Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
Mr. Graham and Mr. Dodd point to the acute impact of inadequate depreciation policies used by public utility companies. As usual, this is done to inflate earnings. The authors go into various examples of tricky accounting within the chapter and in the appendix.
The writers describe various depreciation policies but lean towards using an income tax basis given various logical reasons. However, some exceptions should be carefully analyzed by the analyst.
The authors teach us to use Businessman's thinking in evaluating appropriate depreciation and amortization policies for calculating earning power of a company. The writers introduce the concept of minimum depreciation charge to properly reflect cash generated from operations. The residual depreciation charges are related to the obsolescence of fixed assets and are related to business risk. For real estate concerns, the rules are different when it comes to using depreciation to reflect reality.
Wherein depleting resources such as ore, oil reserves, or patents are concerned, the authors walk us through calculating the appropriate depletion charges based on the current price of the concern.
Mr. Graham and Mr. Dodd spend time explaining how putting inventory reserves in the surplus account can almost, in most cases, result in earning overstatement.
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