Every business has assets. Everything from land and buildings, to equipment, tractors and trailers, goodwill, brands and intellectual property has value. The question is: how to understand the true value of those assets?
Chief executive at Close Brothers Asset Finance (Transport Division) John Fawcett says the Companies Act 2006 demands that a business’s accounts must show a fair and reasonable value of the cost of an asset at the outset and throughout its life. But showing this isn’t simple. “Assets are used in different ways,” he says.
“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 its accounts.” Procedurally, directors must detail fixed tangible assets at cost, less depreciation at rates calculated to write off the cost, less the estimated residual value of the asset over its expected useful life.
In terms of the legal responsibility for the valuation process, Mark Nelson, director, Compass Business Finance, says this rests with the company and its directors. “Accountants will never be involved unless the depreciation policy of the business is consistently out of kilter with the market,” he says.
On top of this Nelson says values should be recorded on a worst-case scenario basis with the only exception being freehold property. Why would a business want to revalue its assets? One major reason, according to Nelson, is the need to understand the equity and risk position it has against the debt owed on those assets.
“It may be the company is looking to restructure its debts in order to manage monthly cashflow, release equity so it can better utilise that cash for another purpose, or understand where its personal risk would be.” He also says that it is common for any equity within the assets of a business to be used during a merger or acquisition.
Fawcett’s experience has taught him that property is the main asset 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, he says.
As for the spur to start the process, it could be just a gut reaction, he reckons. However, 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.
There are, in fact, rarely good reasons for revaluing assets, but it can be justified where depreciation rates have been aggressive or overtly prudent. That said, accounting standard IAS 36 - Impairment of Assets requires a business to review its assets for impairment at least annually.
Some firms, such as listed companies that produce quarterly statements or those ceasing business, might revalue more frequently. Running a business carries numerous duties, especially ensuring legal compliance.
By extension, failing to keep assets properly valued - whether over or under - is a breach of the law and, says Fawcett, 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 the perception of the business in the eyes of its 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 means that the acid test is whether or not the auditor will sign off the accounts with a ‘true and fair view’ opinion.
There are countless causes of fluctuations in asset values, including events such as a change in the value of an investment asset linked to the performance of an underlying investment. For example, an investment in a crossborder haulier could be impaired if its costs of operation rise because of Brexit, say through increased fuel consumption or waiting times.
Small things, says Nelson, can also affect values. He cites the condition of equipment, access to premises, and changes in market perception of the make and model of the equipment in question.
General business housekeeping is a good indicator of this. New technology can rapidly and radically affect the value of equipment making it more difficult to sell - information technology is a case in point.
Businesses depreciate this type of equipment over a long period of time when actually the useful life could be much less. The list also includes asbestos that needs remediation, a lack of spares, or a change in an intangible such as intellectual property.
In fact, it’s the intangibles that can increase when large firms value their brand on the balance sheet. It’s all well and good having assets that increase in value, but what if the asset is impaired and its worth is less than the book value?
From an accounting viewpoint, if an asset is impaired it will affect the profit and loss and the balance sheet. An impairment will reduce the profit recorded for that period, which will affect the distributable reserves of a firm and could restrict its ability to pay any dividends, which could influence investors’ decisions and might result in the breach of any applicable covenants.
In practical terms, Fawcett thinks that most of those who value assets will have an inkling of the problem from watching market values, market demands, technological changes, economic drivers and accepted obsolescence or damage. The valuation of assets is not a science, it is more of an art.
One thing, though, is clear, businesses that ignore the statutory requirements are heading for trouble - especially if they hit the buffers. Directors have duties and the authorities will investigate those who give incorrect information to stakeholders.
By Adam Bernstein