One of the key GAAP principles is the use of historical value for assets on the balance sheet. In other words, the purchase price is what’s shown on the balance sheet, regardless of how much the market value may have skyrocketed or plummeted since then. The reasoning behind the use of historical value is that market prices vary greatly and are difficult to prove, since they can change from moment to moment. Historical value, on the other hand, is something that is concrete and can be verified. (Note that there are certain assets, such as certain investments that can be valued at fair market value or some other measurement attribute).
Suppose an asset—land, for example—has actually increased in value. If we wanted to “mark it up” on the balance sheet to its current value, we would have to record a profit on the income statement, but that profit would be based simply on someone’s opinion as to what the land was worth today – not a good idea. Land is kept at the historical value of what was paid on the balance sheet until the land is sold.
(Excerpts from Financial Intelligence, Chapter 11 – Assets)
The fact that companies must rely on purchase price to value their assets, of course, can create some striking anomalies. Maybe you work for an entertainment company that bought land around Los Angeles for $500,000 thirty years ago. The land could be worth $5 million today—but it will still be valued at $500,000 on the balance sheet. Sophisticated investors like to nose around in companies’ balance sheets in hopes of finding such “undervalued assets.”