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How should a limited company value its fixed assets to best inform those who use its financial reports?

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Introduction

UNIVERSITY OF LEICESTER MANAGEMENT CENTRE How should a limited company value its fixed assets to best inform those who use its financial reports? November, 2007 Accounting literature has identified diverse methods that limited companies can utilize to value their fixed assets to provide comprehensive financial information on their company's performance to internal and external stakeholders. The goal of this paper is to consider the different fixed assets valuation systems a limited company can utilize to value its fixed assets in its reporting to best inform readers of its financial performance, with specific focus on the historical cost, net realizable value and the replacement cost methods. Fixed Assets are defined as "assets that have expected useful lives of more than one year (or normal operating cycle) that are used in the business and are not intended for resale" (Hoskin, Fizzell and Davidson, 2000:462). As business operations are constantly evolving, the value of its fixed assets and liabilities will also be changing. Thus, the valuing and reporting of fixed assets on a balance sheet is affected by the way a business reports its balance sheet items, since all companies are free to decide the valuation methods and related depreciation policies for their fixed assets when preparing financial reports. According to Jim McMenamin, a company's financial reports serve to capture the company's assets and liabilities "at a particular moment in time" (McMenamin, 1999:267). To ensure that the users of its financial reports are best informed, it is advisable that limited companies should choose fixed asset valuation methods that provide the most comprehensive and accurate information to the users of its financial reports. ...read more.

Middle

This according to Lawrence allows for transparency and appropriate disclosure by the company so financial statement readers are best informed by the information they are reviewing (Lawrence, 1999:165). Market Value System Another method of valuation of fixed assets is the market value system, where limited companies can record their fixed assets values through two diverse valuation methods in this system - the replacement cost valuation system and the net realizable value system. According to McMenamin, "market value is the value or price for which an asset currently trades in the marketplace, usually determined by the interaction of supply and demand for the asset" (1999:243). I will now examine these two distinct systems within market value. Replacement cost valuation system In the replacement cost valuation system, a company's fixed assets are listed at the amount required to purchase an identical replacement for that asset and is "carried at its replacement cost" (Hoskin, Fizzell and Davidson, 2000:432-433). This system is over 80 years old, gaining popularity in 1920s as a means for fixed assets valuation due to the severe inflation of the period. In valuing fixed assets using this system, limited companies record the historical cost of the asset at initial time of purchase as the future replacement cost of that particular asset. With on-going use of the asset during business operations, the "carrying value" is modified - increased or decreased - to demonstrate the change in the replacement cost of the asset, with gains and losses listed in the financial statements and the amortization adjusted. ...read more.

Conclusion

must ensure that "both the replacement market and the selling market are the markets in which the company normally trades (Hoskin, Fizzell and Davidson, 2000:433). Additional, many accounting boards in various countries, such as the Accounting Standards Board in Canada, provides recommendations and guidelines to companies using the replacement cost method to value assets. Specifically, the board had advised companies to include "supplementary information on the replacement cost of their property, plant and equipment" (Hoskin, Fizzell and Davidson, 2000:433). Conclusion: In conclusion, my research and subsequent readings have demonstrated that the diverse fixed assets valuation methods available to limited companies have both positive and negative attributes and can provide contradictory financial results to the users of the company's financial reports. It is clear that each fixed assets valuation system - excluding the historical cost principle - will not generally create the same financial results when used by two different accounting professionals. Therefore, it is imperative that limited companies choose the fixed assets valuation methods that would enable them to provide the most comprehensive and accurate information that would best inform the users of its financial reports of the business operations, successes and challenges. Further, limited companies are obligated to ensure that valuation of their fixed assets not only informs users of its results but that it also adheres to the accounting standards and legal reporting requirements of the jurisdiction within which they operate their business. I would recommend that limited companies choose the historical cost principle for valuing its fixed assets as it is the most reliable, highly accurate, verifiable, and provides consistent information to allow end users of financial reports data to make prudent decisions. ...read more.

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