[OPE] replacement cost and historical cost (again)

It is true that GAAP does not allow the adjustment of fixed assets, such as
real estate, to current market values because management would most likely
overstate the value of their fixed assets to improve the appearance of their
firms' economic condition. The "historical cost" principle traditionally
applied by GAAP is justified with the argument that distortions of economic
condition that involve understatement of asset values are preferable to
distortions caused by overstatements. But, in reality, although GAAP insists
on historic cost valuation, it permits a variety of different depreciation
methods which have quite different results, depending on the nature of the
asset. Thus, within broad limits, management can construct the depreciation
figure most beneficial to the business and to its revenue stream.

In the statutes of Washington State (US) we can read for example how the
value of a ship is depreciated:

"The department of revenue shall prepare at least once each year a
depreciation schedule for use in the determination of fair market value for
the purposes of this chapter. The schedule shall be based upon information
available to the department of revenue pertaining to the current fair market
value of vessels. The fair market value of a vessel for the purposes of this
chapter shall be based on the most recent purchase price depreciated
according to the year of the most recent purchase of the vessel. The most
recent purchase price is the consideration, whether money, credit, rights,
or other property expressed in terms of money, paid or given or contracted
to be paid or given by the purchaser to the seller for the vessel."
http://apps.leg.wa.gov/RCW/default.aspx?cite=82.49.040

In the statutes of the State of Victoria (Australia), we can read that:

"FRD 103D requires that subsequent to initial recognition (subject to
limited exemptions), all non-current physical assets are measured using the
revaluation model. For the 'plant, equipment and vehicles class',
depreciated cost (including impairment write-downs) could represent a
reasonable approximation of fair value, unless there is evidence that a
reliable market-based fair value exists for these assets and that the
evidence indicates a fair value materially different from the carrying value
(depreciated cost)."
www.treasury.vic.gov.au/.../GuidanceonfairvalueunderFRD103D/.../Guidance%20on%20fair%20value%20under%20FRD%20103D.doc

This is just to illustrate that depreciation charges can be altered by
changing depreciation schedules, valuations and methods yearly, or by
changing tax deductibility rules, on the side of government; and by
manipulating depreciation methods, costing techniques and the estimation of
residual values, useful lives and impairment on the side of business. By
re-selling a fixed asset at a certain value to another entity effectively
controlled by the same corporation, a business can also gain a revenue
advantage. Thus, within certain limits of credibility, depreciation is a
"negotiation" between a business, auditors and the taxman.

In an economic crisis, you get a problem with lower sales and investment,
causing lower revenue, but by improving your depreciation write-off you can
also improve your revenue. In fact, Mr Bush's administration offered US
business more favourable depreciation rates (under certain conditions).

Jurriaan

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Received on Sat Sep 5 06:53:23 2009