the goods passes from the producer to the purchaser or when the services are provided to the purchaser. The goods or services are valued at the basic prices at which they are sold. If valuation at basic prices is not feasible, they may be valued at producers' prices instead. The values of sales are determined by the amounts receivable and payable by the producers and purchasers, which do not always coincide with the amounts actually received and paid. When payments are made in advance or in arrears, the values of sales should not include any interest or other charges incurred by the producer or purchaser. Such charges are recorded as separate transactions. |
2. Recording of barter
| 6.55. | Barter occurs when goods and services are exchanged for other goods, services or assets. The value of goods or services bartered should be recorded when the ownership of the goods is transferred or the services are provided: they should be valued at the basic prices that would have been received if they had been sold. |
3. Recording of compensation in kind or other payments in kind
| 6.56. | Goods or services provided to employees as compensation in kind, or used for other payments in kind, should be recorded when the ownership of the goods is transferred or the services are provided. They should be valued at the basic prices that would have been received if they had been sold. |
4. Changes in inventories of outputs
Introduction
| 6.57. | The treatment of inventories of finished goods is considered first, followed by the treatment of work-in-progress. The principles governing the recording of changes in inventories and work-in-progress are the same for both market and non-market output. |
| 6.58. | The basic principle underlying the measurement of changes in inventories is that output should be recorded at the time it is produced and valued at the same price whether it is immediately sold or otherwise used or entered into inventories for sale or use later. No output is recorded when goods produced previously are withdrawn from inventories and sold or otherwise used. It follows that entries into inventories must be valued at the basic prices prevailing at the time of entry, while withdrawals must be valued at the prices at which they are then sold. In this way, the value of the sales or other uses of goods produced previously is cancelled out by the (negative) value for withdrawals from inventories. This method of valuing changing inventories, which may be described as the "perpetual inventory method" or PIM, is not always easy to implement in practice, however, and it sometimes leads to results which may be counter intuitive. |
| 6.59. | When prices are stable, the measurement of changes in inventories is relatively simple. However, when there is inflation, significant price increases may occur while goods are held in inventory. Holding gains accruing on goods held in inventory after they have been produced must not be included in the value of output. The perpetual inventory method ensures their exclusion by valuing goods withdrawn from inventory at the prices prevailing at the time they are withdrawn and not at the prices at which they are entered, or their "historic costs". This method of valuation can lead to much lower figures for both output and profits in times of inflation than those obtained by business accounting methods based on historic costs. |
Output, sales and changes in inventories
| 6.60. | It follows from the general principles outlined in the previous section that:
(a) Goods entering inventory are valued at the basic prices prevailing at that time: that is, at the prices at which they could have been sold when first produced;
(b) Goods withdrawn from inventory are valued at the basic prices prevailing at that time: that is, at the prices at which they can then be sold. |
| 6.61. | The total value of the changes in inventories of finished goods recorded within a specified accounting period is then given by:
the sum of the values of all goods entering inventory
less the sum of the values of all goods withdrawn from inventory
less the value of any recurrent losses of goods held in inventory. |
| 6.62. | Goods held in inventory are subject to deterioration through the passage of time and are at risk from theft or accidental damage. Recurrent losses due to normal rates of wastage, theft and accidental damage reduce the value of the total change in inventories, and hence output. |
| 6.63. | It follows from the valuation method used that, when prices are changing, goods entering and leaving inventory at different times are valued at different prices, even within the same accounting period (as also are goods sold at different times). This requires all entries to, and withdrawals from, inventories to be recorded continuously as they occur, and helps explain the complexity of the perpetual inventory method. Assuming that sales and other uses are also appropriately recorded at the prices at which they actually occur and there are no changes in work-in-progress, the following identity must hold for goods or services produced for sale or other use:
the value of output = the value of sales + other uses + the value of changes in inventories
This identity holds whether the goods are all sold or otherwise used within the same accounting period in which they are produced, or whether some goods are sold or used in different periods. |
Storage services
| 6.64. | For simplicity, the above presentation of the recording of changes in inventories has ignored the fact that inventories of goods have to be physically stored somewhere. Many goods have to be stored in a properly controlled environment and the activity of storage can become an important process of production in its own right whereby goods are "transported" from one point of time to another. In economics, it is generally recognized that the same goods available at different times, or locations, may be qualitatively different from each other and command different prices for this reason. |
| 6.65. | When goods are first produced, they may be held in store for a time in the expectation that they may be sold, exchanged or used more advantageously in the future. In these circumstances, storage can be regarded as an extension of the production process over time. The storage services become incorporated in the goods, thereby increasing their value while being held in store. Thus, in principle, the values of additions to inventories should include not only the values of the goods at the time they are stored but also the value of the additional output produced while the goods are held in store. The measurement of storage is considered in more detail in a later section. |
Approximate measures of changes in inventories
| 6.66. | As the PIM requires entries to, and withdrawals from, inventories to be recorded and valued continuously, it may be very difficult to obtain the requisite data, although it may become easier in the course of time as the increased use of microcomputers leads to improved methods of inventory management and control. In many countries, however, data on changes in inventories are among the least reliable information available and it is necessary to consider whether satisfactory approximations can be used which require less data. |
| 6.67. | One special case of some interest occurs when output prices remain constant over time. In this case, all entries to and withdrawals from inventories are valued at the same prices, so that the cumulative value of entries less withdrawals simplifies to the difference between the values of the inventories recorded in the opening and closing balance sheets. In this case, information on actual inventory movements between the beginning and end of the accounting period becomes superfluous. |
| 6.68. | This suggests that even when prices are changing a good approximation to the PIM may be obtained by taking the difference between the quantities of goods held in inventory at the beginning and the end of the accounting period and valuing this difference at the average prices prevailing within the period. This method, which may be described as the "quantity" measure, is widely used in practice and is sometimes mistakenly considered to be the theoretically appropriate measure under all circumstances. The quantity measure will be the same, or virtually the same, as the perpetual inventory method measure not only when prices are constant but also when the quantities of goods held in inventory rise or fall at a steady pace throughout the period. Conversely, the conditions under which the quantity measure may provide only a poor approximation to the PIM are when prices are rising or falling and when inventory levels fluctuate within the accounting period. Unfortunately, there are several important industries, including agriculture, in which inventories normally fluctuate because of seasonal variations either in the sequence of outputs produced or in the pattern of demand. Approximate measures of PIM inventory changes may be subject to considerable margins of error in such cases. |
Changes in inventories in business accounts
| 6.69. | The value of output in business accounts is also usually derived by adding the value of changes in inventories of outputs to the value of the sales. However, the normal practice in business accounting is to value goods held in (and withdrawn from) inventory at the price at which they were recorded as entering (i.e., "at historic cost") if this price is lower than the current price. The intention is to value inventories prudently for balance sheet purposes, but it may lead to measures of profit which are by no means prudent in inflationary conditions. Under historic cost accounting, a good withdrawn from inventory is liable to be valued at a lower price than that at which it is sold so that the value of output includes the value of the holding gain which accrues between the time of production and time of sale. As a result, the holding gain is not separated from the operating surplus on production under historic cost accounting. Composite measures of profit that combine holding gains with the operating surplus may be useful for certain purposes provided that the composite profit measure is not presented, or interpreted, as if it referred to the operating surplus only, i.e., the profit arising out of production. Unfortunately, the distinction between these two different components of historic cost profits is frequently neither made nor appreciated, and may even be deliberately blurred in order to make the production activities of an enterprise appear more profitable than they are. In periods of high inflation, profit as recorded in business accounts is likely to exceed the operating surplus recorded in economic accounts by a considerable margin. |
| 6.70. | Although it is not proposed to go into great detail about business accounting practices in the present context, it is useful to add some further points for clarification. When goods withdrawn from inventory are valued at historic costs in business accounts, it is necessary to know, or assume, the order in which the goods are withdrawn. The most common assumption is FIFO, or first-in-first-out, which implies goods are withdrawn in the same order as they entered. For example, if goods are held in inventory for three months on average, the combination of FIFO with historic cost accounting during inflation implies that the price of each unit sold will include a three months holding gain. As business accountants recognize that this may be undesirable for many purposes, an alternative assumption which has found increasing favour is LIFO, or last-in-first-out, which implies that a good withdrawn from inventory is the last one which entered. This implies that withdrawals are valued at current prices as in the SNA, provided that the level of inventory is not depleted. The proviso is important because, under LIFO, the goods which remain in inventory are those which are assumed to have been there for the longest periods of time. If inventories are eventually run down, those assumed to have been there for a very long time start to be withdrawn and may be valued at very low prices indeed when historic costs are used. Thus, even under LIFO substantial holding gains may be recorded if inventories are greatly diminished. Another method used in business accounting is to value goods withdrawn from inventory at the weighted average of the prices at which they entered. This method values withdrawals at prices between those used for FIFO and LIFO. Finally, in situations of very high inflation, the use of NIFO has been proposed, namely, next-in-first-out. This implies valuing goods withdrawn from inventory at the prices expected to prevail at some point in the near future. |
| 6.71. | Other, and more sophisticated, ways of valuing changes in inventories are, of course, also used in business accounts, especially in accounts drawn up for purposes of internal management as distinct from financial reporting. The methods used for management accounting are often very similar to, and possibly identical with, the PIM used in the SNA. Because so many different methods are liable to be used in business accounts, it is impossible to suggest algorithms, or rules of thumb, which would be generally applicable for purposes of transforming data on inventory changes in business accounts to the data required by the System. Each case has to be treated individually, depending upon the precise way in which the business accounts have been drawn up. |
Work-in-progress
| 6.72. | When the process of production takes a long time to complete, output must be recognized as being produced continuously as work-in-progress. As the process of production continues, intermediate inputs are continually being consumed so that it is necessary to record some corresponding output to avoid obtaining meaningless figures for value added by recording the inputs and outputs as if they took place at different times, or even in different accounting periods. Work-in-progress is essentially incomplete output that is not yet marketable: that is, output that is not sufficiently processed to be in a state in which it can easily be supplied or sold to other institutional units. It is essential to record such output whenever the process of production is not completed within a single accounting period so that work-in-progress is carried forward from one period to the next. In this case, the current value of the work-in-progress completed up to the end of the first period is recorded in the closing balance sheet that also serves as the opening balance sheet for the next period. |
| 6.73. | Work-in-progress may need to be recorded in any industry, including service industries such as the production of movies, depending upon the length of time it takes to produce a unit of output. It is particularly important in industries with long gestation periods, such as certain types of agricultural production or durable producers' goods production, where the period of production may extend over several years. |
| 6.74. | Work-in-progress is treated in the System as one component of inventories of outputs held by producers. However, the borderline between inventories of partially completed structures and gross fixed capital formation may not always be clear. Gross fixed capital formation is undertaken by users of fixed assets so that gross fixed capital formation cannot be recorded until the ownership of the assets is transferred from their producers to their users. This transfer does not usually occur until the process of production is completed. However, in the case of buildings or structures for which a contract of sale has been concluded in advance, the transfer of ownership may be deemed to occur in stages as value is put in place. Such transfer of ownership may actually take place legally. In such cases, stage payments made by the purchaser can often be used to approximate the value of the gross fixed capital formation although stage payments may sometimes be made in advance or in arrears of the completion of the stage, in which case short-term credits are also extended from the purchaser to the producer, or vice versa. In the absence of a contract of sale, the output produced must be treated as additions to the producer's inventories, i.e., as work-in-progress, however large the partially completed structure may be. |
| 6.75. | Additions to, and withdrawals from, work-in-progress are treated in the accounts in the same way as entries to, and withdrawals from, inventories of finished goods. They must be recorded at the times they take place and at the basic prices prevailing at those times. However, further explanation is needed of the time of recording and valuation in view of the special characteristics of work-in-progress. |
Time of recording of work-in-progress
| 6.76. | Additions to work-in-progress take place continuously as work proceeds. Within any given accounting period, such as a year or a quarter, it is therefore necessary to record the cumulative amount of work-in-progress produced within that period. Until a sale is ultimately recorded, the addition to work-in-progress is the only component of output recorded each period. When the production process is terminated, the whole of the work-in-progress accumulated up to that point is effectively transformed into an inventory of finished product ready for delivery or sale. When a sale takes place, the value of the sale must be cancelled out by a withdrawal from inventory of equal value so that only the additions to work-in-progress recorded while production was taking place remain as measures of output. In this way, the output is distributed over the entire period of production. |
Valuation of work-in-progress
| 6.77. | Assuming the basic price of the finished product remains unchanged over the periods during which it is being produced, the value of the addition to work-in-progress in a given period is obtained by multiplying the basic price by the share of the total production costs incurred during that period. In other words, the value of the final output is distributed over the various periods during which production takes place in proportion to the costs incurred. |
| 6.78. | It may be necessary to estimate the value of additions to work-in-progress in successive periods in advance of knowing what basic price will eventually be realized. In this situation, provisional estimates of the value of additions to work-in-progress should be made on the basis of the total production costs incurred each period plus a mark-up for expected operating surplus or estimated mixed income. Such estimates can be revised subsequently when the actual sale price, and hence actual operating surplus or mixed income, become known. |
| 6.79. | The situation is more complicated when the expected sales price is itself continually increasing during the process of production as a result of general inflation. In this case, each addition to work-in-progress should be valued using the expected sale price at that point in time. This implies that during inflation additions to work-in-progress in successive accounting periods may have to be calculated on the basis of progressively higher expected sales prices. Despite the practical difficulties, this procedure has to be followed in order to match the values of inputs and output each period to obtain economically meaningful measures of value added. It is merely an application of the general rule that additions to inventories must always be valued at the basic prices (actual or estimated) prevailing at the times they occur. |
5. Deliveries between establishments belonging to the same enterprise
| 6.80. | As explained in chapter V, an establishment is an enterprise, or part of an enterprise, that is situated in a single location and in which only a single (non-ancillary) productive activity is carried out or in which the principal productive activity accounts for most of the value added. It may coincide with an enterprise, or be part of an enterprise, in which case it may be producing goods or services for the use of other establishments belonging to the same enterprise. |
| 6.81. | Goods or services produced and consumed within the same accounting period and within the same establishment are not separately identified and, therefore, not recorded as part of the output or intermediate consumption of that establishment. On the other hand, goods which are produced by an establishment and remain in inventory at the end of the period in which they are produced must be included in output, whatever their subsequent use. If they are intended to be used within the establishment subsequently, they should be recorded as work-in-progress: this implies that they are not recorded as intermediate consumption in the period in which they are withdrawn from inventories. |
| 6.82. | Goods and services that one establishment provides to a different establishment belonging to the same enterprise are counted as part of the output of the producing establishment. Such goods and services may be used for intermediate consumption by the receiving establishment, but they could also be used for gross fixed capital formation. The goods and services should be valued by the producing establishment at current basic prices; the receiving establishment should value them at the same prices plus any additional transportation costs paid to third parties. The use of artificial transfer prices employed for internal accounting purposes within the enterprise should be avoided, if possible. |
| 6.83. | The accounts and tables of the System include production accounts for groups of enterprises and groups of establishments, i.e., for both sectors and industries. In order to ensure that the total output and total intermediate inputs of an enterprise are the same as the corresponding totals for the establishments which make up that enterprise, the enterprise totals must include any inter-establishment deliveries of goods and services. |
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