So the question gets asked about fair market values of assets, and why we don’t record all our fixed assets on the balance sheet at their market values (we use their original cost if you’re really interested in knowing). It’s a good question, and it strikes right to the heart of the relevance versus reliability dichotomy.
On the one hand, we want information to be relevant. Relevant information is decision useful information.
On the other hand, we want information to be reliable. Wild guesses aren’t so good, even if the thing you’re guessing about is the financial equivalent to “life, the universe and everything.”
We accountants, being a conservative sort (really, we are!), tend to prefer reliability over relevance. Not to the point that we would put (say) CEO shoe size into financial statements (highly reliable, not-so-relevant), but we’re certainly not going to stick our necks out.
So let’s take, for example, the fair market value of a fixed asset. Namely, my house in Indiana. We purchased the house for $115,500 back in 1998, and when we were ready to sell the house in July of 2004, we put it on the market for $142,900. I personally thought that we were reaching a little high, but our real estate agent assured us we were “competitively priced for the neighborhood.” This is code for “I want a higher commission so let’s roll the dice.” I know that now, I didn’t know that then.
Now, time passes, and as we head into the fall, we start to lower our price, bit by bit. Then December comes, and we learn that the refrigerator’s water pipe burst, and flooded our first floor. D’oh. The carpet guys have to come and replace all the padding and dry out the floors.
A little more time passes, and we get our gas bill. It appears that some lovely person decided to leave our door open after showing the house. You know all that stuff you’ve heard about global warming? Yah, that was us. Middle of winter, heat turned up, door wide open. D’oh.
A little more time passes, and suddenly TORNADO!!!! What the…? We had this gorgeous pear tree in our front yard. Everyone else had these maple trees that looked horrible because the development was relatively new and the trees were still small. Our little pear tree, however, was tall and full and grew these beautiful flowers every spring. And the damn tornado just knocked it right over. So we have to pay someone to come out and haul away our pear tree and grind down the stump. Because of course if we left the stump there, and someone tripped on it, we’d be in for some shit, and that’s not worth it for a piece of crap house.
A little more time passes, and oh no! another fucking pipe goes. How do we find out about this? Well first we get a little letter from the water company telling us that we may want to prepare ourselves for the water bill that will be arriving shortly. “Huh,” I remember thinking to myself. That’s something of an odd letter. Then we get the water bill. $500. “What the…?” Well, what the… was that we managed to use over the past month, in a vacant house, two hundred SIX THOUSAND GALLONS OF WATER. I called up the water company and asked about it, saying “surely that is a misread meter.” And the friendly telephone woman said “oh yah, we thought so too and so we sent someone out to check. That’s the actual usage. It appears you’ve got a leak somewhere.” You don’t say. So I asked her if they at least turned the water off for us. “………….um….no?” Sigh. “How ’bout you send someone on over there for us to shut that puppy down.” And of course, the sewer is tied in to the water, so we got a nice sewer bill as well. 7 bucks, 7 bucks, 6 bucks, 400 bucks!!! As it happens the water company agreed to cut us a deal if we proved that it was a leak and we had fixed it, so my wife calls the town to ask if we can get the same deal for the sewer bill. *clickaclickaclicka* goes the person on the other end, and then she hears, no lie, the person do that low whistle “wow” sound and then he says, “my, that is a rather large bill, isn’t it?”
Somewhere along the way, and this isn’t really relevant to the point, but makes a great story, is that we get an email from our agent saying that another agent told her that there was “something” in one of the toilets. So she goes to look, and sure enough, someone took a great big honkin’ dump in one of our toilets, and left it there. Now I remember back in high school when “The Mad Shitter What Shits at Midnight” would strike and leave these monster turds in the toilets, and truth be told, that was pretty damn funny. We’re all grown up now. Go ahead and flush the damn toilet. We’re using a couple hundred thousand gallons of water already, we can spot you another three.
Finally, in August of 05, we find ourselves a buyer (bastard). The appraisal for the mortgage comes in at $131,000 (huh, I wonder why no one bought our house for $143,000). After the buyer (bastard) nickel and dimes us until we were ready to tell them to bugger off and find another house, the final selling price was $122,900. Oh, and we had to
a) Replace the Dishwasher
b) Hire a licensed electrician to screw in a faceplate
c) Hire a licensed HVAC technician to inform us that “the further away you get from the compressor, the less powerful the air will be.” Oh, so THAT’S why that room didn’t quite cool as well as the rest of the house.
d) Replace the downstairs carpet (to be fair, we knew we were going to have to do this).
Oh, and we repainted the entire first floor too, to make the house look a little less lived in before they even got there.
Oh, and of course, we were paying the damn mortgage every month. We had some absolutely wonderful mortgage interest deductions on our taxes that year.
So, of course, the moral of the story is that while the fair market value of our house is indeed a very relevant piece of information (to us, that is), any estimate we could get would be pretty unreliable. We had one real estate professional tell us the house was worth $142,900. We had another real estate professional tell us the house was worth $131,000. And of course, the true test of “fair market value,” the amount at which the asset would sell, turned out to be $122,900. Were we to report financial statements between July 2004 and July 2005, what number should we have used?
That’s why we use historical cost for the valuation of most long-term assets.
Oh, and I’m in no way bitter that I’m the only person in the United States to have lived in a house for 7 years and still manage to take a loss on it.