Apologies for the delay: it’s been a busy couple of weeks.
The first element of the UT allocation formula is Assets. This includes all fixed tangible property, including leased assets (to avoid sale-and-leaseback avoidance). It excludes inventory (and so by extension all other circulating capital?). It excludes intangibles, because it’s hard to tell where they are and they can move about easily – we look through the intangibles to the assets and staff that create them, and anyway we are more interested in how the IP is used than how it is created.
Taking normal tangible fixed assets at first, the key question is how to value them.
The other elements of the UT formula, Sales and Labour, appear to be on a current-year basis, so for consistency assets should also be. That implies that one should bring in a value which reflects the value of the asset in the current year. I am trying to eliminate any subjectivity in the formula, which implies that I need to get an objectively-correct figure that is not open to debate. However, the only number that one can definitely and unambiguously fix on an asset is historic cost, but this is clearly not going to be appropriate in a lot of cases – old buildings, for example.
The obvious alternatives to cost would be market value, or book value. To use market value would mean bringing in a subjective element, and would require a lot of effort each year. Book value also has subjective elements, in the choice of depreciation rate, and where assets are revalued.
I think that the only practical option is to go with market value in principle, but allow for approximations to be used. So for most plant and machinery the NBV is often regarded as an approximation to MV (though in principle it is clearly not meant to be one), and so I will allow NBV to be used as a proxy for MV.
This introduces a potential gap in the system, where assets can be revalued up or down to manipulate the formula, but as the alternative is to have historic cost distort the results I think I have to live with that.
Leased assets: how do we value a lease? As I understand it GAAP is moving to a position where a lessee under an operating lease recognises the value of the asset on the balance sheet, but brings in a matching creditor for the rent payable. This would seem to solve that problem neatly, and the asset value would relate directly to a real-world cost.
For short-term hire, I think this has to be omitted if it doesn’t show up on the balance sheet. I can think of a few areas where this might lead to anomalies, but those can be addressed once I have a working system and can identify them properly.
Lessors: the new accounting principles, as I understand them, require the lessor under an operating lease to remove the asset from its balance sheet and replace it with the receivable. This would seem to distort the formula for leasing companies rather significantly. Subject to people telling me what a bad idea this is, I will regard this sort of lease receivable as an “asset” for UT purposes, as it represents the value of something tangible, even though it is itself intangible. I can see problems already if the lessee takes the asset across borders – perhaps the lessor should attribute assets by physical location of the asset, so an asset you let out becomes a source of income in the jurisdiction in which it is located.
I am going to use the value of assets at the balance sheet date, as that fits with accounting practice. Ideally we would have something like an average value over the year, but that is likely to be inordinately difficult in practice. This does introduce potential distortions, such as bringing forward the acquisition date of property to 31 December in order to bulk up the balance sheet, but I can’t see a practical way round that. Although I suppose one could take the average of opening and closing assets, which would mean that any movements have only half the impact (good or bad), so the effect of any manipulation would be dampened.
There is a question over cut-off: I don’t think capital commitments should count, as the assets are clearly not yet in use, but then having a test about whether things are in use or not adds an awful lot of complication. Again, I think I have to follow accounting practice and say that if the accountants show it as an asset then it’s an asset, and then I can look at possible weaknesses later.
Where an asset ceases to be used and is slated for disposal this must be recognised, so it can be counted as stock and disregarded.
The digital economy is a tricky one. Is a website a tangible asset or an intangible one? What about the cloud, where we lease server time? Paying for servers actually used is functionally the same as paying for servers we then use, but would never show up on a balance sheet. What if the services are packaged, so we pay a single fee for website development and maintenance, hosting, storage, SaaS, etc – how do we disentangle the asset from the service, and the intangible from the tangible? Much as I hate to hand-wave away the current leading edge of service provision, I think that this is all going to have to be classed as not a tangible asset (too much of it is intangible and/or revenue) and so left out of account. This does lead to a possible mismatch with sales: a website is a presence in a country and so is fundamental to Sales but irrelevant for Assets.
Take the market value of tangible assets (or a measure which reasonably approximates it) at the year end date.
Assets for resale must be excluded. Where assets are no longer to be used they must therefore be transferred to stock.
Lessees must rely on lease accounting to bring in exactly what we want to count as an asset. Short-term operating lesaes are to be excluded.
Lessors should continue to include the amount representing their income stream from an asset as being that asset. The location of the asset must be determined, so the amount can be attributed to the correct jurisdiction.