Best Methods For Recording Assets

While cost at the date of purchase is the norm for accounting for assets in conventional enterprises, there are certain types of businesses and certain situations when other methods of recording a monetary figure are used:

Market value:

This is usually used when an asset is sold and there is an established market for that particular type of investment. This could arise when a business or part of a company is to be closed down.

Fair value:

This is described as the estimated price at which an asset could be exchanged between knowledgeable but unrelated willing parties who have not, and may not, actually exchange. This basis is often used in the due diligence process, where, because of particular synergies, a price higher than market value (resulting in goodwill) could reasonably be set.

Market to market:

This is where market value is calculated daily, usually by financial institutions such as banks and stockbrokers. This can result in dramatic changes in value in turbulent market conditions, requiring additional assets, including cash, to be found to cover a fall in market price. This approach is blamed for helping to create liquidity ‘black holes’ by forcing banks to sell assets to meet liquidity targets, which in turn causes prices to lower, requiring yet more support to be sold.

Going concern

Accounting reports always assume that a business will continue trading indefinitely into the future unless there is good evidence to the contrary. This means that the business’s assets are looked at merely as profit generators and not as being available for sale. In year 2, the accounts’ net asset figure, prepared on a ‘going concern’ basis, is US $/L/€3,000. If we knew that the business was to close down in a few weeks, then we would be more interested in the car’s resale value than its value: the car might fetch only 2,000, which is quite a different figure.

Once a business stops trading, we cannot realistically look at the assets in the same way. They are no longer being used in the business to help generate sales and profits. The most objective figure is what they might realize in the marketplace.

Dual aspect

To keep a complete record of any business transaction, we need to know where the money came from and what has been done. It is not enough to say, for example, that a bank has lent a business Elm; we have to show how that money has been used, for example, to buy a property, increase stock levels, or in some other way. You can think of it as the accounting equivalent of Newton’s third law: ‘For every force, there is an equal and opposite reaction.’ The dual aspect is the basis of double-entry bookkeeping

The realization concept

An extraordinarily prudent sales manager once said that an order was not an order until the customer’s cheque had cleared, he or she had consumed the product, had not died as a result, and, finally, had shown every indication of wanting to buy again.

Most of us know quite different salespeople who can ‘anticipate’ the most unlikely volume of sales. In accounting, income is usually recognized as earned when the goods (or services) are dispatched and the invoice sent out. This has nothing to do with when an order is received, how firm the order is, or how likely a customer will pay up promptly. It is also possible that some of the products dispatched may be returned at some later date — perhaps for quality reasons. This means that income, and consequently profit, can be brought into the business in one period and removed later on.

If these returns can be estimated accurately, then an adjustment can be made to income at the time. So the ‘sales income’ figure that is seen at the top of a profit and loss account is the value of the goods dispatched and invoiced to customers in the period in question.

The actual concept

The profit and loss account sets out to ‘match’ income and expenditure to the appropriate time. It is only in this way that the profit for the period can be realistically calculated. For example, suppose that you are calculating one month’s profits when the quarterly telephone bill comes in.

This doesn’t seem right. In the first place, three months’ telephone charges have been ‘matched’ against one month’s sales. Equally wrong is charging anything other than January’s telephone bill against January’s income. Unfortunately, statements such as this are rare to hand when you want the accounts, so in practice, the telephone bill is ‘accrued’ for. The figure (which may even be correct if you have a meter) is put in as a provision to meet this liability when it becomes due.

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