Over the years, we have written many columns describing the limitations of the traditional accounting model that has at its core a fixation on recording assets at their acquisition cost and then systematically depreciating or amortizing them using unverifiable suppositions and speculations about asset life, salvage value and trends in value change over the years.
Adding insult to injury is the portfolio of alternative depreciation methods that can be used to produce highly different patterns of calculated book value changes and recorded income statement impacts over an asset's assumed life. We know the results of these preconceived mathematical operations are unreliable, nay, totally meaningless, because they are not observations of real changes in an asset's value. We have long supported fair-value reporting that transparently reports real factual values and changes in them. These facts are not only logically more useful because they're reliable, but they're also more profitable for managers and auditors because they are demanded by statement users.
Every now and again we read something that provides new insights on these issues, usually as the result of looking at things from a different perspective. That was the case recently when we heard from a reader, Jeff Koch, a CPA from Concordia, Kan. Jeff shared with us his perspective on fair value accounting and encouraged us to keep making our points. From his experience working with clients, Jeff is painfully aware of the traditional system's obvious, even glaring, limitations, and the huge benefits that come from reporting fair values.
Having found Jeff's discussion both clear and persuasive, we decided to let it speak for itself. Here is what Jeff had to say:
"I operate a CPA firm in an area with a focus in production agriculture. Many of our clients are required to prepare or have prepared fair market value balance sheets for their lenders in connection with a renewal of their farm operating note agreements and in connection with obtaining term notes for financing equipment and land on an annual basis. The lenders for these agricultural businesses have long ago learned that a well-cared-for 1967 John Deere 4020 tractor is fully depreciated for tax and book purposes, but still likely has a fair market value equal to or greater than its original cost. Also, these lenders understand that a piece of land purchased by a farmer in 1984 at $500 per acre is today worth four times that much in our area and has additional value to lend against and an economic carrying cost for the farmer far beyond its GAAP basis. Therefore, the financial statements that we prepare based on GAAP or the tax basis of accounting are meaningless, while fair value accounting has significant meaning.
"Naturally, some of these clients wish to have us assist with preparing these financial statements. Basically, in order to issue a report, we have to issue meaningless financial statements based on GAAP or Other Comprehensive Basis of Accounting (such as tax basis), then provide the financial statements on the estimated current value of the assets, liabilities and equity as supplemental information. As an alternative, we have issued financial statements based on estimated current value as a prescribed form. In both cases, we have to include disclaimers in the accountants' reports that cause lenders to question the information. In addition, the information in the GAAP financial statements often leads to questions and unnecessary analysis by lenders or other outside investors.
"My peer review firm and I have often argued this issue. Our peer reviewer has said to me, 'I wish my banker would lend to me on market value.' My response was ... 'If you had a smart banker, he would!'
"Therefore, I urge you to use your platform to keep up the fight and I wholeheartedly agree with your position! [The acceptability of value-based statements] is a very important issue to those of us working with agricultural clients."
Compelling words, indeed. We want to make three points about them.
First, we are often accused of being wild-eyed academics unaware of how things work in the "real world." The usual rant goes that fair values are great in theory but impractical and unreliable on Main Street. Any who have voiced those sentiments need to find another ax to grind. Jeff is a bona fide accountant, working on the front lines of practice, not up in an ivory tower. Yet he still comes down on this issue the same way we do. So much for fair values being academic pie in the sky.
What we see as Jeff's difference from other CPAs is that he is concerned about his clients' needs for providing useful information to lenders. This is quite different from those who are obviously eager to manage their own costs and risks in preparing or auditing the financial statements, instead of maximizing the benefit to the preparers and users alike. Their attitude seems to be that the users ought to gratefully lick up the crumbs and just be happy they're getting anything out of management. What a travesty!
Second, some will surely find merit in Jeff's words but try to constrain their impact by concluding that his clients operate in a specialized industry such that his conclusions don't hold water elsewhere. Sure, land and farm equipment are instrumental to the production process in agriculture. While these sorts of assets may not be as material in other endeavors, we think one would be hard-pressed to find any situations where fixed assets are wholly irrelevant. Thus, his observations carry over, hands down and without compromise. Whether these assets are crucial or only moderately important, GAAP financial statements provided by any business that don't truthfully track the changes in their actual values are fictional at best and perhaps even fraudulent, because the managers and auditors know the information has no connection with reality.
Third, some oppose using fair values largely because doing so is a profound change in the way things have been done. After all, they ask, if the traditional model is so flawed, why has it been used for so many years? With hindsight, many things that seem perfectly reasonable at the time take on a completely different posture when viewed from the present. For example, Paul Bahnson toured a palace in Potsdam on a recent trip to Germany. The tour guide commented on 18th century thinking when he described how back then even the elite considered frequent bathing to be unhealthy. Of course, we now know that opinion is nothing short of harebrained, even though it enjoyed vast popularity. Likewise, we believe that at some point in the near future people will look back at the state of today's GAAP with all that reliance on past events and allocated costs and will first chuckle and then invoke the words of Ralph Waldo Emerson: "A foolish consistency is the hobgoblin of little minds."
As we described in our previous column, much is going on that clearly shows fair value accounting is coming. It's about time, as far as we're concerned, and thanks to Jeff Koch for providing more evidence about why it's so necessary.
He also makes it quite clear that stubborn resistance from the accounting establishment is irrational. It simply makes no sense to force clients to pay for GAAP financial statements that they literally hope no one will ever try to use. It looks to us like those who created and maintain this bizarre and pointless waste of time and talent are the ones who live in the ivory tower, not us, and certainly not Jeff and the many others out there in America's heartland.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul
(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.
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