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Re: HOMESTEAD: A CPA's View on Depreciation as Source of Cash-Pt II
Norm; Long time no talk. I am now just another retired businessman who even in retuirement still likes to read soundbites of 50 words or less.Thise does look interesting but for me at least it is many too many words. Is there a way to distill it so those of us llike me can usderstand. Got to the DC area a couple of weeks ago. Should have looked you up.. Don Ward
>From: "Norman G. Kurland"
>Reply-To: homestead@cog.kent.edu
>To: COG Homestead - Deb Olson , COG Ownership - Dan Bell
>Subject: HOMESTEAD: A CPA's View on Depreciation as Source of Cash-Pt II
>Date: Mon, 11 Mar 2002 16:18:20 -0500
>
>(Part II of Michael Greaney's Response to Bill Ryan, Social
>Credit advocate, posting to Norman Kurland of March 7, 2002)
>
>Returning to the balance sheet, let us assume the
>simplest case where all current assets are solely in
>the form of cash. The question immediately arises: is
>all that cash available for the purposes of the
>company? The answer is, "not necessarily." A good
>deal of the cash may already belong to somebody else,
>even if it is sitting right there in the company's
>checking account. For example, if the company stopped
>paying its bills, it could build up a rather sizable
>cash balance - but it would have no legitimate claim
>on that cash. That is how an increase in accounts
>payable is construed as a source of working capital.
>Such an increase does nothing to increase the cash
>actually held by the company, but it does allow cash
>held by the company to be used for other things in the
>interim before paying the bills.
>
>The use of that cash may also have been allocated
>internally - it may not be available for general needs
>of the company. To determine whether the company may
>legitimately use its cash for various purposes, we
>need to look at other accounts on the balance sheet.
>
>Since this is a "simplest case" scenario, there are no
>accounts receivable. Accounts receivable is a current
>asset, and, remember, all our current assets are cash.
> We may, however, have some current liabilities, of
>which the most significant is "accounts payable." We
>may have a million dollars in cash in the company, but
>if accounts payable are also a million dollars, we,
>effectively, have no cash - all the cash on hand
>belongs to the people to whom we owe the million
>dollars.
>
>Suppose, however, we have a million dollars in cash,
>and "only" $750 thousand in accounts payable and other
>current liabilities. Does that mean that we are free
>to spend $250 thousand any way we like? Again, not
>necessarily. We have to look at our long-term
>commitments, that is, our long-term liabilities as
>well as our responsibility to pay out dividends to
>shareholders or use retained earnings to expand or
>improve facilities (if we take the Henry Ford approach
>and reject the possibility of external debt or equity
>financing). Now we must return to the statement of
>sources and applications of working capital to
>continue our analysis.
>
>On the "applications" portion of the statement of
>sources and applications of working capital, we
>discover that we have purchased long-term assets in
>the amount of $100,000. This "removed" $100,000 from
>current assets (cash in this case) by "reclassifying"
>that amount of current assets as accounts payable.
>Well, that was already taken care of in our review of
>the balance sheet, but it shows where, specifically,
>our cash has gone - even though it hasn't "gone" yet.
>We are morally and legally obligated to pay $100,000
>to our creditor in that instance, and not divert the
>cash to our own use. Even though we have the cash in
>our possession, it does not belong to us. It belongs
>to the people to whom we owe it. This still leaves
>unanswered the question as to where we "got" the
>"additional" $250 thousand in cash.
>
>Remembering for the sake of this example that all of
>our current assets are in cash (i.e., no accounts
>receivable, marketable securities, short term
>investments, etc.), there is only one source for the
>$250 thousand: depreciation expense. The working
>capital thus "generated" may be used for any purpose
>for which the company wishes to use its working
>capital. "Recognized" would be a more accurate term,
>as depreciation expense "frees up" cash instead of
>physically generating it. The term "generation" is,
>however, commonly used in accounting and considered
>proper.
>
>Such "freed up" working capital is, as the quote you
>cited correctly states, not a fund for asset
>replacement - although the company may decide to use
>its working capital for that purpose, as well as for
>the payment of dividends. Depreciation does not
>result in one dollar more or less in the cash account,
>again as the quote you cite correctly points out.
>What depreciation expense does, however, is legitimize
>the use of that cash for working capital purposes by
>changing (reclassifying) the cash "tied up" in
>long-term assets by expensing the long-term asset and
>freeing up the expensed amount for other purposes.
>Conceptually, depreciation does not bring actual cash
>into existence. Depreciation tells where cash came
>from.
>
>In depreciation, therefore, you have at least three
>timing issues involved. One, a long-term asset is
>purchased, but cash is not paid over to the creditor
>immediately. Instead, e.g., a 5-year note is signed,
>thereby increasing long-term assets and long-term
>liabilities in equal amounts. Ideally, the term of
>the loan would be exactly equal to the life of the
>asset, thus matching cash payments to the specific
>periods in which the asset was producing and in the
>same amounts. Don't ever expect to see this - most
>lenders want their money as fast as they can get it,
>and the term of a loan frequently bears no relation to
>the useful life of the asset purchased. The term of
>the loan versus the life of the asset is simply an
>accommodation to reality.
>
>Two, an asset is "used up" over its useful life. In
>accordance with the matching principle of accounting,
>this "using up" should be recognized in the period in
>which the "using up" occurs. Depreciation expense is
>an attempt to assign the cost of the use of an asset
>to the period in which the cost is incurred,
>regardless of when the lender demanded payment for the
>asset.
>
>Three (and this seems to cause you a great deal of
>confusion), an asset is expensed at a time that does
>not necessarily have any connection with when the
>asset was purchased or paid for. It is important to
>note that "purchase," "payment" and "use" are all
>discrete concepts and distinct events. Depreciation,
>accounts payable and accounts receivable, combined in
>various ways on the four essential financial
>statements, relate these three concepts and tie them
>together into an integral whole.
>
>Ideally, again, no one would pay for anything that he
>was not purchasing at the moment of use. A company
>would only pay for an asset as it was using it, and
>only purchase it at the moment of use. A shopkeeper
>would only be paid for the ingredients an individual
>purchased to make dinner as the dinner was eaten. In
>an absolutely ideal and perfect world, this would be
>at the point where "title passes" (not to be confused
>with legal conventions as to when title passes). That
>is, "title passes" in a conceptual sense when
>something is "used up," not necessarily when the law
>says it passes.
>
>As you can see from the above paragraph, refusal to
>recognize depreciation as a source of working capital
>(or "cash" if you prefer) not only gets you into areas
>of such extreme triviality where business is
>concerned, it disconnects you from reality. If
>recognizing an expense in the period in which the
>actual expense was incurred is a "trick" or is somehow
>illegitimate, then credit itself must be called into
>question. It also calls into question the legitimacy
>of accounts payable and accounts receivable. When you
>begin by questioning reality, you end by being
>uncertain of everything based on reality, such as the
>principles of accounting.
>
>Depreciation expense is a way of accommodating the
>recognition of revenue and expense, receipt and
>disbursement of cash, with the real world. In the
>real world, people are not paid immediately for their
>work or their goods, and people take their time in
>paying their debts as well as in using their assets to
>generate production.
>
>If I understand your objections to depreciation
>correctly, you seem to demand instantaneous work,
>production, payment and use. This is unrealistic, as
>the world does not work that way. The basis of any
>kind of credit, of money itself, requires that value
>be transferred at some other point in time than when
>the transaction "officially" occurs, whether in the
>past (as with depreciation) or in the future (as with
>accounts payable and accounts receivable). Your
>quarrel would seem to be not with depreciation or even
>the accounting profession, but with the whole idea of
>credit, or, perhaps, the temporal nature of reality.
>That being so, you will either have to change your
>orientation and accept such basics as delayed payment
>and recognition of expenses and revenues, or somehow
>change the world to eliminate the concepts of money,
>credit or time itself.
>
>As a bit of friendly advice, you might in the future
>want to modify your language somewhat when addressing
>professionals speaking within their area of
>competence. Regardless of your opinion of accounting
>and the accuracy of your historical knowledge, your
>mode of expression and choice of words seem more
>calculated denigrate than to engage in serious
>discussion or seek information. Since that,
>presumably, is not your intention, your chosen manner
>of communication is self-defeating. It tends to
>alienate rather than inform, and to estrange potential
>allies before you have given a fair or comprehensible
>presentation of your ideas. After all, my lack of
>response to your previous "challenge" was predicated
>on the assumption that you could not be serious.
>
>Individuals whose professional qualifications and
>competence you have inadvertently called into question
>would be disinclined to engage in discussion of any
>kind with you. This has nothing to do with any merit
>or lack thereof in the ideas you put forth. There is
>profit to be found in discussing any idea
>intelligently and with respect for the decencies of
>debate and civilized behavior.
>
>In closing, please let me reassure you that I stand by
>my previous statements quoted by Norman Kurland, and
>that the statements are in conformity with GAAP
>("Generally Accepted Accounting Principles") as well
>as accepted accounting theory and practice and current
>tax law in the United States. If you find that you do
>not understand some or all of this discussion, I would
>consider providing more clarification if you could
>specify the language to which you take exception and
>the specific accepted principles of accounting you
>believe I am violating.
>
>Yours,
>Michael D. Greaney, CPA, MBA
>Director of Research
>Center for Economic and Social Justice
>
>__________________________________________________
>Do You Yahoo!?
>Try FREE Yahoo! Mail - the world's greatest free email!
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>
>
>
>"William B. Ryan" wrote:
>
>
> Norman Kurland,> "urn:schemas-microsoft-com:office:office" />
>
> In further reply to your post under the above heading
> archived at
> http://www.geocities.com/socredus/kurland-12-14-01.htm
>
> In continuation of
> http://www.geocities.com/socredus/ryan-01-23-02.htm
> which was in supplement to
> http://www.geocities.com/socredus/ryan-12-17-01.htm
>
> Of relevance to this discussion is this excerpt from
> John-Baptiste Say regarding what has come to be called
> Say’s Law http://www.geocities.com/socredus/say.htm
> and the following excerpts from Douglas:
>
> http://www.geocities.com/socredus/swanwick.htm
>
> http://www.geocities.com/socredus/nature_of_price.htm
>
> http://www.geocities.com/socredus/dickens.htm
>
> 1.You wrote:
>
> “Under Say’s Law, purchasing power is assumed
> only to the extent of production—not beyond or
> addition to production.If production
> increases, so does purchasing power.If
> production decreases, so does the ability to
> purchase that production…”
>
> This we will not dispute.What we dispute is that
> purchasing power increases or decreases
> proportionately to production.The keyword here is
> proportionately.We attribute this disproportionality
> to a flaw or inadequacy in the financial system that
> makes it incapable of rationally accommodating growth
> vectors in population and technology
>
> 2.You wrote:
>
> “Bill, you contend that ‘there exists,
> however, no mechanism in double-entry
> accounting to accommodate the parametric shift
> of an increasing ratio of ‘B’ to ‘A’ flowing
> from labor displacement...’ Again, for reasons
> explained above, cash freed up by accounting
> for depreciation can be used to close this
> purchasing power deficiency...”
>
> To repeat, depreciation does not free up cash.It
> merely delays the expensing of a cash disbursement
> from the present to the future.This is elementary
> accounting 101, which is why I challenged you in my
> last post regarding Michael Greaney. I would still
> like to see his response.
>
> The following is from “Accounting Principles,” by
> Howard S. Noble, MBA, LLD, CPA and C. Rollin
> Niswonger, PhD, CPA, a standard college text, which by
> 1961 had already gone through eight editions:
>
> “…[A] common misconception is that
> depreciation accounting provides a fund of
> cash for the replacement of plant
> assets.Expired portions of the cost of the
> assets are periodically transferred to expense
> by debits to depreciation expense accounts and
> credits to accumulated depreciation
> accounts.The cash account is not affected by
> the entries and, of course, would not be
> affected if the entries were omitted.The
> confusion originates from the fact that
> depreciation expense, unlike most expenses,
> does not require an equivalent outlay of cash
> in the period in which the expense is
> recorded.”
>
> Keep in mind we are interpreting purchasing power in
> terms of it being effective demand.The expense charged
> against current sales is what determines the rate of
> profit and it is the rate of profit that is of
> significance to the concept of effective
> demand.Without profit the willing seller disappears;
> without the willing seller production halts.
>
> The fact that money may be pigeonholed somewhere from
> past disbursement does not mean it is available as
> purchasing power against current production. [*]And if
> the money was used to repay a bank loan at some point
> in its past disbursement it does not exist
> anywhere.Yet it has been transformed into a cost that
> is charged against sales.
>
> [*} Money is a vector quantity.There is directionality
> to production that I will explain in a future post.
>
> 3.You wrote:
>
> “Social Credit, however, violates the basic
> principles of accounting by adding to the
> system on one ‘side’ without anything to the
> other.That is, the amount of existing
> production above a certain amount is declared
> to be a National Dividend, and new money is
> created and inserted into the system in that
> amount.”
>
> We are concerned not so much with existing production
> but potential production--what can be made to
> exist.For more than eighty years the slogan has been:
> What is Physically Possible is Financially Possible!We
> define production broadly to include the increase in
> productive capacity, and consumption to include the
> increasing option for leisure.It is the path toward a
> sustainable world.Nothing has to be taken away from
> anybody because what can be made to exist is so much
> greater than what already exists.What can be made to
> exist includes a great many intangibles.
>
> I refer you to the diagram attached also archived at
> http://www.geocities.com/socredus/baseline.jpg
>
> Let me say parenthetically that the various “binary”
> schemes seem to be inflationary to the extent they are
> financed with “pure credit.”I have not found even a
> single ESOP that did not entail the simple transfer,
> or dilution in ownership, of already existing assets
> from the already existing owners to the ESOP.There is
> no net creation of wealth.ESOPs are often promoted as
> the way for departing owners to “cash out.”Quite often
> it has been the vehicle for the raiding of pension
> funds and to force out unions by financially troubled
> companies.The chief proselytizers for such schemes,
> the most ardent “true believers,” seem to be lawyers
> and financial agents whose business, the way they make
> their! living, is to structure ESOPs.There is moreover
> the matter of disproportionality that Social Credit
> asserts.
>
> Take a look at the diagram.The diagram depicts two
> possibilities.In both the ‘A’ curve is diverging
> exponentially from ‘A + B’ through time.In the first,
> the ‘A” curve is held to be increasing linearly
> through time.In the second, it is ‘A + B’ that is held
> to be increasing linearly.
>
> If we take ‘A + B’ to be the surrogate for the money
> supply and by inference prices, and ‘A’ the surrogate
> for its primary component, wages, and by inference
> employment—the theorem becomes the analytical
> confirmation of the empirically derived Phillip’s
> Curve. There is a “trade off” between inflation and
> employment.
>
> If, as a matter of policy, in monetarist fashion, the
> money supply is held to be increasing at some fixed
> percentage per year, then employment must languish.
>
> If, however, say from union pressure, wages are
> permitted to rise commensurately with “productivity,”
> prices must rise without limit.
>
> The Social Credit solution is to moderate bank credit,
> much as the monetarists do [*], but supplement it with
> credit supplied “exogenously,” that is to say, not
> costed into production so it does not appear in
> prices—through the mechanism of rationally introduced
> retail discounts and consumers’ dividends.The supply
> and demand curves become “parallel.”Production rises
> proportionately with demand.
>
> [*] With of course some differences.
>
> To be continued.
>
> Bill Ryan
>
>
>
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