Re: [Pen-l] The Fragility of Economic Data

[Eugene Coyle <eugenecoyle@xxxxxxx>]

Michael,
	Don't forget John Maurice Clark's STUDIES IN THE ECONOMICS OF  
OVERHEAD COSTS in making your point.
	
	Re depreciation:  When I was working on Wall Street I took graduate  
courses in the NYU business program, including financial accounting.   
One classmate, frustrated by the multiple sets of books corporations  
can legally keep, asked the professor "Which are the real books?"   
"Oh, the real books, those are kept elsewhere."
	In the same time period, I received at my work place a letter from a  
grad student somewhere in the USA asking a serious question:  "What is  
depreciation?"  That was a long time ago but I still don't have an  
answer.  To add a thought to what you have written, suppose an asset  
outlives its depreciated life -- as does happen.  Sometimes assets are  
usefully producing profits for many years after they have been reduced  
to zero value on the books.

Gene


On Jun 7, 2009, at 8:38 PM, michael perelman wrote:

> Measurement of profits always includes a certain degree of  
> subjectivity as long as the operation involves durable physical  
> assets or longer-term financial assets, the value of which will  
> depend upon future economic conditions. The economist who concerns  
> himself most deeply with this issue was J. R. Hicks, a younger  
> contemporary of Keynes. Hicks recognized that accounting is backward  
> looking, while economic values depend upon the unknowable future. I  
> backward looking, Hicks meant that accountants use previous prices  
> and extrapolations based upon historical experience. Economics looks  
> at an investment in terms of how it is expected to perform in the  
> future.
>
> For example, when a business purchases a computer for $10,000, it  
> does not write off the full cost in the year of purchase. Instead,  
> it will follow an accounting convention, which will subtract a fixed  
> amount of depreciation for each year of its expected life. Nobody  
> knows whether the computer will be obsolete in two years instead of  
> the expected five. If it has to be replaced sooner than expected,  
> then the computer will have to be depreciated prematurely.
>
> The degree of uncertainty becomes far greater with financial  
> instruments. For this reason, accounting rules can become a matter  
> of life and death for a corporation. To make matters worse,  
> accounting tricks permit corporations to create an illusion of  
> success. Such practices do not depend upon Enron-like fraud.  
> Instead, skilled accountants can circumvent the law, making  
> financial regulation into an oxymoron. At the same time, investors  
> presumed to be making informed decisions, even though they have no  
> way of penetrating the opacity of accounting that supposed to  
> measure how well a firm is doing.
>
> The FASB is supposed to be there to provide investors with reliable  
> information, but when this information became inconvenient, Congress  
> stepped in. Congress did not have to pass any laws; it merely had to  
> threaten to do so.
>
> So now the banks are healthy. The stock market is improving. When  
> will the other shoe drop?
>
> --
> Michael Perelman
> Economics Department
> California State University
> Chico, CA
> 95929
>
> 530 898 5321
> fax 530 898 5901
> http://michaelperelman.wordpress.com
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