- List and explain the different types of fixed assets and how they are recorded in the financial statements.
- Describe the types of acquisition methods of fixed assets
- State the reasons for revaluation of fixed assets
- List the methods of revaluation
Introduction
In finance, 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 issue shares to existing shareholders (rights issue or follow-on offering).
· 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
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)
· 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.
Important points
· The increase in value of fixed assets because of revaluation of fixed assets is credited to ‘Revaluation Reserve’, and is not available for distribution as dividend. Revaluation Reserve is treated as a Capital Reserve.
· The increase in depreciation arising out of revaluation of fixed assets is debited to revaluation reserve and the normal depreciation to Profit and Loss account.
· Selection of the most suitable method of revaluation is extremely important. The most used method is the appraisal method. Methods such as indexation, and reference to current market prices are also used. However, when these methods are used they are crosschecked with the values arrived at by using the appraisal method.revaluation of loans and bonds is also required;
· When any asset is sold that has previously been revalued, the revaluation within the carrying value is debited to the Revaluation Reserve.
· When assets are revalued, every Balance Sheet shall show for a specified period of years, the amount of increase / decrease made in respect of each class of assets. Similarly, the increased / decreased value shall be shown in place of the original cost.
· In case of land and buildings, revaluation is desirable as their value generally increases over time, and is carried out every 3 to 5 years. In case of plant & machinery, revaluation is carried out only if there is a strong case for it. In case of depreciable assets such as vehicles, furniture & fittings or office equipment, revaluation is not carried out.
· Revaluation should not result in the net book value of an asset exceeding its recoverable value.
