Depreciation, Impairment, And Revaluation Of Fixed Assets

Calculation of Depreciation

Depreciation: Depreciation is the apportionment of cost of fixed asset over its beneficial life or accounting periods. Depreciation on assets is imposing according to the IRS rules. Businesses depreciate their long-term assets like, machine, truck and many more, for tax and accounting purpose (Mao, & Wu, 2018).

Example: Calculation of depreciation of machine having cost $ 100000, life 10 years and having scrap value $ 10000.

Answers: Using these variables depreciation will be calculated, financial analyst calculates depreciation as the difference of cost, and scrap value fixed asset i.e. machine.

1. $100000-$10000 = $90000
2. $90000/10 years

Amount of depreciation = $9000

There are two methods of charging of depreciation

1. Straight line method = at the same rate on initial value of the asset
2. Written down method= at the same rate on value, remaining after deduction of 1^styear depreciation and so on.

Impairments: It is an accounting principle, which describes the reduction in value of asset on permanent basis (Tan & Trotman, 2018).  Impairment is calculated as the change of book price of the asset and its cash inflow. If the book price of the asset exceeds the money movement of the asset, then the change will be written off as expense permanently. In addition, value of the asset will decline accordingly (Schwarzbichler, Steiner & Turnheim, 2018).

Example: Book value of the asset is $100000 and cash inflow from asset is $90000, difference of $10000 will be written off as expense.

Revaluation losses: Revaluation account is prepared to find out the upsurge or reduction in the carrying value of an asset in comparison to its fair market value. This technique is used to control the just market price of the fixed asset. Revaluation of asset gives either decrease or upsurge in the price of the immovable asset.

Example: Balance sheet value of the machinery is $ 1000000, just market price of machinery is $1100000; prepare revaluation account for the machinery.

Revaluation A/c

Depreciation is an expense charged on fixed asset, as deduction from their market value. Charging depreciation with higher rate has its own benefits to the organization. If the organization expecting higher income bracket in later years, then it would be good to charge higher depreciation on machines for saving the deductions in later years. Depreciation saves the taxes of the organization, by showing as expenditure in the profit and loss account.

Depreciation affects profitability of an organization, as depreciation on assets gives more income to the company. Income from depreciation shown in P/L A/c and increase in value of asset will be shown in B/S of the company.

Example: The machinery has a cost $10000, that was purchased in the year 2015. Depreciation charged on machinery was $1000 i.e. 10%, $4000 is the net income and this will increase the asset value in balance sheet. When stakeholders look at financial statements of the company, they would appreciate the increased net income and increased value of fixed asset i.e. machinery.

Methods of Charging of Depreciation

Changes are required for depreciation, impairment, and revaluation of fixed assets. Depreciation is charged as expense and reflects its value in P & L account of the company as deduction from gross profit of the company.

There are mainly two methods of depreciation, one is straight-line method, and other is written down method. Both the methods have their own significance from view of trade and business.

Changes in depreciation, impairment, and revaluation are directly depending on method of calculation, depreciation rate at which the depreciation is charged and  asset life.

These changes are used to manipulate the earnings of the business. Above quoted three factors, manipulates the depreciation. Following are the techniques used for manipulation of depreciation:

Less depreciation on assets: Charging less depreciation on machines would result in higher profit substantially. In some situation, company wants to show high earnings in their accounts, and then they go for less depreciation for their fixed assets. There are some ways, where companies lower their rate of depreciation within the framework of law, and they need not have to explain the reason of changing the rate of depreciation (Pilcher, 2018).

On the other hand, when company wants to show the less profit in their accounts, then they increase the rate of depreciation (Barker & Teixeira, 2018).   

Life span of the asset: If the machine is used for, more than its estimated or useful life, then written down method of depreciation is used to calculate the amount of depreciation (Brett, 2018). On the other hand, when machine is fully used in its useful life, then the company calculates depreciation using straight-line method of depreciation (Rogge, van der Hurk, Larsen, & Sauer, 2018).

Example: Machine costs $ 10000, having life of 5 years, and rate of depreciation is 10%.

Calculate the depreciation on machinery of the company. Assuming two situations where,

1. When the machine has useful life of five years and will be destroyed after 5 years.
2. When the machine has estimated life of five years but will be taken in use for more than 5 years. 

Revaluating assets: Taking an example of a particular machine, there is a sudden soaring in the demand of a particular machine, this leads to the increase in value of that particular machine (Nijam, 2018).  That is why revaluation of asset is necessary for judging the real price of the asset or just price of the asset in the market. In the balance sheet, the revalued value of asset will be recorded (Azmi, 2018).  

International accounting standards (IAS) 16 Property, Plant, and Equipment outlines the treatment of fixed assets like diverse types of property, plant and, equipment. These assets are primarily measure at its cost; subsequently they are measured by revaluation method. Depreciated amount is allocated over the valuable life of asset (IAS plus, 2018).

Impairments

Recognition: Property, plant, and equipment are known as assets when it is likely that: [IAS 16.7]

• It is feasible that future financial assistances are related with the asset  which will flow to the business and
• The price of the asset can be dignified consistently.
• The principle of recognition is practical to all property, plant, and equipment.

Disclosures:

Information about each class of property, plant and equipment

• Basis on which carrying amount is measured
• Method on which depreciation is calculated
• Life of the asset
• Accumulated depreciation and impairment losses
• Reconciling amount at the beginning and end of the period (Rauf, & Matroud, 2018).
• Additions
• Disposals
• Purchase
• Revision
• Damage
• Depreciation
• Foreign exchange (IAS plus, 2018).
• Additional disclosures
  • Restrictions on pledged as security for liabilities
  • Expenditures on construction during the period
  • Contractual commitment
  • Compensation received from third party

Disclosure for impairment of assets: IAS 36 ensures that the properties are not carried amount more than its recoverable amount. IAS 36 was issued in the year 2004 and applies to the goodwill and intangible assets of the trade (Gunn,  Khurana,  & Stein, 2018). 

Disclosure [IAS 36.126]

• Damage losses recognized in profit and losses
• Impairment losses upturned in profit and loss
• Impairment losses on reappraised asset (Cao, & Donnelly, 2018).

The issue raised by the operations manager of company regarding charge of higher rate of depreciation is notable. Operations manager has the issue that, why management accountant charged higher rate of depreciation on plant & machinery. Reporting of this information will be done within the hierarchy of the flow of information of the company (IAS plus, 2018).

 Firstly, managing director of company report to the top officials of company, after discussion on this issue, information will float to the managerial positions of the company. The benefits of charging higher rate of depreciation will be clearly explain to the managers, who manage the plant and machinery of the company. Relevant clarification and right explanation on depreciation will result in convincing the operations manager. Charging higher rate of depreciation on plant and machinery is done to manipulate the accounts when company wants to show less profit (IAS plus, 2018).  

References 

Azmi, A. F. (2018). Revaluation of Fixed Assets and Future Firm Performance: Determining the Effectiveness of Temporary Tax Cut Policy for Fixed Assets Revaluation in Indonesia.

Barker, R., & Teixeira, A. (2018). Gaps in the IFRS conceptual framework. Accounting in Europe, 15(2), 153-166.

Brett, T. (2018). Determining the Useful Life of Infrastructure Assets.

Cao, T., Shaari, H., & Donnelly, R. (2018). Impairment reversals: unbiased reporting or earnings management. International Journal of Accounting & Information Management, 26(2), 245-271.

Gunn, J. L., Khurana, I. K., & Stein, S. E. (2018). Determinants and consequences of timely asset impairments during the financial crisis. Journal of Business Finance & Accounting, 45(1-2), 3-39.

IAS plus. (2018). IAS 16- Property, Plant and Equipment. Retrieved from: https://www.iasplus.com/en/standards/ias/ias16 

Magnan, M., & Parbonetti, A. (2018). Fair value accounting: a standard-setting perspective. In The Routledge Companion to Fair Value in Accounting (pp. 59-73). Routledge.

Mao, C. W., & Wu, W. C. (2018). Does the government-mandated adoption of international financial reporting standards reduce income tax revenue? International Tax and Public Finance, 1-22.

MoneyWorks4me. (2018). Depreciation calculation. Retrieved from: https://www.moneyworks4me.com/investmentshastra/ 

Nijam, H. M. (2018). Motives for Reporting Fixed Assets at Revalued Amount: Evidence from a Developing Economy. Global Business Review, 19(3), 604-622.

Pilcher, R. (2018). Depreciation in local government—still the problems continue. In Public Sector Accounting, Accountability and Governance (pp. 30-42). Routledge.

Rauf, N. A., & Matroud, S. J. (2018). The effect of depreciation the methods of extinction on the identification of the tax base applied research for a sample of the listed companies listed in the Iraqi Stock Exchange. International Journal of Research, 5(01), 560-585.

Rogge, M., van der Hurk, E., Larsen, A., & Sauer, D. U. (2018). Electric bus fleet size and mix problem with optimization of charging infrastructure. Applied Energy, 211, 282-295.

Schwarzbichler, M., Steiner, C., & Turnheim, D. (2018). Impairment of Assets (Fixed Assets and Goodwill). In Financial Steering (pp. 343-370). Springer, Cham.

Schwarzbichler, M., Steiner, C., & Turnheim, D. (2018). Impairment of Assets (Fixed Assets and Goodwill). In Financial Steering (pp. 343-370). Springer, Cham.

Tan, H. C., & Trotman, K. T. (2018). Information Processing Biases in Impairment Decisions: Effect of Reversibility of Impairment Losses and Disclosure Transparency. Behavioral Research in Accounting.

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