Non-current assets are assets held for longer term, usually because they are one of the classes property, plant or equipment. They are usually initially bought as investments and either are essential for operations of a business or increase the profitability of the business.
One framework to look at non-current assets is in terms of life cycle stages : acquiring , holding, disposal.
- 1 Fair value
- 2 Carrying value
- 3 recoverable value
- 4 value in use
- 5 Value relationships
- 6 Acquiring, holding , disposal
The value that can be achieved in an arm's length transaction, after sales costs , or cost of disposal.
The value as recorded as the asset's debit amount, less the accumulated depreciation.
Usually the same as the fair value but can be value in use, if it is higher.
value in use
This may involve a lot of forecasting . For the intended time the asset is held, an estimate is made of the future cash flow generated in, and the future cash flow costs out, extrapolated back according to low-risk interest rates to present value (the future cash flows would have estimates of inflation and budgeted price increase though). This quantification of future economic benefit is added to the net cash flow from budgeted disposal.
- The target value is the lower of x and y where y is the higher of a and b, where x = current carrying value , y = recoverable value, a = fair value less disposal costs, and b = value in use less disposal costs.
- The aim is not to overstate the value, without secondarily understating it.
Acquiring, holding , disposal
These are the stages that costs may need to be recalculated.
- a non-current asset is valued as the fair value of the assets given up in exchange for acquiring the non-current asset.
Issues dealing with acquisitions are:
- when to capitalize or expend, if acquiring an asset that requires repairs, modifications to bring it up as fit for use to generate future economic benefit. Some "enhancements" may be better written down as expenses if they can't be justified as major repairs or modifications , that for instance, undergo depreciation later.
- fair value proportioning of non - whole business multiple package acquisitions. This means if one historical cost is applied to acquire a group of assets, each asset needs to be assessed for fair value, and the total of fair values found to be the denominator for each fair value to act as numerator to find the proportionate initial booked cost of each asset. This is because of the value if asset given up rule, meaning the total of book values must equal the value of asset given up ( cash even), in the non-business combination case.
- goodwill (intangible asset) or bargain (gain income) can be recorded for whole businesses acquired at cost different to fair value, as the business combination of your entity and the acquired entity means the acquired entity's assets are booked at fair value under the subsidiary entity.
- current assets acquired under the above two cases are recorded at fair value (and aren't included in apportioning in non business combination case), unless it is a debtor account ( accounts receivable), then the difference between book value and fair value can recorded as a credit to bad debt allocation if fair value is lower.
Other points to consider:
- liabilities can be acquired, like accounts payable, and a are similarly credits to the entities accounts payable liability , like acquired bad debt allocations.
- shares are liquid assets which have a fair value when disposed of, and can be exchanged at fair value for acquisition of non-current assets.
Goodwill applies to business combinations, where the asset being bought is a whole business and not the assets of a business.
Goodwill is recorded separately as a form of intangible asset on acquisition , and impairment expenses can be recorded against it ( see impairment of non-current assets ). Goodwill cannot be onsold, but another entity can purchase the subsidiary business with a new agreed amount of goodwill.
Sometimes, the acquirer or buyer pays less than the fair value of the assets making up the acquired business, so the opposite of goodwill is a bargain, which is classed as an other income or gain (not arising from normal operations, and hence not profit ), and equals the total fair value of the acquired business's assets , less the bargain amount paid to acquire it, as agreed to by the acquiree ( the former owner ).
held assets - depreciation
There are several methods of depreciation available. The most easily understandable are straight line depreciation , and unit of use depreciation. They all share in common a target residual value in order to give depreciable amount, and the concept of useful life. Useful life can be thought of simply as time e.g. years, but in units of use depreciation, it can be number of units produced, number of operating hours, tons of raw material processed , etc. Another kind of depreciation is diminishing balance, where there is logarithmic rate of depreciation, e.g. a fixed % of the remaining balance of asset value after subtracting accumulated depreciation is determined to be the current period's rate of depreciation. This might be applied to an asset that exhibits greater ability for producing economic benefit when newer and more efficient.
If beginning with the concepts of useful life and residual value, the diminishing balance method can be easily expressed with the years-remaining-over-sum-of-years method, where the ordinal values of each year in the useful life is summed to give the denominator (e.g. 3 years useful life, 1 + 2 + 3 = 6), and the years remaining of life is the numerator, of the rate of depreciation for a given year (e.g. year 1 is 3/6, year 2 is 2/6, year 3 is 1/6). ( The rate of depreciation is applied to the initial cost of the asset, not the cost less accumulated depreciation).
When analysing income statements to determine cash flow, depreciation is a non-cash expense and should be added back in as it doesn't contribute to outflow of cash like other expenses do eventually.
held assets - impairment testing and revaluation model
- If there is an indicator that the book value of an asset is greater than the recoverable value, than assessment of the recoverable value is made, and if the suspicion is correct, then the asset has an impairment loss expense and accumulated impairment loss contra-asset recorded. The accumulated depreciation can be renamed accumulated depreciation and impairment loss in order to summarise negative changes to asset value.
- assets held at historical acquisition cost are following the cost model until a revaluation is made, and then they are in the revaluation model, and a revaluation surplus equity account is created for the asset (assuming the asset is going to be re-valued higher). The asset is debited for the surplus and the revaluation surplus equity account is credited for the surplus. Any accumulated depreciation should be written-back to the asset, just as in disposal, to come to the new re-valued asset value, with zero accumulated depreciation.
For downwards re-valuation, it is similar to asset impairment, except the expense of the lost amount from re-valuation is not recorded against accumulated depreciation and impairment loss contra-account, but against the asset, since previous accumulated depreciation and impairment loss will be written back in the process of revaluation.
- A downgrade from either impairment testing or revaluation should be credited to revaluation surplus until it reaches zero. Then revert to either crediting the asset account if doing revaluation, or crediting the impairment loss contra account ( sometimes combined with accumulated depreciation contra-account) if doing impairment assessment.
- depreciation and impairment losses still apply as usual, in the revaluation model, after revaluation has been made.
held assets - minor repairs are expensed, whereas major repairs are capitalised
When a major repair is performed , this can be added to the asset , along with accumulated depreciation, in order to come up with a new asset value. Otherwise minor repairs are expensed against accounts payable or cash, but disposal expense of remaining depreciation value of old parts for major repairs are expensed against the asset (expensed against means act as credit side of double entry to a debit expense).
A pre-step in disposal is to always check the date of disposal and calculate any unrecorded depreciation upto the date of disposal, and make a debit to depreciation expense against a credit to accumulated depreciation , to update accumulated depreciation, prior to making the recordings for disposal.
The former heuristic was to record disposals at book value (carrying amount) as a kind of disposal expense debit, along with a zeroing debit to accumulated depreciation (contra-asset), against a credit for the acquisition or revalued cost of the asset (the historical cost as recorded not including accumulated depreciation). A separate transaction was a credit of the purchase price to a special income account credit "proceeds from sale" , against a debit to cash in bank ,or in the case of exchange, against a debit to the new non-current asset account of the asset being acquired.
The new net method is to record the difference between the carrying amount and the sale price as a gain or loss, and any loss on scrapping of assets with residual value or loss on scrapping from removal costs as a net loss. The net gain or loss is then reported in the income statement, which previously could only be shown if a separate entries of disposal expense (residual value and disposal costs) and proceeds from sale were two items shown in the income statement regarding the assets disposal. This net method of asset disposal disclosure loses the disclosure of the residual value of the asset at disposal in the income statement.
- If the proceeds from sale is less than the book value, then the loss will be shown in the income statement when profit = income minus expenses. Gain is similar.
- if the proceeds from sale is less than the fair value, but the fair value is greater than the book value, then the above still applies. But if proceeds from sale < fair value < book value, there may be an argument to do some fancy book work and record the impairment in asset value , e.g. as a impairment loss expense debit, and a accumulated impairment loss credit ( viewing impairment as a depreciation-like contra-asset account ). Some authorities suggest renaming accumulated depreciation to accumulated depreciation and impairment loss.
- The other cases are book value < proceeds from sale < fair value, and book value < fair value < proceeds from sale. In the latter case, no one is worried who has put money in the company because a gain was made, but in the first a loss was made, despite the books showing a gain. Ideally , the book value should be revalued to fair value, the revaluation surplus recorded, and the book value adjusted before the sale. Then the loss would be shown in the income statement.