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April 01, 2009



Replacement cost moves with the market too. If the market loses confidence in some class of instruments (say sub-prime), then the market nose-dives and with it the replacement cost. Then everyone has to write down their assets and you're back to square one.

>>The Ford dealer still knows almost exactly how much he would have to pay to buy 300 trucks

Valueing an asset for which there is little to no demand at anything above market value a recipe for disaster. Just because Ford think the truck is worth $XX and lists it at that on it wholesaler sheet, doesn't mean anyone else agrees.

If I sell you empty coke cans at $1 million each, then that does not make the coke can worth $1mil and it would be foolish to let you list it at $1mil on your balance sheet.

No. If the perceived value of an asset crashes (aka Market Value) then the Balances sheets *must* crash too. Anything else is wishful thinking/fantasy.

Bob Hinkel

I think your comments are spot on, and I also feel that there are good accounting guidelines and rules that exist already for companies to follow...if (and this is the big "if") they are serious about transparency and managing for long-term value; not making the next quarterly targets. Having managed companies in highly cyclical industries; I believe that you have to set "ruthless" inventory aging rules and then follow them; if the product doesn't sell in the given time frame, then it must be written down to liquidation value. Likewise, each long-lived asset on the books needs to be subjected to regular impairment tests.

However, both of these require internal standards that most Boards just don't and won't demand (I could comment on the ability of many Board members to even understand these issues...but that's a story for another posting). By the way, the SEC just gave another "gift" to the oil and gas industry by actually loosening the reserves reporting and recognition standards on the last trading day of 2008. But this little ticking time bomb won't go into effect until the end of this year; and then you will see all the company valuations rise again; only to crash several years down the road when it becomes apparent that the valuations cannot be sustained.

Shawn Fahrer

As long as balance sheets are full of ESTIMATES (which 'fair value accounting' and 'replacement cost accounting' ENCOURAGE rather than discourage), you can NOT have the 'reliable, transparent, corporate accounting' you allegedly desire.

And as for historical cost being a 'fiction', it is at least a 'fiction' BASED ON FACT. Both replacement cost accounting (especially in a time when prices are rising or falling QUICKLY), and fair value accounting (ditto) are based on far less 'fact' than the actual bill of sale for a purchased asset dated at the time that asset was purchased (because the 'cost' to be recorded under the other methods is recorded at an ARBITRARY moment in time -- the date of the balance sheet-- as opposed to a defined moment in time (the time of purchase, which need not have been that date).

Another problem here: The IFRS folks don't even allow LIFO for inventory valuation-- only FIFO and average cost method. Since 'replacement cost' is more like a LIFO valuation, IFRS must make your head spin altogether.

In any case, I'm not buying what you're trying to sell. Your 'fiction' is the best fact we have on the cost of an asset; your 'fantasy' is the real fiction and your 'fact' is the real fantasy....

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