It is the end of 2016 and you are an accountant for Stone Company. During 2016, sales of the company’s products slumped and the company’s earnings are expected to be much less than those of 2015. The president comes to you with an idea. He says, “Our Company’s property, plant, and equipment cost $300,000, and that is the amount we usually report on our balance sheet. However, I just had these assets appraised by an independent appraiser, and she says they are worth $400,000. I think that the company should report the property, plant, and equipment at this amount on its December 31, 2016, balance sheet and should report the $100,000 increase in value as a gain on the 2016 income statement. If we use this approach, it will show how much our company is really worth and increase our earnings. This will make our shareholders happy. What do you think?”
Required:
Prepare a written response to the president.
SOLUTION
To: President
From: Accountant
I am writing in response to your question concerning the recording of property, plant, and equipment at its appraised value. Although this method would increase our reported 2016 earnings, it is not appropriate.
According to GAAP, property, plant, and equipment is measured and recorded at the exchange price (historical cost) minus any accumulated depreciation. Consequently, reporting it at appraised value would violate this historical cost concept. In addition, by using appraised value and showing a gain in this year, we would be reducing comparability, not only between our own financial statements of past years, but also between our financial statements and those of other companies that follow GAAP. This would create an ethical issue because we would appear to have higher earnings than a company using GAAP, which might put us at an unfair advantage regarding the market price of our stock and our ability to sell stock and borrow money.
Furthermore, because we are using a method which is not in compliance with GAAP, our auditor would be required to disclose this in the auditor’s report. If the difference between using historical cost and appraised value were material enough, it may prevent the auditor from giving us an unqualified opinion. Such a result would greatly harm our reputation to external users.
Although our goal is ultimately to increase the value of our company’s stock and satisfy the investment requirements of our shareholders, using a method which is not GAAP to manipulate our asset values and earnings is unethical in that it is unfair to (justice criterion), violates the rights of (rights criterion), and does not optimize the satisfaction (utility criterion) of our various stakeholders (e.g., current and potential investors, creditors, suppliers, community, etc).
Therefore, it will be more beneficial to our company in the long run if we report our property, plant, and equipment at historical cost in accordance with GAAP, even though it results in lower earnings, than to ignore GAAP and mislead our external users.