Current Thoughts and Practices on Tangible Fixed Assets

FINANCIAL ACCOUNTING THEORY AND ANALYSIS

TOPIC: CURRENT THOUGHTS AND PRACTICES ON TANGIBLE FIXED ASSETS

DEFINITION

Fixed Assets are defined as long-term tangible property that a firm owns and uses in the creation of its revenue and are not expected to be completely utilized or converted into cash any sooner and normally last for more than one year.

Tangible fixed assets are fixed assets that have a physical form and they include plant and machinery, buildings and land etc. They are the assets of the company that can be seen and touched and can last for more than one financial year.

Items of property such as property, plant and equipment are generally a major source of future service potential to a company. These tangible fixed assets represent an important commitment of economic resources for companies in capital intensive industries.

Inventory is also considered a tangible current asset, they not fixed because they do not fit the definition of fixed assets and are normally used for operational purposes. For the purpose of this discussion, we focus is only on tangible fixed assets.

Financial Reporting Standards (FRS) 15 issued by the Accounting Standard Board( ASB) in February 1999, "Tangible Fixed Assets" set out the principles for accounting for initial measurement, valuation and depreciation of tangible fixed assets. The objective was to ensure that tangible fixed assets are accounted for on a consistent basis and where a policy of revaluation is kept, that revaluations are kept up-to-date.

CHARACTERISITICS OF TANGIBLE FIXED ASSETS

Three essential Characteristics of an asset as specified by Concept Statement 6 are as follows;

* A tangible fixed asset embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to combine directly or indirectly to future net cash inflows.

* A particular entity can obtain the benefit and control others' access to it

* The transaction or other event giving rise to the entity's right to or control of the benefit has already occurred.

It should however be noted that for a not-for-profit organization, the service potential or future economic benefit is used to provide desired or needed goods or services to beneficiaries which may or may not directly result in net cash inflows to the organization. Some not-for- profit organizations rely on donations and other contributions of cash as a source of inflows or revenue.

INITIAL MEASUREMENT OF TANGIBLE FIXED ASSETS

Many businesses commit substantial corporate resources to acquire property, plant and equipment. Investors, creditors and other stakeholders rely on accountants to report the value of investment in these assets. The Initial investment or costs of these assets represent a sacrifice of current resources given up to accomplish future benefits.

Whether acquired or self-constructed, a tangible fixed asset should initially be measured at its cost. Only costs that are directly attributable to bringing the asset into working condition for its intended use should be included in its measurement. These include acquisition costs; site preparation; delivery and handling; installation; dismantling and site restoration, labor costs of own employees arising directly from construction; and incremental costs that would have been avoided only if the asset had not been constructed or acquired.

Capitalization ceases when all activities necessary to get the asset ready for use are complete, even if the asset has not yet been brought into use.

That is to say, to measure the true cost or value of a fixed asset, whether acquired or constructed, all auxiliary costs incurred in making the asset ready for use by the company should be capitalized and added to the cost of the asset.

For example, when measuring the initial value of a factory building, the cost of the land, preparation for construction, costs of all material used in construction and payments to construction workers should be considered as part of the cost of the building. Valuing the building based on some of the costs incurred will not represent a true value or measurement of the cost of the building.

Finance costs may also be capitalized, as a consistent policy for all tangible fixed assets, where they are directly attributable to the construction of the asset, but may not exceed the total finance costs incurred in the period. For this purpose, if any asset is made up of parts that are capable of being used while construction continues on the rest, the completed parts should be treated as separate assets and further capitalization of finance costs on them should cease.

Capitalization is appropriate where: the expenditure enhances the asset, e.g. renovation of an administrative building; separately depreciated components are restored; or it relates to major overhauls or inspections restoring the asset's economic benefits, the consumption of which has been reflected in depreciation.

Cost is the preferred valuation method used to account for the acquisition of tangible fixed assets because cost is more reliable and verifiable than other valuation methods such as discounted present value, replacement cost or net realizable value. There is also the presumption that the agreed upon purchase price represents the future service potential of the asset to the buyer in an arm's length transaction.

Despite the reliability of purchase price or cost as the basis of initial measurement for tangible fixed assets, the assignment of cost to individual assets when assets are acquired in groups, self constructed, acquired in a non monetary exchange etc. can present some accounting issues.

In a group purchase whereby a group of assets are acquired for a lump sum, the total acquisition cost must be allocated to individual assets so that an appropriate amount of cost can be charged. The most frequent practice has been to assign the purchase cost of the various assets on the basis of weighted average of their respective appraisal or assessment values. Where appraisal values are not available, the cost assignment may be based on relative carrying values on the seller's books.

Self constructed assets on the other hand give rise to questions about the proper components of cost. Although as previously stated, it is agreed that all expenses directly associated with the construction process should be included in the initial measurement of the cost of the asset, there are controversial issues regarding the

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