Corporate Accounting For The Modern Economy – Asset Valuation And Revaluation

Analysis

Describe about the Corporate Accounting for The Modern Economy.

The modern economy runs on the profit margin of all the organizations present in the market. All the companies competing in the market have the common goal of making profits and differentiating products from each other. Every enterprise looks for different innovative techniques to reduce their cost of production and increase revenue and one such way to increase the profit margin is by asset valuation and revaluation (Zadek, Evans and Pruzan 2013) . The two different types of techniques used are Cost model approach and Revaluation Model approach. Different organizations use different asset valuation methods, which are according to the needs and policies of the organization (Deegan and Ward 2013).

The report concentrates on the asset valuation process of Sha Maru Ltd with total assets being $35,500,000. The property plant and equipment is $27,500,000, which is depreciable over a period of 10 years on a straight-line basis. The liabilities of the company are $17,500,000(long term) and 2,500,000(short term). The company requires that the debt ratio will remain below 0.6, and the interest rate ratio will be above 6 to provide a dividend to its shareholders. 

The Chief Executive Officer of Sha Maru Ltd wants to change the asset valuation model of the company from cost model to revaluation model to increase the value of the property by 25%. 

The report clarifies the reason of whether to change the asset valuation model and whether any change will bring about reforms in the financial statements along with the mindset of the shareholders, the senior managements and the investors of the organization.

The company Sha Maru Ltd uses the Cost Model method of evaluating the assets of the organization. Cost Model technique involves carrying the property plant and equipment at the cost price deducting the losses and the accumulated depreciation ( Hu, Percy and Yao 2015). 

Cost Model= Cost- Accumulated Depreciation-Losses

The Cost of the assets never changes being a classical figure, but depreciations are computed on the asset. The method of depreciating the asset depends on upon the policy of the organization be it straight- line method or written down value (Zakaria et al. 2014). 

The Revaluation method, on the other hand, is a much complex process involving a regular revaluation of the assets so that the carrying amount does not differ from the fair value of the asset. The process of calculation of depreciation is the same as compared to the Cost Model method and the entire class of the assets in connection has to be revalued accordingly. The residual value and average life of the assets must be evaluated every financial year. The revaluation model which the organization carries will take the revalued amount in consideration deducting the accumulated depreciation and average impairment losses (Zakaria et al. 2014).

Conclusion

Revaluation Model= Revalued Amount- Accumulated Depreciation-Average losses.

The revalued amount is the fair value of the property on the date of revaluation. Proper measurement can be gained from external sources like market-based proofs and internal data from income and cost approach. The calculations in this process will be of relevant regularity to avoid differences in materials between the carrying amount and the fair value at the end of the accounting period.

Sha Maru Ltd, having a total asset value of $35,500,000 comprising of property plant of $27,500,000 and the rest of the current assets. The depreciation is calculated on the straight -line basis over a period of 10 years resulting in a Depreciation value of $275,000 for every year not leaving any residual value. The assets are in the middle of their useful life. The value of the property will not change in the future period. Sha Maru Ltd has long-term liabilities of $17,500,000 and short-term liabilities of $2,500,000. The chief executive officer of Sha Maru Ltd believes that the current book value of the property plants can increase by 25% so that the company can serve better. He is also in the view that the revaluation method of asset valuation can be a better method than cost method. Revaluation method is a complicated method of calculation, but if this approach is taken into consideration, the revalued surplus will act as income in the equity as revaluation surplus. The forecast depreciation is same in both the model cost method and the revaluation method, and thus no additional changes will be visible (Hu,  Percy and Yao 2015). According to the current loan agreement, the debt ratio will be less than 0.6 and in the current scenario, the debt ratio according to the current values is:

Debt Ratio= Total Liabilities/Total Assets

Debt Ratio= 20,000,000/35,500,000

                  =0.56

The above ratio reveals that the criteria of keeping less than 0.6 are maintained thus maintaining a proper balance between the assets and liabilities. The company requires the interest earned ratio to be greater than 3 to pay dividends to the shareholders. The interest earned ratio according to the current scenario is:

Interest Earned Ratio= Profit Before Tax+ Interest Expense / Interest expense

Interest Earned Ratio= $2,000,000+$900,000+$250,000/$900,000

                                   =3.5

It is seen that the time’s interest earned ratio of Sha Maru Ltd Company is 3.5, which is 0.5 higher than the desired ratio rate. Thus, the organization is making the expected profit to pay adequate dividends to its shareholders.

In the revaluation method, if the revalued amount of the assets increases, then the additional increase is credited to the equity as a surplus revaluation. The growth in the current year of the property can also be treated in the profit and loss account because it shows an advantage on the value of the previous years. On the other hand, if the carrying amount of an asset falls, then it is treated as a loss and becomes a credit balance in the revaluation surplus account. The revaluation surplus and retained earnings are both part of the equity account, but they are separate from each other. The revaluation surplus can be transferred to the retained earnings just to debit the surplus revaluation and to credit the retained earnings but in both these incidents, profit and loss account is not taken as the mode of transfer. The surplus revaluation can also be sent to the retained earnings even when the asset is in use by the organization. The transferable amount is the discrepancy between the depreciation on the revalued amount and the depreciation on the asset’s original cost (Schönbohm 2013).

From the above calculations and observations, it is clear that the organization wants the value of assets to increase by a considerable amount by changing the evaluation model, and if revaluation model is used instead of the cost model, then the assets will increase considerably. The modification of the design will enhance the value of the property and this revalued amount on the fair value will be treated as profit to the organization providing additional reserve and will helpful to enhance the goodwill of the enterprise in the eyes of the investors (Brigham and Ehrhardt 2013). The shareholders of this organization will also be happy because the dividend payout ratio will also increase once the profit margin increases. The process of evaluation depends on upon the goal of every organization and in the case of Sha Maru Ltd, the revaluation technique is best suited for their cause because the CEO of the organization wants the assets to increase up to his expectations and requires a change in the financial statement of the organization. Revaluation method though is a complicated technique with a comparison to the cost model, but still the according to the demands of Sha Maru Ltd it is best suited.  

Conclusion

The observations and the calculations initiated in the above report determine the goals and objectives of Sha Maru Ltd and the manner in which the company wants to improve its financial position in the economy. The Cost Model and Revaluation Models of asset valuation are compared in this report, and proper calculations are done to calculate the Debt Ratio and Time Interest Earned ratio, and it is observed that the organization is has been able to fulfill the minimum criteria. The observations reveal that the enterprise needs to change its technique from cost model to revaluation model as it will improve the asset valuation of the company on the previous years and will bring in extra profits in the business. The objectives and demands of the CEO can only be met only if the revaluation techniques are used this will lead to the goodwill and asset valuation increase of the company making the company more stable and competitive.

It is recommended that Sha Maru Ltd changes its method from cost to revaluation method to increase its efficiency in the financial statements and also to revalue its assets on fair value increasing reserves of the organization and making the company economically more strong.

Reference List

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