Setup On the Chart of Accounts
All transactions in connection with the acquisition of works of art are accounted for through a category level account, Fine Arts, established on the Chart of Accounts and coded in Quickbooks as a Fixed Asset. For a client with a modest collection, a dedicated subaccount may be established for each piece. Large collections, however, demand a dedicated subsidiary ledger to provide the scale necessary to organize a comprehensive and detailed relational database. Before discussing the organization of fine art assets within the general ledger, an understanding of the transactions associated with the purchase of art is in order.
The Six Elements
The accounting for the purchase of a work of art encompasses the six elements of a financial transaction:
- Reporting entity: The entity acquiring the work of art. The entity could be a family member or it could be a foundation or other legal entity such as an LLC or a revocable or irrevocable trust.
- Date: The date the acquisition is legally consummated. This may be the date on which a $6,000 Hockney lithograph is charged to the Amex card. Or it could be the date that funds to procure a $15 million Ruscha oil painting are transferred to the seller upon close of escrow. The purchase of a significant piece of art may have an escrow that is no less substantive than one associated with the purchase of a home. A noteworthy work of art may, after all, cost more than the residence in which it will hang.
- Amount: The purchase price or other value assigned to the piece. This may be readily ascertainable: it could simply be the price paid for the work. If the work is acquired via a gift from another family member, the value would be determined through an appraisal, an estimate or other means.
- Name of transacting party: The gallery, individual or entity from whom the work was acquired.
- Account to debit: An asset category, fine arts. As will be seen, to preserve the carryover tax basis attached to a gift, the acquisition value may be split between two balance sheet accounts: the purchase price subaccount and the valuation adjustment subaccount.
- Account to credit: The account or accounts out of which funds were drawn and/or borrowed to purchase the work. If the piece is acquired as a gift, the Gift income account would be credited.
There is a proactive way and a reactive way to account for any financial transaction and accounting for fine art is no different in this regard. A responsive database anticipates the informational needs of the users and that means infusing the system with content relevant to the financial management of fine art. When Roberta Roberts contemplates the purchase of her twentieth Warhol, a large canvas titled Campbell’s Tomato Soup No. 5, her decision may be influenced by factors unique to the fine arts asset class. She may ask: how many Soup Can paintings do I already have? Is my Warhol collection too heavily weighted with pieces from the early and mid 1970s? Should I sell a Warhol in inventory to fund the new purchase? The financial database should capture sufficient data to facilitate Roberta’s decision making including: the name of the piece, the date of the composition, the condition, the purchase price, the fair market value. The data should be organized in a format that is clear, understandable and easily extracted. That requires a general awareness of those characteristics and nuances unique to art. No pun intended, there is an art to accounting for fine arts.
In addition to the financial data embodied in the six financial elements, a work of fine art carries ample supplementary information pertinent to identifying and cataloging the asset such as:
- Name of the artist (i.e., John Baldessari)
- Name of the piece (i.e., Two men at Stonehenge)
- Medium of the work (i.e., painting, screenprint, sculpture, woodcut, lithograph, etc.)
- Date of the work
- Edition number and edition size (i.e.: 46/200)
- Dimensions (i.e., 62” x 132”)
- Signature data (i.e., signed in pencil on the verso)
- Condition of the work (i.e., museum quality, minor fading, some soiling at that margins, crease in left corner)
- Parties involved in the transaction (the art consultant who brokered the deal; the appraiser who valued the art, etc.)
Content indexing is critical. When the principal considers donating the sculpture Tuna Wearing a Sombrero to his alma mater, the information pertaining to the granite composition must be efficiently retrieved from an inventory of potentially hundreds of works within the financial database. How can the accountant zero-in on the relevant data from thousands of records of information? Supplementary data serves to identify and index the individual works of art within a collection and is generally manifested as keywords in a memo entry or in the description field of the account setup window. The financial data for Tuna Wearing a Sombrero may be located using the Quickbooks Find tool or by the Google Desktop Search icon.
Alternatively, Tuna Wearing a Sombrero may be the title of a dedicated account in the Fine Arts subsidiary ledger. The financial data for the sculpture may found by scanning the chart of accounts in search of the account name. In either scenario, the accounting system is populated with data that facilitates targeting and extracting the information utilized in decision making.
Subsidiary Ledger for Large Collections
A substantial art collection demands a subsidiary ledger. A subsidiary ledger limited to fine art affords the accountant the scale necessary to set up a dedicated account for each work of art. A collection may be comprised of hundreds of pieces – establishing a separate account for each piece in the general ledger would be impractical and bog down efficiency. A subsidiary ledger provides the Business Manager with the flexibility to structure and organize a true fine arts database and replaces the Excel schedules that less efficiently accumulate the same data in a legacy accounting office.
The name for each dedicated account on the Chart of Accounts corresponds to the title of the composition. Three subaccounts would capture, respectively, the purchase price, ancillary costs and a valuation adjustment (discussed later). Category levels may also be established for each artist and possibly each medium. Financial transactions relating to the Richard Serra screenprint Path & Edges #2 would be accounted for in an account named Path & Edges #2. Path & Edges #2 would, in turn, be subordinate to a category-level account titled Richard Serra. The media (painting, print, sculpture, etc.) may be positioned as the highest category level with the artist a subordinate category as in the following hierarchical tree:
Marilyn No. 3
Living Room No. 4
Cow Going Abstract
Alternatively, the hierarchy may be arranged with the artist in a superior ranking and the media in a subordinate category:
Marilyn No. 3
Living Room No. 4
Cow Going Abstract
Either approach is acceptable, but the latter is probably more practical since any search is typically driven by the artist name.
Three Subaccount Structure
Three subaccounts are assigned to each work of art:
The Purchase price subaccount isolates the amount paid for a work of art exclusive of extraneous costs not associated with the creation of the work itself. For acquisitions via gift or inheritance, the purchase price subaccount generally records the donor’s carryover tax basis in the asset. The Ancillary costs subaccount captures any expenditure made in connection with the purchase but not directly linked to the creative process. Items posted to the ancillary cost subaccount would include: the cost of framing or mounting the piece; amounts paid in connection with transporting the work from the gallery to a residence; fees paid for authentication, research and legal fees associated with the acquisition and other related costs. The third subaccount, Valuation Adjustment, is used to record the journal entry required to mark the work of art to fair market value. A comprehensive discussion of each of the three subaccounts will follow.
The goal in proactive accounting is to organize information in a format that facilitates analytic review of the financial data. The three subaccount structure for fine arts achieves this goal and brings transparency to the books in a concise and logical scheme. A quick perusal of the balance sheet report concisely summarizes the most pertinent information to analysis and decision making: purchase price, ancillary costs, and valuation adjustment. Assuming the accounting is current, the valuation adjustment gives a good approximation of the realized taxable gain should the work be sold.
In the legacy office an art inventory would typically be maintained on an Excel spreadsheet. Columns in the spreadsheet would delineate index items (artist name, piece, date, etc.). Each row would contain the data pertaining to a particular work of art. But as we know, Excel produces a static spreadsheet and not a dynamic database. Maintaining the information in the GL standardizes the data in the same accounting system and utilizes the database capabilities inherent in accounting packages.
Purchase Price Subaccount
The purchase price sub-account captures the contracted sales price for a work of art. The price paid for the piece may be greater or less than the retail list price and any adjustments to arrive at the bottom line should be recorded. If the seller grants a discount, both the gross sales price and the markdown are posted to this account. For example, Patty Patterson purchases a Pollack print from the Paul Paulson gallery in Peoria. The list price for the print is $35,000. Paulson agrees to give his favorite client a 10% discount and sells the piece for $31,500. Both components of the transaction are recorded in the purchase price sub-account:
Paul Paulson Gallery Dr 35,000 Gross sales price
Paul Paulson Gallery Cr (3,500) 10% discount offered by Paul Paulson
Why post the discount? Why not simply enter the cost at $31,500? That is, after all, the amount charged on the Citbank card. Price concessions are recorded because Proactive Accounting anticipates the prospective informational needs of management. The discount represents a record of information with material future utility. In three years when Patty Patterson wanders into Peoria she may call the CFO and ask, Hey Preston, how much of a discount did Paul Paulson give me on that Pollock print? Patterson’s CFO can answer the question on the spot: the data is in the database and no one needs to embark on a fishing expedition to locate a three year old invoice. The Proactive approach eliminates the let me get back to you in half an hour syndrome.
At the time a journal entry is recorded every effort should be made to accumulate supplemental detail conveying informational value. In this example, the memo associated with the discount specifically identifies Paul Paulson as the individual offering the markdown. The Paulson gallery may be owned by two or more partners and employ several sales consultants. Specifying the name of the individual offering the discount may or may not be of any consequence. Incorporating that secondary information into the database is a preemptive action.
If the work of art is acquired via a gift from a relative or friend, the purchase price account would record the donor’s cost, thereby preserving the carryover tax basis. The purchase price account should always be maintained with the intention that this is the primary account out of which taxable gain or loss is computed. Ancillary costs may also augment basis for measuring taxable gain or loss but those amounts are captured in a separate subaccount. The acquisition of art by inheritance may yield a step-up in basis of the asset. The accounting for artwork transferred via a gift or inheritance is discussed later.
A marital dissolution may call for the division of an art collection. In theory, each spouse had a preexisting interest in the community property or marital estate. The collection items awarded to each party therefore represent distributions from the previously jointly owned property. As with a gift, each item so distributed will retain a carryover basis that would be preserved when transferred to the separate property GL. The agreed upon fair market value of assets per the judgment would also be recorded in the ledger.
Ancillary Costs Subaccount
The ancillary costs subaccount accumulates supplemental costs proximate to the purchase of a work of art. Sales tax, VAT, shipping, inspection, framing, transfer insurance, restoration, commissions or consulting fees (if paid by the buyer), appraisal and temporary storage are examples of such ancillary outlays. These overhead expenses may be sizeable, particularly when in connection with the purchase of a significant work of art.
After much thought and debate Aaron and Ann Aarons decide to add a noteworthy painting to their quarter-billion dollar collection of Pop Art. They purchase a $22 million Roy Lichtenstein triptych from the ultra exclusive Galleriè Gââjââjèè in Beverly Hills. Their due diligence leading up to the closing included utilizing the services of a prominent art historian and expert on Pop Art who authenticated the piece; a restoration expert who cleaned a smudge on one corner of the canvas; an art consultant who brokered the deal; an attorney who reviewed the purchase and sale contract and a professional installer specializing in hanging large pieces of art. Other costs included a nail-to-nail policy insuring the painting from the point the painting left the gallery to the point that it was successfully mounted on the wall of the Aaron’s den; a custom designed cleat for hanging the piece and the armed delivery service to transport the piece from the Rodeo Drive gallery to the Bellagio Road estate.
Ancillary costs on a significant acquisition can alone add up to more than the cost of a mansion in some parts of the country. The sales tax alone on a $20 million painting could be close to $2 million. The time to shove all of this information into the database is when the transaction is fresh in everyone’s mind and the purchase documentation is readily at hand. It also means maintaining open communication channels among the staff and keeping everyone informed of the status of the transaction. Some ancillary costs may miss being capitalized to the work of art if the bookkeeper is unaware of their link to the piece.
The out of pocket price paid for of a work of art may exceed the “list” price. If the art is acquired at auction, a buyer’s premium is generally added to the hammer price of the lot. The buyer’s premium may range from 10% – 20% and represents the administrative overhead to the auction house. The buyer’s premium is posted to the ancillary cost sub-account. Some might argue that, as on a discount, this premium should be posted to the purchase price sub-account. However, a discount represents an arms-length adjustment to the price and is therefore distinct from a premium charged as a fixed percentage of the strike price. In this regard, the premium is more akin to a tax and represents a cost of doing business rather than a negotiated price concession based on market conditions.
The cost of a frame may be included in the purchase price of a work of art. When the purchase is recorded in the ledger the price should be allocated between the composition and the frame. An estimate of the value of the frame is required to complete the journal entry. The cost of the frame can generally easily be determined by calling the gallery and requesting the value. For an unframed piece the cost of the framing will be readily apparent and included in the invoice.
The purchase price of a work of art and all of the capitalized costs could be accounted for out of a single account. However, segregating the ancillary costs isolates the pure cost of the painting itself in a single reference account. Isolating the purchase price facilitates the computation necessary to mark the piece to market via a valuation adjustment. The ancillary cost account also accumulates any costs that augment the tax basis for purposes of computing gain or loss on the disposition of the art.
Restoration & Repair Costs
Restoration and repair costs are recorded in the ancillary costs sub-account. These costs may not be insignificant. In 2006 Las Vegas resort and casino magnate Steve Wynn accidentally planted his elbow through the oil painting Le Rêve, a Picasso he had only days before agreed to sell to hedge fund mogul Steven Cohen for $139 million. The accident left a two inch puncture in the canvas. The prized painting subsequently underwent a painstaking eight week rehabilitation by a world renowned restoration expert. The cost for the repair: $90,493. This expenditure is capitalized directly to the painting and debited to the linked ancillary cost subaccount. When a work of art is damaged an insurance claim is sure to follow. The recovery of any insurance proceeds to reimburse for the repair costs would be recorded as a credit to the ancillary cost account (and a debit to cash). Insurance proceeds in excess of the actual repair costs may result in taxable income, in which case the accounting should be adjusted accordingly.
Valuation Adjustment Subaccount
The third sub-account for a given work of art captures the adjustment necessary to mark the asset to fair market value. This account is identical in theory to its counterpart for financial securities. Unlike publicly traded stock, however, the value of artwork generally is not readily determined – there is no public exchange reporting bids and asks on oil paintings. The valuation of art is typically established in an appraisal by a qualified appraiser. The appraisal report identifies each work of art and assigns a fair market value. The appraiser determines the piece’s worth based on research of auction results, pricing surveys, gallery inquiries and other means. The difference between the net amount paid for the piece, exclusive of ancillary costs (as reflected in the purchase price sub-account), and the valuation per the appraisal, is the amount that is debited or credited to the adjustment account to mark the piece to market. An example will illustrate the relationship between these three sub-accounts.
Wendy Wendell purchased a Warhol soup can print, New England Clam Chowder, in 1999 from the William Walters Gallery for $4,500. She also paid $425 in sales tax and $575 for framing. The GL initially reports the total value of the print as $5,500 ($4,500 + $425 + $575). In January 2010 Wendy makes a New Year’s resolution to have her single-piece art collection appraised and to finally secure the proper insurance. She calls upon Wallace Wolcott, a renowned art appraiser. Wolcott issues his report and Wendy is thrilled: her collection is currently worth $23,500. Wendy’s GL will now show a valuation adjustment on her art in the amount of $19,000, the difference between the current fair market value ($23,500) and the purchase price ($4,500). As with stock held in a brokerage account, the debit to the valuation adjustment is offset by a credit to unrealized gain. Wendy’s GL shows the following activity in her fine arts section:
Dr Purchase Price 4,500 Cost
Dr Ancillary costs 425 Sales tax
Dr Ancillary costs 575 Framing
Dr Valuation Adjustment 19,000
The $19,000 adjustment is posted as of the appraisal date. The associated memo should reference the name of the appraiser and the date of the appraisal: Per Wallace Wolcott Valuation Services report dated 01/11/10. In reality, the value of Wendy’s Warhol appreciated gradually over a period of 11 years. The one-time adjustment in the year of the appraisal represents a compression of the true time frame for the increase in value. In theory, the accountant could amortize the adjustment over several years but, for practical purposes, the single-year adjustment is a reasonable compromise.
Although the art market has consistently escalated in recent years, events or circumstances may trigger depreciation in the value of a work of art. Steve Wynn purchased Le Rêve in 2001 for $60 million. Steven Cohen’s consent to pay Wynn $139 million for the Picasso established a new fair market value in an arm’s length transaction. A $79 million debit to valuation adjustment marked the painting to this new value on Steve Wynn’s books. After Wynn elbowed the painting, an appraisal revalued the work at $85 million, a $54 million decline. On the date of the calamity the valuation adjustment account would be credited for $54 million and unrealized loss would be debited for the same amount. The roller coaster ride in the value of Le Rêve highlights the magnitude that fluctuations in the value of art may have on a family’s wealth. Subsequent to the reappraisal, Steve Wynn filed a $54 million claim with Lloyds of London followed by a lawsuit for the same amount. Wynn and Lloyds eventually settled out of court.