Deprival value

Deprival value is a concept used in accounting theory to determine the appropriate measurement basis for assets. It is an alternative to historical cost and fair value or mark to market accounting. Some writers prefer terms such as 'value to the owner' or 'value to the firm'. Deprival value is also sometimes advocated for liabilities, in which case another term such as 'Relief value' may be used.

The deprival value of an asset is the extent to which the entity is "better off" because it holds the asset. This may be thought of as the answer to the following questions, all of which are equivalent: - What amount would just compensate the entity for the loss of the asset? - What loss would the entity sustain if deprived of the asset? - How much would the entity rationally pay to acquire the asset (if it did not already hold it)?

Deprival value explained

Deprival value is based on the premise that the value of an asset is equivalent to the loss that the owner of an asset would sustain if deprived of that asset. It builds on the insight that often the owner of an asset can use an asset to derive greater value than that which would be obtained from an immediate sale. For example, a machine may be profitably employed in a business but no more than scrap value could be obtained from its sale (net selling price).

Deprival value reasons that the maximum value at which an asset should be stated is its replacement cost as, by definition, the owner can make good the loss arising from deprival by incurring a cost equivalent to replacement cost. However, if that amount is greater than the amount that can be derived from ownership of the asset, it should be valued at no more than its recoverable amount. Recoverable amount is, in turn, defined as the higher of net selling price and value in use, which is the present value of the future returns that will be made by continuing to use the asset.

In summary:

  • Deprival value equals the lower of replacement cost and recoverable amount; and
  • Recoverable amount is the higher of net selling price and value in use.

An important practical implication of deprival value reasoning is that many assets will be stated at replacement cost, as entities tend to hold and use assets that they can employ profitably and dispose of those that they cannot.

Criticisms of deprival value

Critics of deprival value assert that it is more complex than other measurement bases. Its use may also give rise to values that differ significantly from market values. Comparison between the values of assets owned by different entities may be difficult where deprival value is used because it reflects the position of the reporting entity. Critics also point out that the calculation of value in use is difficult and may be subjective.

History and current developments

The origin of deprival value is frequently ascribed to JC Bonbright's 1937 work The Valuation of Property.[1] Edwards and Bell's The Theory and Measurement of Business Income (1961) [2] was hugely influential in emphasising the difference between entry and exit values and making the case for replacement cost. Articles by Solomons, David [3] and Parker and Harcourt influenced a generation of accounting scholars.[4] In his 1975 work, WT Baxter seems to have been the first to use the term 'deprvial value'.[5]

During the 1970s deprival value played a major role in the development of accounting in times of inflation, being endorsed by official reports in the UK,[6] Australia,[7] New Zealand [8] and Canada[9] Deprival value also formed the basis of the disclosures required in the United States by SFAS 33.[10]

Although the extent to which deprival value contributed to the failure of attempts to introduce inflation accounting is debatable (see Tweedie and Whittington [11] for a review) there is no doubt that interest in deprival value subsequently declined. It was, however, endorsed in 1999 by the UK Accounting Standards Board in its Statement of Principles for Financial Reporting [12] and has featured in recent collections of articles on accounting measurement.[13]

Most recently, the International Public Sector Accounting Standards Board has discussed deprival value (and its application to liabilities under the 'relief value' model) in a Consultation Paper issued as part of its project to develop a Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities.[14]

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See also

References
  1. WT Baxter "Accounting Values and Inflation" 1975, page 126
  2. Edgar O Edwards and Philip W. Bell "The theory and measurement of business income" 1961. For a modern appreciation see Geoffrey Whittington's ‘What the Old Guys can Tell Us: Edward and Bell's The theory and measurement of business income’ (The Irish Accounting Review, Summer 2008)
  3. Solomons, David "Economic and Accounting Concepts of Cost and Value" in ‘Modern Accounting Theory’, edited by Morton Backer (Prentice-Hall, New Jersey 1966)
  4. Introduction to Parker and Harcourt Readings in the Concept & Measurement of Income (Cambridge University Press, 1969). Also in the second edition edited by Parker, Harcourt and Whittington (Phillip Allan 1986).
  5. WT Baxter "Accounting Values and Inflation" 1975
  6. Inflation Accounting: Report of the Inflation Accounting Committee Her Majesty's Stationery Office, London, 1975. (The Sandilands Report)
  7. Report: Inflation and Taxation Committee of Inquiry into Inflation and Taxation, Australian Government Publishing Service, 1975. (The Matthews Report)
  8. The Report of the Committee of Inquiry into Inflation Accounting, New Zealand Government Printer, Wellington, 1976. (The Richardson Committee Report)
  9. Committee on Inflation Accounting, Report Government of Ontario 1977. (The Alexander Report)
  10. Financial Accounting Standards Board, Statement of Financial Accounting Standards No 33 Financial Reporting and Changing Prices, Stamford 1979
  11. David Tweedie and Geoffrey Whittington The Debate on Inflation Accounting (Cambridge University Press 1984)
  12. Accounting Standards Board, Statement of Principles for Financial Reporting, 1999
  13. For example: The Routledge Companion to Fair Value and Financial Reporting edited by Peter Walton (Routledge 2007); Special Issue: International Accounting Policy Forum Accounting and Business Research (2007); Wanted: Foundations of Accounting Measurement (Abacus Vol. 40, No 1 2010)
  14. International Public Sector Accounting Standards Board Consultation Paper: Measurement of Assets and Liabilities in Financial Statements, 2010 (available at http://www.ifac.org/Guidance/EXD-Details.php?EDID=0150)
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