This fourth of four columns on mythbusting is aimed at an old chestnut that has been repeated so often that virtually no one ever casts a wary eye in its direction. Here is a quote from a standard intermediate textbook (italics in the original): "Cost has an important advantage over other valuations: It is reliable."

We'd venture to say it's likely to be found in all comparable books over the last 60 years, and who knows how long before then. This fundamental doctrine is pounded into brains from the beginning week in introductory accounting classrooms (but not ours). However, that kind of repetition doesn't mean it's true.


Here's the myth: Even if costs aren't relevant, at least they're reliable.

We think those who cling to this myth (including several who have recently published or shared their thoughts with us in private correspondence) are missing a big point. The only justification for financial reporting is providing useful information that is both relevant and reliable for users. Both qualities are essential: It does no good to have only one without the other.

But there is more to the issue of cost's reliability than that fundamental but simple point. Suppose you are presented with the number 39, for example. Is it a reliable measure? We don't think you can say so without answering a series of seven questions.

1. Which units? What unit of measure is being applied? Thirty-nine somethings cannot be added, subtracted or compared to any other number unless that quantity is also expressed in the same somethings. Just as apples cannot be meaningfully added to screwdrivers, dollars obviously cannot be added to euros, and it's just as wrong for accountants to keep thinking it's fine to mix together dollars from a few decades ago with recent dollars. Cost advocates always overlook this point in defending reliability.

The fact is that mixed measures always produce unreliable results. For example, consider how cost-based depreciation expense measured in 1990 dollars is deducted from this year's revenues in 2008 dollars. The result is nonsense that cannot be relied upon.

2. What attribute? Suppose that number 39 applies to one of your columnists. You can't call it reliable unless you know which attribute it's supposed to be describing. If you look at our photos, you might think it's our age (OK, perhaps not), but it could be our belt size, our latest score for nine holes, the amount of money in our wallet, or whatever. The information can be useful only if the measured attribute serves the purpose of describing a relevant characteristic of the measured item.

Similarly, no one can rationally conclude that, say, an asset's original purchase price is reliable without first knowing what relevant attribute ought to be described. The Conceptual Framework helps here by saying that users make assessments of the amount, timing and uncertainty of future cash flows for the entity. As a result, the relevant attribute of assets and liabilities is their ability to affect those cash flows. (We call it AAATUC.)

3. How close? Is cost automatically a reliable measure of current AAATUC? Not even close. Cash-flow potential changes as economic conditions shift, but original costs don't change. Just because one of us was 39 some years ago doesn't mean he still is today. And just because an asset cost $100 million in 1995 doesn't mean that number still describes its cash-flow potential as of today.

One cannot judge any number's reliability, including a historical cost, without some idea of the real amount of the relevant attribute. In all likelihood, market values of assets and liabilities reflect current cash-flow potential, while old costs don't. If not, then they aren't reliable.

4. Why? Why should monetary amounts be reported for a company's assets and liabilities in the first place? If, as the Financial Accounting Standards Board proclaimed, the purpose of financial reporting is assisting investors, creditors and other external users, then it is their interests that must be served.

We recently received an impassioned letter from a defender of historical costs. We picked up at once that he wanted to protect auditors' interests and that he never acknowledged that financial statement users have different and valid interests, much less more important interests than auditors.

The point is that you can't judge whether a number is reliable without knowing why it is being reported. If financial statements don't move capital markets closer to the social goal of efficiency, they aren't reliable.

5. How? Any measure's reliability is impacted by the process used to create it. Advocates of cost seem to think that all costs come from cash purchases of individual assets. What if a purchase occurs in stages? What if the consideration isn't all cash? What if multiple assets are acquired at once? What if the assets are acquired in a business combination, such that they are recorded at their estimated market value?

Besides these factors, a couple columns back, we busted the myth that even an actual cash purchase price cannot be wisely assumed to equal the asset's market value on that date.

In addition to these complexities in measuring original cost, GAAP practice messes with original costs through depreciation and amortization, and through impairment. In fact, then, very few historical costs are actually presented in the statements. Instead, a book value that's an allocated remnant of some other amount is deemed to be a cost. But it isn't. And it certainly isn't reliable.

6. By whom? As we discussed in that previous column, you can't make a judgment about a population on the basis of a nonrandom sample consisting of a single transaction. Instead, valid samples need to be sizable and random.

Certainly, reliability is lost if the person doing the measuring has an ax to grind. Yet what happens under GAAP? Management records its own costs without regard to others' transactions and then proceeds to allocate and write them off according to its own desires. This freedom to indulge a bias surely deprives historical costs and cost-based measures of any -- and perhaps all -- reliability.

In contrast, market values are based on multiple observations of others' transactions and are not allocated. As for us, we see far more reliability in market-based measures than in costs. For those who shout, "Look at what happened at Enron!" we also see no reliability in fabricated numbers, whether they are characterized as costs or market values.

7. When? Timeliness is an important component of usefulness. If information isn't timely, it isn't much good except as historical trivia. If statement users are predicting future cash flows, they find no reliability in numbers that don't reflect current abilities to affect those flows. No matter how many people verify that an asset was acquired 12 years ago for $4 million, that measure does nothing for someone trying to predict what cash flows can be generated today, either by sale or use. Timeliness isn't just getting reports out before deadlines; it's publishing information that is up to date. By this test, historical costs are not reliable at all.


The myth that costs are reliable even if not relevant is: Busted! As we see it, costs are not reliable, even if some of them are verifiable. They don't serve users' needs, they don't describe current conditions, and their amounts are usually diced up using arbitrary and biased allocation systems.

We are convinced beyond doubt that it's time to move on from costs to continuously marking all assets and liabilities to market value. This is the only way that financial reporting can help users assess the AAATUC of the entity's assets and liabilities. We have no, repeat, no inclination to compromise on that principle simply because auditors feel safer auditing past numbers or simply because management wants to filter all volatility out of reported earnings.

Accounting is too important to be based on unreliable numbers that don't convey relevant facts. The longer the two of us go on after discovering that cost's alleged reliability is mythical, the more flabbergasted we are that so many still deny this truth while advocating what is patently false.

Maybe, just maybe, our busting of these five myths will jar some to think differently from the programming they received in Accounting 101. That would be good because users deserve better.

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

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