Pentagon Corrects “Accounting Error.” As Always, The First Casualty Of War Is The Truth

In June, a spokesperson for the Department of Defense announced that the value of equipment transferred to Ukraine, originally valued at $6 billion, was “corrected” to $3 billion. The prior month, the Pentagon had made a similar correction.

Initially, the equipment was valued at replacement cost. That is, the equipment was valued at the cost of acquiring new equipment sufficient to replace the transferred equipment. As corrected, the equipment was transferred at historical cost less depreciation. That is, at the cost of acquisition at the time of acquisition, less an amount determined by the equipment’s expected useful worklife.

The first valuation, replacement cost, supposes the equipment is well-maintained, and thus has the same expected worklife as when it was new. This assumption clearly overstates the value of the equipment. By reason of technological obsolescence as well as physical wear and tear, the value today of equipment acquired in the past is probably lower than its cost at the time of acquisition.

The second valuation, historical cost, supposes the equipment can be replaced today at the same cost as at the time it was acquired. This assumption clearly understates the value of the equipment. By reason of inflation, it probably costs more to replace old equipment now than it cost in the first place.

A third valuation – current cost, or historical cost adjusted for inflation – is kind of a compromise. With this method, periodic depreciation charges are adjusted for cumulative inflation as indicated by a price index; as is the book value of equipment net of depreciation. Arguably, this method – current cost – is fair (meaning, on average correct).

Going back to the 19^th century, railroad corporations tended to report “maintenance expenses” associated with their track and other permanent assets, and rolling stock. These maintenance expenses supposedly enabled the company to maintain the capacity of their road, whether this involved repair of their track or replacing their locomotives and passenger and freight cars as they wore out. Adding to capacity, such as by installing signaling equipment, was supposed to be reflected in additions to the book value of their fixed assets. Of course, these distinctions were subjective, and we might suspect that some railroad companies were more honest with their creditors and shareholders than others, in the reporting of their financial condition.

Later in the 19^th century came a debate on valuation in conjunction with rate of return regulation. Relying on the judgment of railroad managers was no longer acceptable. Some kind of formula had to be used. Initially, because of the long period of deflation that marked the second half of the 19^th century, proponents of regulation argued for current cost valuation because this would lower rates; and railroad men argued for historical cost, because thaat would increase rates.

During the early part of the 20^th century, when inflation – not deflation – was the rule, positions flipped. Regulators suddenly discovered that historical cost accounting was the best, and railroad men discovered that current cost accounting was the best. (As previously stated, current cost would be fair.)

The facility with which parties at interest flip from one to the other side of valuation raises the question: Why has the Pentagon flipped? Obviously, the Pentagon initially wanted to exaggerate the amount of aid being given to Ukraine. Now, because of budget restrictions, the Pentagon wants to minimize the amount of aid given, so it can give more.