Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

GENERAL PRINCIPLES OF VALUATION Content of the Balance Sheet The problems of content and valuation strike at the very heart of the balance sheet. Form, framework, and method of presentation are important and their usefulness should not be discounted. Particularly is this seen to be true from the standpoint of availability of the information presented and facility in its interpretation; but the meat of the balance sheet is its content. In connection with this, two points demand consideration, viz.: (1) what items shall be admitted to a place in the balance sheet; and (2) on what basis shall they be admitted, this latter being the problem of valuation. The first question can be answered without much trouble. All properties owned and all liabilities incurred must find a place in the balance sheet. The properties belonging to a business include both the tangibles and intangibles, rights and claims. Most of these have cost value, some may have been gifts. All the assets must, therefore, be listed. Similarly, the liabilities, all those things which represent debts owed by the business or established claims against it, must be given place in the balance sheet. Neither from the assets nor the liabilities must there be allowed omission. As stated in Chapter IV, as to content, the balance sheet must be “full and fair.” Some classes of items, known as _contingent_ assets and _contingent_ liabilities, will be discussed and their place determined as they are met. The net worth items, in whatever detail desirable, must also be included. Valuations for Rate Regulation The second problem as to the basis on which items shall be valued for the balance sheet is our chief problem. The general question of valuation may be viewed from so many points that definition of its meaning here is necessary. Principles that are applicable to valuations for one purpose frequently cannot be made to serve another purpose. Because of the agitation in recent years relative thereto, when the problem of valuation is mentioned it is associated almost invariably with public service corporations. Most of the so-called valuation work has been done in connection with railroads, water companies, gas and light companies, etc. Here the issue of regulation is involved. Regulation of rates is price regulation and therefore regulation of profits. The purpose of valuation in connection with public utilities is the determination of the amount of investment on which rates must be so regulated as to secure a return based on fairness and equity to all parties. Where such valuations have been made they have not proven entirely satisfactory and it is placing too great faith in human kind to expect the satisfaction of all parties with the results of any valuation. Where the properties involved have not been exceedingly complex and have been fairly well localized, results have seemed to justify the effort; but in the case of a large and complex plant covering widely separated areas and serving many and different communities, as is the situation with railroads, in the minds of many the results obtained in such instances are of doubtful value when compared with the effort and cost expended. Though much can be learned from such valuations, the principles underlying them differ at many points from those which must control in valuations as applied to commercial balance sheets. It is in connection with public service valuations that very valuable studies of the depreciation problem have been made. Valuation for Sale and Purchase Again, valuations and appraisals are often made in cases of prospective sale and purchase negotiations. While most of the determining principles are the same, not all apply to our problem of going concern valuation. Thus, the plant to be purchased may not be continued in its present use but must be adapted to other uses. Results secured towards controlling the market by means of this purchase may make the plant much more valuable than its physical worth. Elements of “going concern” and good-will call for valuation in the case of a purchase and sale transaction and are frequently not present in commercial balance sheet valuations. These last questions touch closely our problem and will receive careful consideration in their proper places. Other Kinds of Valuations There are several other kinds of valuations, all more or less closely related to commercial balance sheet valuations but differing from them in some respects because of their differing purposes and ends sought. The chief of these are: (1) valuations for purposes of fire loss adjustments; (2) valuations for purposes of liquidation to satisfy creditors and determine the owners’ equities, as in bankruptcy and voluntary dissolutions; and (3) valuations for purposes of taxation. In all of these cases, many points of similarity to, and of some differences from, our present problem are found. In the first and third kinds enumerated, there is marked similarity, but the problem in the case of the income tax is not so broad. In the second kind, the problem is entirely different, as values have to be determined on the basis of forced sale. Going Concern Valuation The kind of valuation to be treated here may be called “going concern” valuation. By that will be meant the values at which the various items shall appear in the balance sheet when viewed from the standpoint of a concern which expects to continue operations—a going concern as contrasted with one which is facing dissolution, reorganization, sale, or other eventuality. As stated above, the principles of going concern valuation are not distinct and separate, except in a few instances, from those governing the other types of valuation referred to. Oftentimes they are the same principles applied in the same way because the purpose is practically the same; again they are the same principles but applied differently in order to serve different purposes; and finally they are sometimes entirely distinct principles because the purpose to be served is entirely different. It is not purposed in this treatment of valuation to set forth the points of variance and sameness with the other types; that is beyond the scope of the present volume. Endeavor will be made to set forth clearly underlying principles and their detailed application to the chief items met in the average balance sheet as viewed from the standpoint of a going concern. Elsewhere, notably in Chapter XXXV, some principles of another type of valuation will be discussed. In any consideration of valuation, it is necessary to seek out the sources and kinds of value to determine in the one case its basis, and in the other to establish the type of value applicable to the given conditions. Value is not of spontaneous origin; it cannot be created out of nothing. Here it is not intended to search for causes of value or to inquire into the forces back of them. The author is content to leave that to the economist. Kinds of Value Various kinds of value are established facts of the world of business and by their sources, as the term is used here, is meant the information which vouches for or establishes the fact of value, rather than a search for the cause of it. Thus we find, among others, the following kinds of value: