Putting a price on assets is an important part of any business’s responsibilities – but what does it involve? Close Brothers Asset Finance’s Transport CEO, John Fawcett, explains more.
What are the legal principles involved in valuing assets?
The Companies Act 2006 requires a business’s accounts show a fair and reasonable value of the cost of an asset at the outset and also throughout its life. But showing this isn’t simple because assets are used in different ways. A truck, for example, which is run lightly will be worth more over time than a unit run 24/7 and accounting principles allow for a business to reflect this in their accounts.
Also, procedurally, directors must detail fixed tangible assets at cost, less depreciation at rates calculated to write off the cost, less estimated residual value of the asset, over its useful expected life.
So why would a business ever want to revalue their assets?
One major reason is the need to understand the equity and risk position a business has against the debt owed on those assets. For example, a company may be looking to restructure their debts to manage monthly cashflow, release equity so they can better utilise that cash for another purpose.
What is the main that typically gets revalued?
Property is the main asset class that gets revalued. In the main, leasehold land and buildings are depreciated over time at 2%, but if property has gone up in value the directors will need, and indeed may want, to reflect the increase to the correct figure.
As for the spur to start the process, it could be just a gut reaction, but another push might come from the need to strengthen the balance sheet to demonstrate that the business is worth more in shareholders’ funds than is currently shown.
What legal duties are there?
Running a business carries numerous duties, especially legal compliance. By extension, failing to keep assets properly valued – whether over or under - is a breach of the law and the company and directors could find themselves in serious difficulties.
There are other risks associated with failing to keep values accurate, not least of which is access to borrowing. If assets are not valued properly it can lead to errors of judgement on credit ratings and perceptions of the business in the eyes of suppliers.
The key to a good valuation is to see what auditors agree to. Where assets are over-valued, directors will rarely reduce the balance sheet and auditors will rarely insist that this is done. This is why the acid test is if the auditor will sign off the accounts with a ‘true and fair view’ opinion.
What causes asset values to change?
As to what causes fluctuations in asset values, there are countless causes. For example, a change in the value of an investment asset linked to the performance of an underlying investment. For example, an investment in a cross-border haulier could be impaired if its costs of operation rise because of Brexit, say through increased fuel or waiting times.
What happens if an asset is impaired, i.e. it’s worth less than the book value?
From an accounting viewpoint, if an asset is impaired it will impact on both the profit and loss and the balance sheet. An impairment will reduce the profit recorded for that period, which will impact on the distributable reserves for the firm and could restrict their ability to pay any dividends; this could influence investors decisions and may result in the breach of any applicable covenants.
But in practical term, most asset owners will have in inkling of the problem from watching market values, market demands, technological changes, economic drivers and accepted obsolescence or damage.