top stories

Share

by John Craner 03 Feb 2001 Diploma in Financial Management Relevant to Paper D1

In 1998 I wrote an article for this newsletter which dealt with the impact on the financial statements of tangible fixed asset revaluation. In that article I characterized UK accounting practice with respect to asset measurement as ‘permissive’ and although this remains the case for the Companies Act rules, the Accounting Standards Board (ASB) has introduced more consistency with the requirements of FRS 11 “Impairment of Fixed Assets and Goodwill” and FRS 15 “Tangible Fixed Assets”. This short article will deal with the basic approach to asset valuation introduced by these standards.

Asset measurement and valuation - The FRS 15 approach
The Companies Act 1985 requires that fixed assets be initially included in the accounts at their purchase price or production cost. However, the Act also allows assets to be included in a balance sheet at their market value or current cost. These need not necessarily be at the current balance sheet date but may be the value as arrived at some previous balance sheet date. The item in the balance sheet described as “Tangible Fixed Assets at cost or valuation” may be made up of some assets at historical purchase price, some at the current market value and others at market values allocated to them at some previous balance sheet date, that is a heterogenous mixture of measurement bases. To achieve total consistency the ASB could have either banned revaluation or made annual revaluation compulsory for all assets – neither of these would have been acceptable to preparers, or necessarily the best solution for users. The compromise solution adopted is to allow preparers the choice of whether to revalue or not to revalue but to impose conditions to prevent ‘cherry-picking’ of which assets are revalued and when.

The basic principles of the FRS 15 approach to revaluation can be summarized as follows:

• Where a policy of revaluation is adopted it should be applied to all assets in an individual class (e.g. land and buildings) but need not be applied to all classes of assets.
• Where an asset is revalued it should be carried at its current value at the balance sheet date. The standard does not insist on full annual revaluations but requires full revaluation every five years, interim valuation in year 3 and interim valuations in years 1,2 and 4 if a material change in value is likely.
• Revaluation gains are normally recognised only in the Statement of Total Recognised Gains and Losses. Gains are only recognised in the Profit and Loss account where they reverse previous losses on revaluation on the same asset.
• Appropriate bases of valuation for different types of assets are set out in the standard.

This approach still gives preparers of company accounts a choice of policy but at least users will know that the policy is applied consistently (if not universally) in the financial statements.

Impairment of fixed asset value
Impairment occurs where the value of an asset to the company falls below its carrying (book) value. Even before the issue of FRS 11 the application of basic accounting principles (and to some extent legislation) would require that where an assets value is impaired it should be written down to the lower value. The contribution of FRS 11 is to set out the principles and methodology by which this approach should be accomplished. The basic approach described in the standard can be summarized as follows:

• A review for impairment of a fixed asset or goodwill should be carried out if events or changes in circumstances indicate that the carrying amount of the fixed asset or goodwill may not be recoverable.
• The recoverable amount is the higher of an asset’s realizable value and its value in use (economic or present value).
• To the extent that the carrying amount exceeds the recoverable amount the asset should be written down and the loss recognized in the profit and loss account.
• The standard provides guidance on how to calculate value in use. In particular, where individual assets values cannot be measured the entity should identify ‘income - generating units’ (that is groups of assets) and apply the impairment principles to these.

Conclusions
The preceding sections of this article set out briefly the basic principles to be applied where asset values differ from their book value. Where assets are being carried at a value higher than the value to the entity FRS 11 requires them to be written down. Where assets are carried at less than their market value preparers have a choice of whether to revalue or not but FRS I5 imposes a consistency of application of this choice. We can see therefore that things have improved since I wrote my article in 1998!

Back to top