Dean asks: “Why is
the suggestion "that the company write off the entire cost of the machine
in the year it is purchased, and treat it in all the subsequent years of its
use as a free good" not objective and impartial? As for inventory,
wouldn't the objective, impartial valuation be the actual price paid for each
unit used? Sure, that would be a cumbersome, inefficient method, but it would
be objective...wouldn't it?”
The problem is that all of these alternative schemes are
objective, but none of them is impartial.
None is dictated by the market, so the company must choose among them,
and each choice benefits some persons in the management of the company and disadvantages
others – i.e. each is in a sense an internal political choice.
For example: Suppose
the item to be written off is an air conditioning system with an expected life
of ten years. If it is entirely written
off in the year it is purchased and for the next nine years is treated as a
free good, then a division chief who was appointed in year three gets seven
years of free air conditioning, which decreases the costs of her division for that
time, as compared to the chief of a different division who was appointed the
year before the new system was installed and had to take a share of that cost
against his division’s profits. And so
forth. All the alternative accounting
conventions are objective, in the sense that they do no rely on someone’s subjective
estimate of the value of having air conditioning, but there is no impartial
basis for preferring one scheme over another.
As for the pricing of inventory, LIFO, FIFO, and so forth
are all objective, but as I indicated, one favors one branch of management [or
one group of investors] and another favors a different branch.
2 comments:
Thank you for this helpful response. It generates more questions, but I'll try to think through them before posting any.
My questions boil down to, "What does 'dictated by the market' mean in this scenario?" Put another way, if an action is dictated by the market, is it by definition not impartial, i.e., the action won't treat different parties differently, and so the manager won't suffer the dilemma of choosing between competing managers?
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