Bob O'Brien
Head Instructor
bobrien@mywealth.com
There is a really good joke in the accounting world that is really important to know in order to understand the economy, the stock market and the current credit crisis. It is important to realize that there are times when you may have to make your own challenging decisions when calculating your own net worth.
The joke is about an accounting firm looking to hire a recent graduate. The accounting manager has only one question for the candidates. The first candidate walks in and the accounting manager asks, “What is two plus two?” The candidate says “4” and the manager states “don’t call us, we will call you” (obviously no longer a candidate).
The second candidate steps in and the accounting manager asks the same thing, “What is two plus two?” This candidate says “it depends” and the manager states” OK!, you are a really strong candidate and we have one more interview and we will definitely let you know soon.”
The accounting manager asks the third candidate the same exact question, and the candidate answers “What do you want it to be?” The manager says, “You are hired!”
This maybe a little bit of an exaggeration, but not as much as one might think in the world of accounting. The moral to the story is that there are different ways to value assets. Some ways are more aggressive and some are more conservative.
How do you calculate your own net worth?
Calculating your own net worth is more subjective then one might think. Should you count the present value of your defined benefit pension plan? Social Security? How about anticipated liabilities in the future? There really is no absolute correct answer, and what is really important is that you are calculating your net worth from time to time while footnoting things that may seem more subjective.
We see a similar debate going on the world of business currently, when it comes to “mark to market”. Mark to market simply a means by which you can calculate the value of something based on the current market value and not the “book value” that can be much more subjective. The “market value” is objective to all at any given time.
Accounting firms have been forced to value assets for companies using “mark to market” since the accounting scandals of 2001-02. This has caused a certain degree of controversy, because it has forced banks to mark themselves down on their own balance sheets and therefore require more capital.
Banks are always forced to have a certain degree of capital in reserves, which is based on assets. These markdowns reduce the value of bank regulatory capital, requiring additional capital which has been one of the major causes for the current credit crunch! For further reading on this topic please refer to this link: “Mark to Market”
Did you find this article helpful? Please share your comments below. E-mail me any articles that you would like to see written And check out our courses!
Sincerely,
Bob O’Brien
Sr. Instructor
