The purpose of this article is to relate accounting material to the movie “Other People’s Money.” Danny Devito can be described as a corporate raider who buys up companies he thinks are undervalued and liquidates them. Liquidation is the process of selling all physical assets and the proceeds are paid to creditors and then to shareholders. He is attracted to a company called New England Wire and Cable. It is an attractive company because it has no debts, lawsuits, contingent liabilities and has an excellent liquidity position. However, competition and improved technology have made one division of his business obsolete. The division has been experiencing losses and is headed lower. This is indicated by its market value of ten dollars per share. Danny believes it is time to step down and do the right thing in the best interest of the shareholders given the given circumstances and financial conditions. The management of the company maintains an opposite position. They believe the business will pick up and help keep their local people in jobs. Danny proves his point by showing that the liquidation value of the company exceeds its current market value. Although it appears that Danny is getting involved through questionable ethics, he is actually serving the best interests of the shareholder. Upon liquidation, shareholders will get $25 per share instead of its current value of $10 per share. US GAAP measures at historical cost do not allow you to see the difference in liquidation and market value.

GAAP is a set of rules and procedures for preparing financial statements in the United States of America. History-based accounting is an asset valuation measure. Under GAAP, companies value fixed assets at historical cost. Fixed assets are characterized as acquired for use in operations and not for resale, long-term and depreciable in nature, and possessing physical substance. Because New England Wire and Cable is in the manufacturing industry, the company has a large number of fixed assets. Historical costs made up of the cash or cash equivalent price of the asset and all other costs associated with bringing the asset to its location and ready for its intended use. This cost is objective. No estimates are made, free from bias, and the amount can be traced. They are recorded in this way even if the market value is above or below the historical cost. Is there a problem with history-based measures?

Relevance is defined as information that can have an impact on making a decision. The problem with historical measurements is that they lack relevance. As an investor in the company, this information is of no use to me. By contrast, fair market value measures are not objective, but rather subjective, but relevant. Fair market value is the sale price that will be received among market participants who are willing to do so. The problem with using subjective figures is that the valuation of the assets will not be easy to determine. Cost estimation can be expensive, timely, and subject to manipulation. A business may hire appraisers to value its property, plant and equipment. Subjectivity means a lot of room for interpretation. The measure is neither clear nor objective. Problems arise when assets are valued above fair market value. Indicating assets above fair market means overstated assets on the balance sheet. The law of conservatism in accounting requires overstating losses and liabilities, but understating income and assets.

In sum, measuring plant assets at historical cost is useless in the event of liquidation. As a manager or investor, I don’t care how much I paid for that asset. I would be more concerned about the price I would receive from the asset. Measurement of assets at fair value or market price is more relevant. History-based accounting does not fully account for market and economic changes. Essentially, by using historical accounting to value these fixed assets, the user is not provided with information that is relevant to making a financial decision. As stated above, the liquidation value of the business is greater than the market value of the business. Danny quotes: “You’re worth more dead than alive.” Danny’s argument is to liquidate and flee. Although people will lose their jobs, the main goal of a company is to maximize shareholder wealth. Are you doing the wrong thing, actually the right thing? With a liquidation value of a share of twenty-five dollars, investors are sure to benefit. Or investors may continue to hold $10 a share which only appears to be declining, despite pleas from company management. In addition, the liquidation value is greatly undervalued relative to its market value. Financial statements must provide information that is useful and relevant to investors, managers, and creditors in making an informed decision.