Distortions Produced by Asset Valuation of Buildings in Accounting Balance Sheets
Note: I sent this as an email to Accounting Coach on Nov 28, did not load it to the blog till Dev 4, but loaded it as at the Dec 2 date because it covers what "Accounting Coach"'s online book covers first. Usually I try to avoid doing this because it obscures things like psychic insights into events that later occur.
Thanks to "Accounting Coach" for the relatively well-explained story about Joe and Marilyn and the basics of accounting, his first chapter in his online book on accounting.
RE Accounting Basics Part 2 at http://www.accountingcoach.com/online-accounting-course/60Xpg02.html I have a couple of "clever comments".
His (Accounting Coach's) idea of a balance sheet buildings asset, is, that if the building was bought for $100k 10 years ago, and can be expected to have a salvage value of $0 in 100 years, it should now be valued at $90k, even if it is now worth $500k!
Clever comment: This approach is bound to stumble over factors such as inflation. For example, if a building was bought 20 years ago for $100k, and it is now due to depreciation given a book value of $80k, and its real (real vs current dollars) market value has also declined by 20 percent, if due to 400% inflation (general consumer price index type inflation balanced by income increases) over the 20 years its current market value is now $320K, then reporting in the balance sheet its book value as only $80K, will imply that it has depreciated by 80 percent, whereas its actual depreciation has been only 20 percent!
Clever comment: It all makes you wonder as to why such weird rules of asset valuation for balance sheet purposes are adopted. Such "weird" methods of asset valuation are incomprehensibly weird, and their usefulness for management purposes is limited, until you understand why they are used. Seems such is an attempt to separate the costs and revenues of a business, from the increases in value that luck independent of the performance of the business in question may bestow upon the assets of a business--lucky increases in the value of the assets of a business could obscure low level of performance in the business itself. Nevertheless, seems there must be better ways to distinguish between the performance of a business, and increases in the asset values of a business that are unrelated to the performance of the business.
Useful Relevant Link:
http://www.google.com/search?sourceid=navclient&ie=UTF-8&rls=GGLD,GGLD:2004-43,GGLD:en&q=assets+cost+%22fair+market+value%22+%22depreciation+expense%22+%22market+value%22+%22balance+sheet%22
@2006 David Virgil Hobbs
Thanks to "Accounting Coach" for the relatively well-explained story about Joe and Marilyn and the basics of accounting, his first chapter in his online book on accounting.
RE Accounting Basics Part 2 at http://www.accountingcoach.com/online-accounting-course/60Xpg02.html I have a couple of "clever comments".
His (Accounting Coach's) idea of a balance sheet buildings asset, is, that if the building was bought for $100k 10 years ago, and can be expected to have a salvage value of $0 in 100 years, it should now be valued at $90k, even if it is now worth $500k!
Clever comment: This approach is bound to stumble over factors such as inflation. For example, if a building was bought 20 years ago for $100k, and it is now due to depreciation given a book value of $80k, and its real (real vs current dollars) market value has also declined by 20 percent, if due to 400% inflation (general consumer price index type inflation balanced by income increases) over the 20 years its current market value is now $320K, then reporting in the balance sheet its book value as only $80K, will imply that it has depreciated by 80 percent, whereas its actual depreciation has been only 20 percent!
Clever comment: It all makes you wonder as to why such weird rules of asset valuation for balance sheet purposes are adopted. Such "weird" methods of asset valuation are incomprehensibly weird, and their usefulness for management purposes is limited, until you understand why they are used. Seems such is an attempt to separate the costs and revenues of a business, from the increases in value that luck independent of the performance of the business in question may bestow upon the assets of a business--lucky increases in the value of the assets of a business could obscure low level of performance in the business itself. Nevertheless, seems there must be better ways to distinguish between the performance of a business, and increases in the asset values of a business that are unrelated to the performance of the business.
Useful Relevant Link:
http://www.google.com/search?sourceid=navclient&ie=UTF-8&rls=GGLD,GGLD:2004-43,GGLD:en&q=assets+cost+%22fair+market+value%22+%22depreciation+expense%22+%22market+value%22+%22balance+sheet%22
@2006 David Virgil Hobbs
posted by David Virgil at 10:49 AM
4 Comments:
This is a very well written post, my compliments. I’m glad to find your post. Keep sharing this type of stuff.
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