Jamesian Philosophy Refreshed

The other central document of accounting is an income statement.   This represents a period of time, rather than the moment-in-time of the balance sheet. If all is working properly, the income statement should give investors an idea of the underlying processes that have made the present condition of the company what it is.   We won’t spend a lot of time on the income statement, simply because much of what we might say about it we’ve already said. The issues that arise in compiling an income statement look familiar to anyone who understands the latest balance sheet.   For example, the expenses part of an income statement should indicate the costs of goods sold (COGS), that is, the costs directly attributable to such of the goods that have gone out the door in the hands of a customer over the past year or quarter, separately from all the other costs, especially the “general and administrative expenses.” The issues that arise when valuing COGS are the same is...

An issue quite analogous to depreciation is depletion. For businesses that operate by extracting resources from the ground, surely one of their most important assets is the expected amount of oil, coal, diamonds, or whatever-it-might be that is still down there, yet to be extracted, on the land owned or leased by the company for this purpose. Over time, as oil [let us say] is removed, necessarily the remaining oil under there is depleted. The issue has often been politically contentious. Indeed, references to the oil depletion allowance in various stages of its development run like a Wagnerian motif through the various volumes of Robert Caro’s work on the life and times of Lyndon Johnson, who as both Representative and Senator from the oil-rich state of Texas was a stalwart defender of a very generous allowance for the tax accounting books, one which does not have to be duplicated in the financial accounting books. But let’s stick to the latter.   One way in which account...

  Continuing down the list of assets on a balance sheet (beyond those described in our last discussion of such a sheet), we come to a line for prepaid expenses. If our business has paid $1,800 for a year of insurance coverage, it will own something, a claim against the insurance company. This may not sound like an “asset” in a rough commonsensical sense of the world but … hey … the common sense cookie often crumbles. We have to recognize this as an asset in order to convey fairly the economic realities our books are designed to describe. We’ll move now to tools & equipment. Perhaps our business involves a conveyer belt, which we use to move a product from the back room to the front, where it is shown to the customers and, with luck, purchased. The conveyor belt is a fixed asset or, in less formal parlance, it’s part of our “overhead.”   When we bought the conveyor belt and had it installed (for, we will say, $500) we might have paid $100 cash, charging...

Entities large enough to hire accountants tend to keep a different set of books for each of three purposes: 1) Dealing with the tax authorities, 2) Communicating with their own investors and creditors, and 3) Allowing their managers to engage in informed internal deliberations about mergers, spin-offs, prices, wages, and so forth. That is to say, there are three sorts of accounting: tax, financial, managerial. The two sets of books that are designed for external communication, the tax and financial accounting books have a fascinating off-setting feature. The normal temptation in financial accounting will be to overstate revenue, and the normal temptation in tax accounting will be to understate it.   If you are a potential investor, and if you suspect the books they’re showing you are a bit too rosy, you’ll want to see the books they show the tax authorities. At any rate, in what follows we will chiefly discuss financial accounting. There is a good deal of drama ...

Thinking this through. What happens to the value of shares of public stock if the company buys some of the stock back in the marketplace? Think of it first as a simple accounting matter, and let's assume for simplicity's sake that the actual or potential buyers of the stock in the marketplace (who constitute the market demand) know and care about the book value on the balance sheet: that is, the equity as defined by the formula Assets - Liabilities = Equity . Suppose the company has 1,000 shares of stock outstanding, each selling for $50. Its market capitalization, then, is $50,000.  Now, it uses some of its own cash (an asset) to buy back some of the shares of stock. This decreases the amount of stock still available to a would-be buyer.  So if 100 shares are retired and 900 are left, as a first approximation -- assuming demand for the stock stays the same, we might well expect the value of those to increase to $55.55 per. BUT something else has taken place, ...