ISSUES OF COMPARABILITY
Although some would regard the prohibition of adjusting debt figures to the market as artificial, they might at least find it tolerable if it applied in every instance.
Consider what happens, however, in an acquisition. Statement of Financial Accounting Standards (SFAS) 141 (“Business Combinations”) makes it mandatory to revalue the acquired company’s debt to current market if its value differs significantly from face value as a consequence of a shift in interest rates since the debt was issued. Here again, as in the case of first-time recognition of goodwill, the historical cost principle makes comparable companies appear quite dissimilar. The equally large “hidden asset value” of another company with low-cost debt will not be reflected on its balance sheet, simply because it has never been acquired.The lack of comparability arising from the revaluation of the liability persists long after the acquisition is consummated. By contrast, the footnote detailing the adjustment eventually disappears from the acquired firm’s annual report. In later years, readers receive no hint that the company’s debts have been reduced—not in fact, but through one of accounting’s convenient fictions.
Critics of historical-cost accounting deplore the quirks that give rise to such distortions, arguing that corporations should be made to report the true economic value of their assets. Such criticisms assume, however, that there is a true value. If so, determining it is a job better left to metaphysicians than to accountants. In the business world, it proves remarkably difficult to establish values with which all the interested parties concur.
The difficulties a person may encounter in the quest for true value are numerous.
Consider, for example, a piece of specialized machinery, acquired for $50,000. On the day the equipment is put into service, even before any controversies surrounding depreciation rates arise, value is already a matter of opinion. The company that made the purchase would presumably not have paid $50,000 if it perceived the machine to be worth a lesser amount. A secured lender, however, is likely to take a more conservative view. For one thing, the lender will find it difficult in the future to monitor the value of the collateral through “comparables,” since only a few similar machines (perhaps none, if the piece is customized) are produced each year. Furthermore, if the lender is ultimately forced to foreclose, there may be no ready purchaser of the machinery for $50,000, since its specialized nature makes it useful to only a small number of manufacturers. All of the potential purchasers, moreover, may be located hundreds of miles away, so that the machinery’s value in a liquidation would be further reduced by the costs of transporting and reinstalling it.The problems encountered in evaluating one-of-a-kind industrial equipment might appear to be eliminated when dealing with actively traded commodities such as crude oil reserves. Even this type of asset, however, resists precise, easily agreed on valuation. Since oil companies frequently buy and sell reserves “in the ground,” current transaction prices are readily available. These transactions, however, are based on estimates of eventual production from unique geologic formations, for there is no means of directly measuring oil reserves. Even when petroleum engineers employ the most advanced technology, their estimates rely heavily on judgment and inference. It is not unheard of, moreover, for a well to begin to produce at the rate predicted by the best scientific methods, only to peter out a short time later, ultimately yielding just a fraction of its estimated reserves. With this degree of uncertainty, recording the true value of oil reserves is not a realistic objective for accountants. Users of financial statements can, at best, hope for informed guesses, and there is considerable room for honest people (not to mention rogues with vested interests) to disagree.