Asset Management: Asset Valuation

Non-current Assets

Non-current assets are assets held for use in the business over more than one year, not for resale. They include tangible assets, such as land, buildings, machinery, vehicles, furniture and computers, and intangible assets, such as goodwill, patents and software licences. Their function is to provide the capacity to produce goods and services, so their cost is spread over their useful lives through depreciation.

Valuation of Non-current Assets

Non-current assets are normally valued at cost, meaning the purchase price plus costs of getting the asset ready for use, such as delivery and installation, less accumulated depreciation. Some organisations revalue certain assets, such as land and buildings, to market value (fair value), the price they would fetch in an open market. Net realisable value (NRV), the expected selling price less costs of selling, is used when an asset is to be sold, or to test whether its value has fallen below its carrying amount.

Current Assets

Current assets are assets expected to be sold, used or turned into cash within twelve months, such as inventory, trade receivables, prepayments, bank and cash. Their function is to support day-to-day trading and provide liquidity to pay debts.

Valuation of Current Assets

Inventory is valued at the lower of cost and net realisable value, where cost is found by FIFO or AVCO (LIFO is not allowed under IAS 2, though it may appear in internal records and examinations). Some organisations use the replacement cost method for internal purposes, valuing stock at what it would cost to buy now. Trade receivables are valued at the amount expected to be collected, after the provision for bad debts, and cash and bank at their actual amounts.

Here you are valuing inventory at the lower of what it cost and what it can be sold for. First work out the net realisable value: the expected selling price minus any costs still needed to sell it, such as repairs or commission. Compare it with cost item by item, and take the lower figure for each item. Below, we show you how it is done, step by step.

Source Documents

On acquisition, the supplier's invoice gives the cost and the supplier's details, and for cash purchases the receipt shows the cash price paid. The delivery note and GRN confirm that the asset was received. The manual book or specification sheet gives the model, serial number, expected useful life and maintenance needs. Costs of delivery, installation and testing are added to cost, while VAT is excluded if it can be claimed back.

Here you are working out the cost of a new asset from its documents. Start with the price on the invoice, less any trade discount, then add only the costs needed to get the asset to its place and ready to work, such as delivery, installation and registration. Leave out running costs such as insurance, fuel, servicing and staff training, and leave out VAT that can be claimed back. Below, we show you how it is done, step by step.

Straight Line Method

The straight line method charges the same amount every year: (cost - residual value) ÷ useful life. It suits assets that are used evenly over their lives, such as furniture and buildings.

Here you are spreading the cost of an asset evenly over its life, so every full year gets the same charge. Subtract the residual value from the cost, then divide by the number of years; if a rate is given instead, multiply the cost by the rate. If the asset was bought part-way through the year, charge only for the months it was owned, if the policy says so. Below, we show you how it is done, step by step.

Reducing Balance Method

The reducing balance method charges a fixed percentage of the net book value each year, so the charge is highest in the first year and falls over time. It suits assets such as vehicles and computers, which lose value fastest when new.

Here you are charging a fixed percentage of the asset's value that is left, so the charge gets smaller each year. Each year, multiply the opening net book value (not the cost) by the rate, then subtract that depreciation to get the new NBV. Carry the new NBV into the next year and repeat. Below, we show you how it is done, step by step.

Sum of the Digits Method

The sum of the digits method also charges more in the early years. The years of useful life are added (for 4 years, 1 + 2 + 3 + 4 = 10), and each year's charge is a fraction of (cost - residual value), using the remaining years as the numerator: 4/10 in year 1, 3/10 in year 2, and so on.

Here you are charging more depreciation in the early years using fractions. Add up the years of the asset's life to get the bottom number of each fraction, then find the depreciable amount (cost minus residual value). In year 1 the top number is the full life, and it falls by one each year after that. Below, we show you how it is done, step by step.

Comparing the Methods

The table compares the first two years' depreciation of the machine under each method.

Double Entry for Non-current Assets

When an asset is bought, debit the asset account and credit bank or the supplier, recording additions at cost. Each year, depreciation is recorded by debiting the depreciation expense (charged to the statement of profit or loss) and crediting the provision for depreciation account. The asset account stays at cost, and the NBV is cost less the provision. Both accounts are balanced at the year end.

Showing the Asset in the Statement of Financial Position

At the end of year 2, the machine is shown at cost $22,000, less accumulated depreciation $10,000, giving an NBV of $12,000, which agrees with the fixed asset register. Regular comparison of the register, the ledger and a physical count of assets confirms that the asset values are complete and correct.