ings" must remain in the same category as unaudited
company financial statements.
Evaluation Certificates may eventually become
almost indispensable to companies such as paper,
lumber, or petroleum companies which maintain in
the form of growing forests or underground oil reserves extensive assets which — since their value is not
periodically redetermined through market "turnover,"
may be changing materially in value.
Changes brought about by inflation, or recessions;
changes due to good or poor maintenance; and changes
brought about by new competition are all duly reflected through the medium of net worth accounting.
These are among the reasons for Sheraton's interest
in net worth accounting, and in the proposed depreciation substitutes or net worth factors.
The following illustration presents a comparison
of application of principles of net worth accounting
and ordinary accounting relating to transactions of the
Company for the ten years ended April 30, 1961.
TEN-YEAR PROFIT & LOSS
To April 1961
Net Worth Accounting
Operating Costs and
Net Worth Factor
Net Worth Profit (Note 2)
Income From Operations
Realized Capital Gains
Income From Operations
Note 1 —Takes into account changes in estimated asset values, realized
capital transactions, and differences arising from sales and purchases of common stock at more or less than net asset value.
Adjusted for minority interests. Not adjusted for income taxes
on unrealized appreciation as amounts are based upon a continuing business theory and sale of properties or liquidation are
not ordinarily contemplated.
Note 2 — See table on page 4.
It can be observed from the above tabulation that
earnings are 93 million dollars greater as determined in
accordance with the net worth accounting concept.
It is apparent that this substantial difference can be
related largely to the depreciation reserves provided
under ordinary accounting which do not always reflect
true economic performance. A net worth factor has
been substituted, based on Company officers' estimates
of changes in market value — realized or unrealized
during the period — of real estate as well as other
assets of the Company.
This net worth factor increases reported earnings
(becomes a negative quantity) when net appreciation
in values is indicated.
The improvement in operations reflected by net
worth accounting results largely from the fact that the
market value of Sheraton properties and other assets
held in 1951, together with the cost of subsequent
acquisitions, additions and improvements, — instead
of declining to the extent suggested by depreciation
reserves of $101,000,000 that were recorded — actually
appears to have increased an indicated $8,000,000 in
value as measured by the net worth factor. Accordingly, all in all, the depreciation reserves provided
during the ten-year period were substantially unnecessary, therefore becoming the equivalent of retained earnings. Such an indicated discrepancy, we
believe, should be recognized from year to year if
shareholders are to be properly informed on economic
developments affecting the Company.
It is for this reason that under the concept of "net
worth accounting" we would substitute for a $101,-
000,000 theoretical, and in this instance seemingly
unrealistic depreciation reserve set up for contingencies
which did not materialize, a much more scientific "net
worth factor." It is not hereby contended that aging,
obsolescence, and shrinkages in values due to competition and other causes, are not a very real and ever
present force constantly affecting adversely the value
of income real estate. We believe these ever present
deterrents can be partially, and in our ten-year (and
prior) experience, more than offset by constructive
developments such as good maintenance, effective
merchandising, and especially by investing the
amounts represented by our large depreciation reserves
in improvements, additions, or new acquisitions. The
added earnings from these improvements when
capitalized, usually add enough more, over and above
their cost, to the value of Sheraton properties to compensate at least in part, and frequently more than
compensate for aging, obsolescence, etc.
An example is our experience with another of our
larger Sheraton hotels. We purchased it fairly recently
for approximately 3% million dollars and have since
invested some six million dollars in improvements,
additions, etc. This investment of six millions has
added over twelve millions to the fair market value of
the property as a going business, as measured by
capitalizing the increased basic earnings.
There are, of course, instances, frequent in the
industry, though fortunately rare for Sheraton, when
inadequate maintenance, competition, or other factors
caused properties to decline in value even faster than
was compensated for by depreciation reserves. In such
instances the net worth factor could exceed any normal
permissible depreciation. Ordinary accounting often
obscures such danger signals, sometimes causing costly
repercussions, whereas net worth accounting highlights such developments.
We believe an important task facing the Company
is to clarify to shareholders and to the financial community the basic philosophy behind Sheraton's major
objective of building up net asset values. Sheraton
cannot be judged by yardsticks applicable to companies whose principal product is constantly revalued
through the process of periodic market turnover; nor
can the Company's progress be judged by reported
earnings, due to the variables involved in determing the
large depreciation reserves. It is our belief that Sheraton's rate of growth can only be measured accurately
by true economic changes in net asset values, or measured approximately, by its cash flow.