The difference between net income and profits adjusted for current cost of supply comes down to the way inventories are accounted for. The net income figure is calculated according to IFRS standards in Europe which demand ‘first-in first-out’ (FIFO) methodology for accounting inventory. Most US companies however produce based on ‘last-in first-out’ (LIFO) accounting.
Shell’s current cost of supply (CCS), however, are neither FIFO nor LIFO compliant. This means that Shell’s CCS figure are not recognized by US GAAP or IFRS. They are an industry measure only provided for in quarterly results for the benefit of investors.
Instead of the FIFO method, Shell uses a weighted cost pricing methodology for the reporting period. In other words, Oil Products and Chemicals cost of sales sold during the period is based on the cost of supplies during the same period after making allowance for the estimated tax effect. The latter means that Shell also accounts for tax adjustments based on the new inventory value and one-time provision. However, earnings calculated on an estimated current cost of supplies basis does not reflect drawdown¹ effect the same way LIFO methodology would. But, as Shell mentions in their 3rd Quarter Results, this basis provides a better understanding of underlying business performance. This is because it provides useful information concerning the effect of changes in the cost of supplies on Shell’s result of operations and is a measure to manage the performance of the Downstream segment but is not a measure of financial performance under IFRS.
CCS can be best compared to LIFO, especially in a quarterly period when inventories do not change much.
Because prices of oil and gas changes every day, CCS figures outperform their historical cost. That is why it is important to know that the Earnings Per Share (EPS) is calculated on the basis of the net-income figure arrived at via FIFO inventory accounting. In...
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