Valuation of

Tangible Fixed
Assets and
Depreciation
 Introduction

• You are familiar with the distinction between

fixed and current assets, a fixed asset being one
bought for ongoing use in the business.

• Fixed assets are held and used by a business

for a number of years, but they wear out or lose
their usefulness over time. Every tangible fixed
asset has a limited life. The only exception is
land held freehold or on a very long leasehold…
 Introduction
• The accounts of a business recognize that the
cost of a fixed asset is consumed as the asset
wears out, by writing off the asset’s cost in the
profit and loss account over several accounting
periods. For example, a machine costs £1,000
and is expected to wear out after ten years. We
can reduce the balance sheet value by £100
each year. This process is known as
‘depreciation’.
 Definition of Depreciation

• ‘Depreciation’ is an example of the

‘matching’ principle in action. It
represents the diminution in value of a
fixed asset over a period of time. Since
depreciation is a provision, it is important
to calculate this figure as accurately as
possible. The Net Book Value is the
reduced fixed asset value at any point in
time after depreciation.
 Definition of Depreciation

• As a fixed asset has a life of over 1

year and is expected to produce
revenue over a number of years, it is
important to spread the cost of the
fixed asset over these years.
Depreciation accounting is the
process of systematically
allocating depreciation
[expense] to time frames.
 Causes of Depreciation
1) Physical deterioration
i) Wear and tear – When a motor vehicle
or machinery or fixtures and fittings are
used, they eventually wear out. Some last
many years, others last only a few year.
ii) Erosion, rust, rot and decay – Land
may be eroded or wasted away by the action
of wind, rain, sun and other elements of
nature. Similarly, the metals in motor
vehicles or machinery will rust away.
 Causes of Depreciation
2) Economic factors
i) Obsolescence – This is the process of becoming out of date.
For instance, replacing a computer with
old operating system with a new
computer with XP system.

ii) Inadequacy – This arises when an asset is no longer used

because of the growth and changes in the
size of the firm. For instance, a small
ferryboat that is operated by a firm at a
coastal resort will become entirely
inadequate when the resort becomes more
popular, to be more efficient and
economical, the firm may replace it with a
large ferryboat.
 Causes of Depreciation
3) The time factor (the effluxion of time)
Some assets might have a legal life fixed in terms of years.
For example, the patents, and leasehold. You may agree to
rent some buildings for 10 years. This is normally called a
lease. When the years are finished, the lease is worth nothing
to you, as it has finished. Whatever you paid for the lease is
now of no value.

4) Depletion
Other assets are of wasting character, perhaps due to the
extraction of raw materials from them. These materials are
then either used by the firm to make something else, or are
sold in their raw state to other firms. Natural resources such
as mines, quarries and oil wells come under this heading.
 What can be depreciated?
• You can depreciate property only if it meets the
following requirements:
– It is used in business or held for the production of
income.
– It must be expected to last for more than one year.
In other words, it must have a useful life that
extends substantially beyond the year it was placed
in service.
– It is property that wears out, decays, gets used up,
becomes obsolete, or looses value from natural
causes.
• Depreciable property can be either tangible or
intangible
 Tangible Fixed Assets
Tangible Fixed Assets : Assets that
have the four characteristics of being
[TURN] ...
• tangible, you can see or touch
• used in the operations of the business,
• relatively long-lived, and
• not intended for resale.
 Tangible Fixed Assets
• Fixed assets (non-current assets) represent
future economic benefits which are
expected to be consumed at a slow pace
(generaly over more than one financial
year)

• Every fixed asset can be considered an

unexpired expense, and at balance sheet
date a company must review to what
extent the individual asset has been
consumed during the accounting period
 Tangible Fixed Assets
– Livestock (purchased)
– Machinery
– Plant
– Equipment
– Buildings and improvements, fences
– Dams, ponds, or terraces
– Irrigation systems and water wells
– Partial business use
•You can claim depreciation on the part of a
vehicle used in the business (ex - 1/2
business value of a truck)
 IAS 38 - Intangibles
• An intangible is an identifiable, non-
monetary asset without physical substance
- you cannot readily see or touch.

• Main characteristics:
– They meet the definition of an asset
– They lack physical substance
– They are identifiable
 Intangible Fixed Assets
• Specifically identifiable
– Patents
– Copyrights
– Trademarks and tradenames
See anything?
– Franchises
– Organization costs
• Unidentifiable
– Goodwill
 Intangible Fixed Assets
• Purchased property that has value that
Scientific and Technical Knowledge,
• Development of New Processes or Systems,
• Intellectual Property,
• Privileged Customer Relationships,
• R&D,
• Brand Names,
• Copyrights,
• Computer Software,
• Licences,
• Patents
 Natural Resources
(assets subject to depletion)
• Acquisition costs
(capitalized)
• Exploration costs – two
methods
– Successful efforts
(capitalize costs
related only to successful
completion)
– Full costing (capitalize costs
related to all exploration)
 What cannot be
depreciated?
• Property placed into service and disposed of
in the same year.
• Land (land can never be depreciated)
• Inventory
– You cannot depreciate property held for resale in
the normal course of business
• Leased property
– The value of the lease is already showing up as a
rental expense
• Raised Market Livestock (Because there is
no cost to recover)
When depreciation begins & ends?

• Begins • Ends
– When you “place – When the cost of
the property in the item has been
service”. recovered or when
– When it is ready it is retired from
and available for service, whichever
a specific use in
the business happens first

• Example • Example
– When it was – When it is sold or
bought for the is not longer
business useable
 Cost Allocation Processes
• Depreciation (applies to long-lived
tangible assets): The estimated cost
of the utility extracted from
property, plant, & equipment assets.
• Depletion (applies to natural
resources): The cost of natural
resource units removed (e.g.,
mined) from the source of such
natural resources, for consumption
or resale.
 Cost Allocation Processes

Amortization is a term ordinarily

applied to the “writing-off” of some
defined intangible asset, similar to
depreciation when used as a verb.
 Cost Allocation Processes
and Methods

• Depreciable assets – Straight line is

predominant method*
• Natural resources – Units-of-output
is predominant method
• Intangible assets – Straight line is
predominant method
(*) Note: The unit-of-output, e.g., flight hours, may
be used on airplane motors, etc.
 Methods of Depreciation
1. Straight Line Method/Fixed Installment Method
2. Diminishing Balance Method/Reducing Balance
Method/Written Down Value Method
3. Sinking Fund Method/ Depreciation Fund Method
4. Insurance Policy Method
5. Annuity Method
6. Depletion Method
7. Machine Hour Rate Method
8. Revaluation Method
9. Sum-of-the-Years’ Digits Method
10.Depreciation & Repairs Fund Method
11.Group Depreciation Method
 Leasing: Basics
• The lease is a contractual agreement
between the lessor and the lessee.
• The lease gives the lessee the right to
use specific property.
• The lease specifies the duration of the
lease and rental payments.
• The obligations for taxes, insurance,
and maintenance may be assumed by
the lessor or the lessee.
 Advantages of Leasing
1. Leases may not require any money down.
2. Lease payments are often fixed.
3. Leases reduce the risk of obsolescence to
the lessee.
4. Leases may contain less restrictive
covenants than other types of lending
arrangements.
5. Leases may be a less costly means of
financing.
6. Certain leases may not add to existing
debt on the balance sheet.
 Conceptual Nature of a
Lease
According to the FASB:
• a lease transferring substantially all of
the benefits and risks of ownership
should be capitalized.
Transfer of ownership can be assumed
only if there is a high degree of
performance to the transfer, that is,
the lease is non-cancelable.
Leases that do not substantially
transfers benefits and risks are
operating leases.
 Accounting for Asset and
Liability by Lessee
• In a capital lease transaction, the lessee records an
asset and a liability.

• The asset is depreciated by the lessee over the

economic life of the asset.

• The effective interest method is used to allocate the

rental payments between principal and interest.

• Depreciation of the asset and discharge of the lease

obligation are independent accounting procedures.
 Accounting Treatment of
Leasing
 The accounting treatment of lease
transaction in India is as follows:
1.Operating leases are capitalised in the
books of the lessor.
2.Lease payments are treated as income
of the lessor and expense of the lessee
3.The depreciation of leased assets
should be on a basis consistent with the
normal depreciation policy of the lessor
for similar assets…
 contd…
4. Finance leases are capitalised in the
books of lessor but AS-19 issued by
ICAI insists that finance lease must be
capitalised in the books of lessee. This
means:
5. At the time of inception, the leased
equipment is shown as an asset in the
balance sheet of the lessee. Its value is
equated to present value committed
lease rentals. The leased assets is
matched by a corresponding liability
called the ‘lease payable’…
 contd…
6. Lease payments are split into two:
finance charge and principal amount.
Finance charge is treated as revenue
expense and the principal amount is
deducted from the liability ‘lease
payable’
7. The leased asset is depreciated in the
books of the lessee as per its
depreciation policy
Thus, there is divergence
between the tax treatment and the
accounting treatment
 Investments
• Non-current financial assets
• Investments in not-controlled
companies
–Equity participations (shares)
–Long-term receivables / loans
• They should reflect a strategic (long-
term) relationship
• If no long-term relationship (only
speculative purposes) they are
classified as current assets
• Specific measurement rules