A revaluation of fixed assets is a technique that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation, where the recorded decline in value of an asset is tied to its age.
Fixed assets are held by an enterprise for the purpose of producing goods or rendering services, as opposed to being held for resale in the normal course of business. For example, machines,buildings, patents or licenses can be fixed assets of a business.
The purpose of a revaluation is to bring into the books the fair market value of fixed assets. This may be helpful in order to decide whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.
Reasons for revaluation
It is common to see companies revaluing their fixed assets. It is important to make the distinctions between a 'private' revaluation to a 'public' revaluation which is carried out in the financial reports. The purposes are varied:
- · To show the true rate of return on capital employed.
- · To conserve adequate funds in the business for replacement of fixed assets at the end of their useful lives. Provision for depreciation based on historic cost will show inflated profits and lead to payment of excessive dividends.
- · To show the fair market value of assets which have considerably appreciated since their purchase such as land and buildings.
- · To negotiate fair price for the assets of the company before merger with or acquisition by another company.
- · To enable proper internal reconstruction, and external reconstruction.
- · To get fair market value of assets, in case of sale and leaseback transaction.
- · When the company intends to take a loan from banks/financial institutions by mortgaging its fixed assets. Proper revaluation of assets would enable the company to get a higher amount of loan.
- · Sale of an individual asset or group of assets.
- · In financial firms revaluation reserves are required for regulatory reasons. They are included when calculating a firm's funds to give a fairer view of resources. Only a portion of the firm's total funds (usually about 20%) can be loaned or in the hands of any one counterparty at any one time (large exposures restrictions).
- To decrease the leverage ratio (the ratio of debt to equity).
Methods of revaluation of fixed assets
Indexation
Under this method, indices are applied to the cost value of the assets to arrive at the current cost of the assets. The Indices by the departments of Statistical Bureau or Economic Surveys may be used for the revaluation of assets.
Current market price (CMP)
· Land values can be estimated by using recent prices for similar plots of land sold in the area. However, certain adjustments will have to be made for the plus and minus points of the land possessed by the company. This may be done with the assistance of brokers and agencies dealing in land, or by a licensed appraiser.
· Buildings values can be estimated by a realtor (real estate dealer) or Chartered Surveyor (in the UK) in a similar manner to land.
· Plant & Machinery): The CMP can be obtained from suppliers of the assets concerned. However, with efflux of time, many earlier brands are not available in the market due to closure of companies manufacturing them. Similarly, there is change in the models manufactured by a company from time to time. Comparison of assets to most similar types available for sale, new or used, can provide an estimate of value.
CMP of an existing asset = CMP of comparable new asset x Remaining useful life of asset / Original useful life of asset.
Appraisal method
Under this method, technical experts are called in to carry out a detailed examination of the assets with a view to determining their fair market value. Proper appraisal is necessary when the company is taking out an insurance policy for protection of its fixed assets. It ensures that the fixed assets are neither over-insured nor under-insured. The factors which are considered in determining the value of an asset, are as follows:
- · Date of purchase.
- · Extent of use i.e. single shift, double shift, triple shift.
- · Type of asset. Whether the asset is a general purpose or special purpose asset?
- · Repairs & Maintenance policy of the enterprise.
- · Availability of spares in the future, mainly in the case of imported machines.
- · Future demand for the product manufactured by an asset.
- · If the asset is part of a bigger fixed asset, the life of the latter is crucial.
Selective revaluation
Selective revaluation can be defined as revaluation of specific assets within a class or all assets within a specific location.
A manufacturing company may have its manufacturing facilities spread over different locations. Suppose it decides to undertake a revaluation of its plant & machinery. Selective revaluation will mean revaluing specific assets (such as boiler, heater, central air-conditioning system) at all locations, or revaluing all items of Plant & Machinery at a particular location only. Such revaluation will lead to unrepresentative amounts being shown in the Fixed Assets Register (FAR). In case of revaluation of specific assets of a class, while some assets will be shown at a revalued amount others will be shown at historic cost. The same will happen in case of revaluation of all assets of plant & machinery at a particular location only.
It is not consistent to value and depreciate fixed assets using different bases. Therefore, selective revaluation is generally not considered best practice.
Preliminary considerations
Revaluation will typically require liaison between the company's Production Department, Accounts Department, Technical Department and external appraisers. To commission the project they should set out their conclusions to the following questions:
· Why is the revaluation necessary?
· What is the most suitable method, taking into account the type of fixed assets, statutory requirements, availability of required information? Should the values arrived at by one method be crosschecked with the values derived from another method?
· What assets are to be revalued?
· What is the period within which the revaluation has to be completed?
· What guidelines should be laid down for the revaluation?
· What modifications will be required in the FAR to show revalued figures in place of historic figures? Similarly, depreciation will be computed twice. One taking into account the historic cost, and the other as per revalued figures.
