Meaning of Asset Valuation
Asset valuation is a process concerned with knowing the present fair market value of business assets. This method helps in determining the right value of a company’s assets such as plant, machinery, equipment, goodwill, building, stocks, land, and many more. Asset valuation is most widely used at the time of buying and selling shares of the company, asset insurance, and acquisitions.
It is mainly focused on documenting the financial value of all infrastructure assets which an enterprise owns and includes in its balance sheet. Process of asset valuation carry out verification of all assets in accordance with generally accepted accounting standards in order to bring uniformity. There are numerous tools which are employed by asset valuation including value of assets which are of similar nature, the historical value, fundamental analysis, current supply as well as demand.
The whole process of asset valuation is performed by an authorized officer which is then re-checked by auditor to ensure that every property is truly valued or not. The company officials need to perform a prime duty of asset valuation and should prepare reports in a manner that is well-understood by the auditor. Assets of the company can’t be verified unless and until they are properly valued. Also, if this valuation goes wrong then both the financial statements of the company i.e., Balance sheet and Profit and loss account would be incorrect.
Objectives of Asset Valuation
The objectives of asset valuation can be well-understood from points given below: –
Ascertain correct financial position of company
Valuation of assets helps in knowing the real financial position of the firm. It examines all the assets and liabilities of a business to derive its true value. This way it carries out a detailed analysis on the company’s balance sheet which determines the accurate financial picture of the organization.
Determine the goodwill of concerned firm
Goodwill of firm has an effective role in deciding its long-term existence among customers. Asset valuation determines the health of business by knowing its owned assets and outstanding liabilities. A business enterprise whose value of assets is more than its liabilities is able to enjoy high goodwill. It will enable it to pay off its debts timely thereby ensuring good relations with creditors and suppliers.
Calculation of right taxes
Tax computation requires consideration of all range of assets which comes under company control and generates revenue for it. There are numerous properties which are owned by firm such as production plants, sale store, R&D centre and many more. Asset valuation takes into account all of these properties which ease down the whole process of tax calculation.
Evaluate right price of company
Asset valuation serve as a key tool of knowing the real price of company at time of acquisition. The acquirer can easily take decisions to buy a firm at price determined by officials carrying out valuation process.
Making decisions of buying or selling stock
A decision regarding buying and selling a company’s stock is taken by investor based on its financial performance and value of assets held by it. Analysts while doing an asset valuation employs fundamental approach in order to know the fair market price of shares. This helps in making buying and selling decisions quickly in smooth manner.
Methods of Asset Valuation
Various methods of asset valuation are discussed in points given below: –
The cost method is one of the simplest and widely used methods of asset valuation. Under this method, the purchase price of assets serves as a basis for carrying all valuations of that asset. The valuer does not need to carry out any other complex calculations to arrive at its accurate value. The present value of the asset is equal to the purchased price as per this valuation method. However, many times the existence of an asset is dependent upon the existence of another asset. This thing adds difficulty while doing computation of assets value under the cost method.
Standard Cost Method
The standard cost method is one where organizations on account of their past experiences fix standard costs for assets. The standard cost is treated as a base for calculating the asset values and is presented in the balance sheet. Unlike the cost method, the actual cost of the asset does not have any role to play in the computation of the final value of the asset.
Base Stock Method
Under the base stock method of asset valuation, a company maintains an inventory level up to a certain limit. The value of this base stock is used as a basis for computing the value of firm inventories.
Market Value Method
The market value method is a method that takes into account the market price of assets as a base for their valuation. However, under the scenarios where assets of similar nature are not available in the market then this method may face difficulty. Taking into account this issue, there are two subsequent methods that are adopted under it:
a). Net Realizable Value Method: This valuation method says that value left after deducting expenses from sale value of asset is net realization value. It considers the price at which a particular asset is saleable in market. The expenditures incurred on sale of asset are deducted from value derived via sales to arrive at true of asset. Net realizable method of asset valuation is more commonly used when assets of same nature are available in market.
b). Replacement Value Method: Replacement value method values an asset on the basis of price which an old asset possesses, if asset of similar nature needs to be purchased.
Importance of Asset Valuation
The importance of asset valuation is as discussed below: –
Right valuation of assets helps in knowing the accurate cost of the asset. Knowing the true cost helps in receiving the appropriate value while selling off an asset and at the same time while purchasing an asset, a relevant value will be paid.
Asset valuation serves as a great help for companies while trying to avail loan facilities from a bank and financial institutions. While applying for the loan, a bank asks for collateral security which offers protection against any chance of debt default. A lender for ensuring safety can easily find out via asset valuation whether assets are covering the loan value or not.
The auditing process involves verifying the transparency of company financial statements. The true financial position of the company is depicted by the information contained in its financial statements. A significant part of the audit process involves doing an evaluation of assets value.
Valuation of assets plays a significant role in events of a company’s mergers and acquisitions. Asset valuation enables parties to know the real value and thereby close deal at an accurate price.
Taxes are paid by companies on the number of assets held by them. Valuation of assets is necessarily required for them for computing the precise value of taxes to be paid.
Problems in Assets Valuation
Different problems which arise while carrying out the valuation of assets are as listed below: –
Nature of assets
The nature of assets influences the method to be used for their valuation. Identification of an asset whether it is a fixed asset or current asset is a must before initiating a valuation process as it differs from one asset to another. Sometimes, the identification of an asset’s nature becomes critical for analysts which makes the valuation process difficult.
Asset’s life valuation
Ascertaining the actual life of an asset is a difficult task while doing valuation. The life of assets can merely be estimated but can’t be actually calculated. Therefore, the valuation under these conditions is based on estimates only.
The type of product usage is considered while doing the valuation of assets. It is most widely used in case of re-purchased assets like company again purchasing machinery and using for the particular purpose which affects its valuation process. In case if this machinery is getting used for multiple purposes, then it will lead to confusion.
Inadequacy of facts
Many times, the fact’s inadequacy affects the valuation of assets in a negative way. There is a possibility that the auditor may miss some key facts or information due to which accurate values can’t be computed.
The ill effects of future contingencies on a company’s assets are not considered by the auditor while preparing financial statements. These negative impacts may cause difficulty afterward and may not derive the fair value of assets.
Duty of Auditor with Regard to Asset Valuation
An auditor does not directly carry out valuation of assets himself but it is done by company officials having past experience. The duty of auditor with regard to asset valuation is to ensure that valuation is done in suitable and accurate manner. For this, he/she verifies whether each and every asset is valued as per the accounting principle which gives true value. He ensures that all assets which company has mentioned in its financial statements are in actual present within the organization. This is because if valuation itself goes wrong at any point, then the financial statements of firm will depict a fair and true position of financial affairs.
Valuation of assets in simple terms means ascertaining the monetary values of company assets. It is quite important aspect for preparing fair financial statements by company for its stakeholders. Correct valuation is necessarily required to know the profit or less status of business enterprise. Company officials while performing this process of valuation should make sure that none of the asset is missed for valuation. Also, it should be checked that general accounting principles are followed at every stage which bring uniformity in whole process and avoid confusion. Auditors are appointed to verify the genuineness and accuracy of asset valuation. It is their duty as well as responsibility to cross-check whether all assets are shown at fair prices in the financial statements of the company at year-end.