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Chapter 8 - CHAPTER EIGHT Assets Accounting 8 8.1 Chapter...

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CHAPTER EIGHT 8 Chapter Introduction: Accounting for the Left-Hand Side of the Balance Sheet Assets Accounting 8.1 NEL “Well, Mr. Groven, for us to determine the value of your business, we have to consider both what is in the financial statements and what is not. We also have to consider a lot of other things, espe- cially income tax considerations for you and the potential buyer. “Essentially, your company has value partly because of what it has now, but mainly because of the earnings and cash it can gener- ate in the future. How do the financial statements help with this? Well, some assets and liabilities on the balance sheet can be taken at their accounting values: cash, most of the accounts receivable, accounts payable and specific debts, such as to the bank. And the income and cash flow statements give us a pattern of resource inflows that we might be able to extrapolate into the future. So we have to look carefully into how you measure earnings and cash flow in your company’s financial statements, and so how you calculate cost of goods sold, depreciation and amortization, and other important earnings components. Knowing all this, we can do some calculations to tell us whether the company makes more money than similar companies or similar investments—its ability to generate such excess earnings would add a lot to its value. “But in many ways, the financial statements are of limited help in valuing the business. Accountants measure most assets at historical values, and those old values are likely a poor indication of either immediate cash value or future earnings power. And then there are the intangible assets that really give your company its value—reputation, location, brand name, quality of employees, and you, Mr. Groven. To a large extent you are your company, and without you, the company would be worth much less. Unless you have outlived your usefulness, ha, ha. Some companies’ values go up when their founders die, but I’m sure you’re not one of those dinosaurs! We have another client, who runs a popular and pricey restaurant; she wants to sell, but finds that without her and her skills, the restaurant is just a bunch of pots and pans. There are many intangible assets in a business like yours, and they are essen- tial to the company’s value and ability to make money in the future, but you won’t find them in the balance sheet. “Now, let’s get on with doing the valuation….”
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Valuing Mr. Groven’s business raises questions about how to value the balance sheet’s assets, and whether there are assets not on the balance sheet that are important to the business’s future. The connection between the asset values and the income and cash flow measures is also raised. (Let’s remember right away that most accounting policy choices don’t change the net cash flow for the year, though they may rearrange some of the details in the cash flow statement.) In this chapter, you will learn: That there are several methods for determining asset
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