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Lesson 5. Valuation, revaluation and depreciation.

Lesson 5. Valuation, revaluation and depreciation. The main methods of valuation. Purchase price and its calculation. FIFO and LIFO Revaluation of assets and debts: conditions and outcomes Depreciation of tangible assets. -1-. The main methods of valuation. Historical (initial) value

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Lesson 5. Valuation, revaluation and depreciation.

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  1. Lesson 5.Valuation, revaluation and depreciation. The main methods of valuation. Purchase price and its calculation. FIFO and LIFO Revaluation of assets and debts: conditions and outcomes Depreciation of tangible assets -1-

  2. The main methods of valuation • Historical (initial) value • Purchase price • Production cost Current value (if such transaction would take place today) Realizable value (If we tried to sell this asset today) Fair value – in direct deals between well-informed counterparts Market value – in active market (a lot of sellers and buyers) -2-

  3. Principles of valuation of the items shown in the Accounts The same methods must be applied for a long time Items of Assets and Liabilities must be valuated separately Valuation must be made on a prudent basic (assets, costs, profit - down, liabilities, losses – up) Departures – in exceptional cases -3-

  4. The main method of valuation – “purchase price or production cost” The price of the raw materials and other consumables + other additional expenses The price + other additional expenses During the period until this item is ready to be used Only costs directly attributed to the product can be taken into consideration Example

  5. Example № 1 The real–estate has been bought by the company. Price in the invoice = 100 000, the payment to some intermediary = 10 000, the duty for registration = 2 000 the repair costs = 8 000 the total purchase price = 100+10+2+8=120 thousand. (100 – price, 20 – added costs) Directive 78/660/EEC, art. 35 (fixed assets), 39 (current assets)

  6. Some small details about valuation of assets Stocks (inventories) Fixed assets Debtors’ debts • At first “Historical price” (purchase or production) • Annual depreciation of tangible assets • Annual revaluation of- Investment property, biological active, fixed assets for sales • -Revaluation of other fixed assets is possible under certain conditions • Valuation according to bills • Revaluation according to probability to receive money back • -Hopeless and unreliable debts must be written off • At first “Historical price” (purchase or production) • Then – revaluation only if the market price goes down • Calculation of costs at the moment of writing off

  7. Criteria for classification of debts -The debtors' debts are considered to be unreliable (doubtful) if there is a delay of payment more than 30 days. Creditors have the rights to claim a fine for delay (11% per year – according to Civil law in Latvia). But there are not any precise criteria for admission the doubtful debt. -The debt is considered to be hopeless when the debtor has been struck off the Commercial Register because of insolvency

  8. Writing off the doubtful and hopeless debts Out of balance sheet

  9. Writing off the fungible items: calculation of costs Fungible = replaceable, mutually interchangeable Example: shares and other securities, raw materials The problem: A company often buys the same goods several times during a period. The price of them can be different every time. How to calculate the costs of goods that are sold?

  10. The purchase price or production costs of replaceable items Available valuation methods LIFO “Last in, first out” Weighed average costs example 3 FIFO “First in, first out” All methods are available according to Directive 78/660/EEC art. 40

  11. Example 3: question 15 X it was decided to sell 200 items The selling price- 8 Ls Profit - ? The profit depends on methods of costs’ calculation

  12. Example 3: use each of methods! LIFO = 7*100 + 6*80 + 5*20 = 1280 Ls Profit = 8*200 – 1280 = 1600 – 1280 = 320 Ls FIFO = 4*100 + 5*20 + 6* 80 = 980 Ls Profit = 8*20 – 980 = 620 Weighed average costs= (1680/300) * 200 = 5,6 * 200 = 1120 Ls Profit = 8*20 – 1120 = 480 Ls P.S LIFO method is not allowed in Latvia although the Fourth Directive allows it (art. 40).

  13. Revaluation of creditors' debts • Revaluation – possible if there are: • Changing in the currency’s exchange rate • Fine (penalty) interest rate for delay of payment (11% per year in Latvia) Firstly are shown in Balance Sheet according to bills (invoice) payable

  14. Revaluation of fixed assets (must be shown in annual Records) Possible Obligatory conditions: -A company is sure that changing in the market price of such assets will be at the same level for a long- term period -It is allowed only: *for tangible assets(1.2) *for financial assets(1.5) conditions: -A company uses service of valuator with approved certificate -The company does it every year: *for investment property(1.3) * for biological assets (1.4) * for long-term assets placed among goods for sales (2.2)

  15. Revaluation of fixed assets:example before revaluation after revaluation Land = 20 000. (+10 000) Car = 5 000. (+ 4 000) real-estate =110 000 (+ 10 000)  = 135 000 Land = 10 000 Car = 1 000 Real-estate = 100 000  = 111 000 • These changing is shown in: • Revaluation reserve (within Equity) if the tangible assets are revaluated : D1.2 C 3.3 • Revenue –> incomes –> profit, if the investment property is revaluated : D 1.3 C 6

  16. Depreciation (the process of including in the costs) Tangible assets Intangible assets Obligatory Possible Executive determines a period of using of tangible assets Can be written off during a period according to Law (5 – 20 years)

  17. Depreciation (increasing of costs) Deterioration Obsolesce Physical process of wearing out Usefulness because of moral reasons (become obsolete, is replaced with something new

  18. Example 1 1 2. Calculation of depreciation: 60 000Ls : 5 years = 12 000Ls/ year A vehicle is bought = 60 000 Ls Useful period = 5 years • 3. The vehicle has been given to use to other company: • rent payment 2 000Ls per month. The money is paid regularly every month • Total earnings 24 000Ls per year (there was not another revenue in this year) • Revenue (rent payment) – Expenses (depreciation) = Profit • 24 000 Ls - 12 000 Ls = 12 000Ls • Remaining amount of free money = 12 000 Ls

  19. Example 2: useful period is longer • 60 000Ls :10 year = 6 000Ls / year • Revenue = 24 000Ls (money) • Expenses = 6 000Ls (depreciation) • Profit = 18 000Ls (amount available for dividend increases) • Free money = 24 000 – 18 000 = 6 000 (decreases) Conclusion – the method of regulation the profit and cash Decision maker – executive only, not owners

  20. HOMEWORK • Answer- in which cases FIFO is better than LIFO for a company and why? • Codify these transactions: • hopeless debt is written off -1000Ls • land for sale is bought at the price 2000Ls though the market price is 4000Ls • the contribution in subsidiary is revaluated from 5000Ls to 8000Ls, because there is a big profit • depreciation is calculated -20% of value 10 000

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