This article is in relation to two film clips from Other People's Money (1991) and how these clips relate to such accounting topics as historical cost, salvage value of assets and most prominently liquidation and market value. Danny DeVito who is named Larry the Liquidator in this film is important in both scenes and it is his comments that I am using to link in these topics.
To begin, Danny DeVito is named Larry the Liquidator as he liquidates companies i.e. turns assets of the company into cash. Liquidity is how easily an asset can be turned into cash, as cash is the most liquid asset. In the clip he is described as someone who leaves nothing in his path. This links in with one of the topics, Liquidation value. Liquidation value is the total worth of all physical assets that a company owns. I stated physical assets as intangible assets such as goodwill or intellectual property is not included in the liquidation value. Normally the liquidation value is lower than the actual market value of the assets and shares. Although in this example and when companies have low market price per share the liquidation value of a company may exceed the fair market value of its assets.
This leads on to the next important topics, historical cost and fair market value. Historical cost is the price measured by cash or cash equivalents to obtain the asset and bring it to the condition necessary for the intended use. Historical cost is the method Danny DeVito used to show the value of equipment at its salvage value after depreciation. Other People's Money (1991) also shows us how irrelevant historical cost really is when used to prepare financial statements under US GAAP as the firm as no debt, no lawsuits, no environmental or contingent liabilities and a fully funded pension. The obvious advantage of historical cost is that it is objective therefore leaves no room for any manipulation. Fair market value however is basically the complete opposite, it is relevant but it is also subjective and whenever there is subjectivity in accounting the doors of manipulation open wide for anyone to enter. In this example, Other People's Money (1991), the fair market value of the company is less than the liquidation value and not only that but Danny DeVito describes how obsolescence of the product has caused the company to drop in market value and continue on the road to bankruptcy.
As previously mentioned Danny DeVito uses historical cost for the calculation of the equipment at Salvage value. They equipment came to this salvage value after depreciation, which is an accounting process of allocating cost of physical assets to expense in a rational and systematic manner to match the periods expected to benefit from the use of the asset. This is called depreciation over the assets useful economic life and once fully depreciated the asset is left at salvage value.
In the first clip Danny DeVito mentions that the land is valued at $10 million at fair market value. Fair market value was described above but the reason why the land is valued in this way is because land does not depreciate and therefore can easily be valued at market value for liquidation purposes. Something else mentioned in the first clip was that the working capital of the company was at $25 million with $10 million in cash. Working Capital is current assets minus current liabilities. In this example it is positive therefore current assets were greater and therefore had enough short term assets to cover short term liabilities.
My final topic is the principle of conservatism; this is an accounting principle that applies in most aspects of accounting. It effectively leads accountants to anticipate or disclose a loss as soon as it is foreseen but does not allow it to perform similar processes for a gain. This principle is significant in accounting and many other aspects of the financial statements. As if you recognize a gain in an asset before the transaction takes place you may overstate the asset value and this could cause a huge problem in the financial statements. So, in this example Danny DeVito uses the principle of conservatism by stating the company's total worth at $100 million instead of $125 million, as he does not want to overstate the asset values of the company if those gains are not realistic.
You may ask why the title is; relevance or objectivity, which one is more important? The answer to this question is that throughout this article I have been linking accounting topics to the film clips from Other People's Money (1991) to solve a dilemma of whether it is superior to use the historical cost method or the fair market value method of valuing assets. I came to the conclusion that relevance is more important than objectivity, especially as if subjective decisions have evidence behind them and can be regulated the subjectivity becomes objective and the financial statements stay relevant. The purpose of financial statements is to provide information to stakeholders on the financial position of the company and how can a company's financial position truly be assessed if the figures are not relevant, you can't.
To begin, Danny DeVito is named Larry the Liquidator as he liquidates companies i.e. turns assets of the company into cash. Liquidity is how easily an asset can be turned into cash, as cash is the most liquid asset. In the clip he is described as someone who leaves nothing in his path. This links in with one of the topics, Liquidation value. Liquidation value is the total worth of all physical assets that a company owns. I stated physical assets as intangible assets such as goodwill or intellectual property is not included in the liquidation value. Normally the liquidation value is lower than the actual market value of the assets and shares. Although in this example and when companies have low market price per share the liquidation value of a company may exceed the fair market value of its assets.
This leads on to the next important topics, historical cost and fair market value. Historical cost is the price measured by cash or cash equivalents to obtain the asset and bring it to the condition necessary for the intended use. Historical cost is the method Danny DeVito used to show the value of equipment at its salvage value after depreciation. Other People's Money (1991) also shows us how irrelevant historical cost really is when used to prepare financial statements under US GAAP as the firm as no debt, no lawsuits, no environmental or contingent liabilities and a fully funded pension. The obvious advantage of historical cost is that it is objective therefore leaves no room for any manipulation. Fair market value however is basically the complete opposite, it is relevant but it is also subjective and whenever there is subjectivity in accounting the doors of manipulation open wide for anyone to enter. In this example, Other People's Money (1991), the fair market value of the company is less than the liquidation value and not only that but Danny DeVito describes how obsolescence of the product has caused the company to drop in market value and continue on the road to bankruptcy.
As previously mentioned Danny DeVito uses historical cost for the calculation of the equipment at Salvage value. They equipment came to this salvage value after depreciation, which is an accounting process of allocating cost of physical assets to expense in a rational and systematic manner to match the periods expected to benefit from the use of the asset. This is called depreciation over the assets useful economic life and once fully depreciated the asset is left at salvage value.
In the first clip Danny DeVito mentions that the land is valued at $10 million at fair market value. Fair market value was described above but the reason why the land is valued in this way is because land does not depreciate and therefore can easily be valued at market value for liquidation purposes. Something else mentioned in the first clip was that the working capital of the company was at $25 million with $10 million in cash. Working Capital is current assets minus current liabilities. In this example it is positive therefore current assets were greater and therefore had enough short term assets to cover short term liabilities.
My final topic is the principle of conservatism; this is an accounting principle that applies in most aspects of accounting. It effectively leads accountants to anticipate or disclose a loss as soon as it is foreseen but does not allow it to perform similar processes for a gain. This principle is significant in accounting and many other aspects of the financial statements. As if you recognize a gain in an asset before the transaction takes place you may overstate the asset value and this could cause a huge problem in the financial statements. So, in this example Danny DeVito uses the principle of conservatism by stating the company's total worth at $100 million instead of $125 million, as he does not want to overstate the asset values of the company if those gains are not realistic.
You may ask why the title is; relevance or objectivity, which one is more important? The answer to this question is that throughout this article I have been linking accounting topics to the film clips from Other People's Money (1991) to solve a dilemma of whether it is superior to use the historical cost method or the fair market value method of valuing assets. I came to the conclusion that relevance is more important than objectivity, especially as if subjective decisions have evidence behind them and can be regulated the subjectivity becomes objective and the financial statements stay relevant. The purpose of financial statements is to provide information to stakeholders on the financial position of the company and how can a company's financial position truly be assessed if the figures are not relevant, you can't.
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