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Historical Cost as a Balance Sheet Issue in Small Business Accounting

A Wilmington NC CPA and tax accountant discusses small business accounting

Do you need help in getting the most managerial use from your small business accounting? Please consider calling us at (910) 399-2705 for a free initial consult.

Let’s look at the issue of Balance Sheet historical cost from the perspective of  Wilmington NC Widgets’ CPA, our demo company.  Typically, small business accounting doesn’t get the same managerial usefulness from the Balance Sheet as Fortune 500 companies do.  A real shame.                                                                        

“Balance Sheet components can be used to build powerful managerial tools like the Fortune 500 companies use. ”
Gary Bode, CPA
Wilmington NC Tax Accountant

Example: Land Over and Under Valued on Balance Sheet

The Balance Sheet is one of four inter-connected Financial Statements in small business accounting.  It shows the company’s assets, liabilities and owner equity at a specific point in time. Sort of a snapshot of the company’s financial position.  But required accounting conventions can distort that snapshot.  Here’s an example of historical cost, one of those accounting conventions.

Wilmington NC Widgets owns a piece of land they hope to build a manufacturing plant on: 10 acres they bought in 1994 for $600,000, which is what their current Balance Sheet lists it as under Long Term Assets. The acreage was a dump site and junk yard for 40 before they purchased it. But even without any additional work, in 2000, the CPA estimates it was readily saleable at 1.2M.  But the Balance Sheet still had to list it at the original historical cost of $600,000.  So in 2000, Wilmington NC Widgets had an additional $600,000 of assets not listed on the Balance Sheet. 

Then WNW started hauling off the junked cars to the scrap metal recycler.  The owner’s Wife took an interest and landscaped the perimeters, especially along the access road.  So, in 2007, with a robust Wilmington economy, the CPA received an unsolicited offer to purchase it for 1.5M.  But the Balance sheet still showed it at the historical cost if $600,000.  So in 2007, Wilmington NC Widget’s small business accounting had $900,000 of assets not listed on the Balance Sheet.

Finally, in 2011, the land is ready for construction, but the CPA for Wilmington NC Widgets calculates they can’t afford to build until 2013, despite having the site paid for and prepped. Realistically, in the recession, they could sell the land for $500,000.  So 2011’s small business accounting over values the land by $100,000 on the Balance Sheet.

The property is always listed at the historical cost of $600,000 on the Balance Sheet.  Most of that time, it could have been sold for more than that.  At one point, it was under valued on the Balance Sheet by $900,000.  Now, in 2011, despite improvements to the land, it is over valued on the Balance Sheet by $100,000.

While you don’t have to be an accountant to understand Balance Sheets, US GAAP (Generally Accepted Accounting Principals) requires using conventions that can impede their usefulness for managerial purposes.  Historical Cost is only one of them.  Your CPA should show you how to translate your Balance Sheet for managerial use.

If you need a free initial consult on this or any tax or accounting issue, please feel free to call us at (910) 399-2705.

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