Question: BP plc a large British based international oil and gas

BP plc, a large British- based international oil and gas company, provides an interesting example of pro- forma earnings reporting. In its second quarter 2012 quarterly report, BP reported a net loss, based on IASB standards, of US$ 1,385 million. However, the company emphasized its “underlying replacement cost profits,” which, it claimed, give a better picture of its operations. A summary of BP’s determination of replacement cost profits is as follows:

Net loss based on IASB standards........... ($ 1,385)
Add back inventory holding losses, net of tax. This is the difference between cost of sales based on FIFO as per IASB, and cost of sales based on the aver-age cost of inventory acquired during the quarter (regarded as an estimate
of replacement cost of sales) ................ 1,623
Add back non- operating item losses, consisting mainly of writeoffs of an offshore oil project off the coast of Alaska and abandonment of a solar power project, impairment test writedown of shale gas assets due to low gas prices, provisions for losses on planned sales of two U. S. refineries, and further provisions for losses arising from Gulf of Mexico oil spill; net of tax ................ 3,447
Underlying Replacement Cost Profit .............. 3,685
Interest and tax costs ..................... 2,214
Underlying Replacement Cost Profit before Interest and Tax costs. $ 5,899

a. Under ideal conditions, what is the relationship between fair value of an asset (as defined by IFRS 13— see Section 7.2), and replacement cost? Explain why.
b. When conditions are not ideal, which measure, earnings as per IASB standards (based largely on fair value accounting) or replacement cost profit as defined by BP, best reports on and motivates manager performance? Discuss.
c. Which measure best informs investors about future firm performance? Discuss.
d. According to BP, underlying replacement cost profit is “closely tracked by management to evaluate operating performance and make financial, strategic, and operating decisions.” Is underlying replacement cost profit a better way to evaluate company performance and make decisions than IASB- based earnings? Discuss.

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