CAPITAL ASSETS THAT YOU WANT 195
DECISIONMAKING VALUES
An excellent way to establish the actual or useful value of your fixed assets is to examine
the depreciation schedule and fixed asset register. These show the original cost, current
book cost and the age of the assets. The written-down (depreciated) value is often way
out of line with current or replacement values. You need to conduct a realistic appraisal to
decide what is reasonable.
1 Market values. During your management review of the business, you will base
decisions on market values. What is the underlying value of plant or machinery?
Would it be better to sell it and use the proceeds elsewhere? Do you have
competitive advantage because you have already written off the cost?
2 Insurance value. For your operational decisions, you will also have to decide
whether to insure for current or replacement values.
‘Better to wear out than to rust out.’
BISHOP CUMBERLAND
Capital assets that you want
It hardly needs to be said that you need to draw up a list of capital outlays that are
required by your strategic and operational plans. For each category of assets (plant,
machinery, office, etc.) you should show the expected date of acquisition, total acquisi-
tion costs and a depreciation schedule. Some thoughts follow.
WHAT DOES IT COST?
For accounting purposes, the acquisition cost – booked value – of fixed assets is usually
taken to include all outlays incurred in bringing them into use. For example, for a compu-
ter, booked-value might include the cost of the hardware itself – plus operating software,
shipping, installation fees, cabling and so on.
This is one situation where profits for the current period are inflated –
consumables are put on to the balance sheet rather than in the profit and
loss account. The downside is that it reduces profits in future periods.
t
196 CHAPTER 9 GETTING TO NET PROFIT
HOW LONG WILL IT LAST?
There are two decisions to be made before you can draw up a depreciation schedule.
1 Determine the period over which the asset will be written off. Ideally this will
coincide exactly with the operating life of the asset. If you have a machine that
will last for exactly three years and then expire, your write-off period will be 36
months. Of course, you rarely know this in advance. Moreover, the depreciation
period may be imposed on you by company policy, statutory regulations or the
use of generally accepted accounting principles. If you consider such imposition
to be unrealistic, you might be bold enough to challenge it or run two sets of
accounts – one for economic and management analysis and one for official
reporting purposes. Examples of working lives are provided on page 201.
2 Determine the depreciation method. The straight-line method is shown in the
examples in this chapter (e.g. see Figure 9.1, later). Units of production – matching
the depreciation of a machine or resource against its output – is a troublesome if
attractive alternative. Other methods include the double declining balance and sum
of the years’ digits; these are noteworthy techniques for accelerating depreciation
during the early months of an asset’s life when it is falling in value most rapidly.
SHOW OFF YOUR ASSETS
The accounting entries that you pass for one asset in one category are shown in Figure 9.1.
By repeating this simple procedure, you can account for any number of assets. A sample
extract from a business plan showing capital outlays and depreciation is given in Figure 9.2.
Four steps to projecting capital spending
1 Classify required assets according to purpose (plant, office, etc.).
2 Show the month in which they will be delivered to you.
3 Show their expected cost.
4 Draw up a depreciation schedule commencing in the month after delivery.
CAPITAL ASSETS THAT YOU WANT 197
REPLACING FIXED ASSETS
Depreciation is a set of book-keeping entries created at a stroke of the accountant’s pen.
It does not establish a cash reserve for replacing an asset. If you wanted to do this, you
would have to pass a separate set of entries – moving some of your profits from your bank
account to a fixed-asset replacement fund each year. Then, of course, the cash in the fund
would probably be earning less than your cost of capital and so it would be clawing-down
your overall return on capital employed (see Chapters 11 and 12). Such replacement or sinking
funds tend to be the exception rather than the rule. You should decide if you need one using
rational judgement and standard capital investment appraisal techniques (see Chapter 11).
A NEW LEASE OF LIFE
It frequently makes sense to lease rather than to buy. This reduces the up-front demands
on your cash flow and is particularly helpful for new businesses. There are two categories
of lease:
Finance lease – where the risks and rewards of ownership are passed to the
company using the things being leased to them.
Operating lease – all other leases.
About Tetrylus’s capital outlays
The sample extract from a business plan (Figure 9.2) sets out clearly how much this
new business will be spending on various categories of fixed assets. Computers is the
largest single entry – not surprising given that Tetrylus deals in computer technology.
The acquisition cost of the computers includes the operating systems and other
office software ‘bundled’ (included in the price) with the computers. The separate
$5000 capital outlay on software is for software tools that are used to develop
Tetrylus’s product. Another entry for software purchases is shown in the operating
expenditure accounts (Figure 9.4) – this is for graphics and contact-management
packages acquired by marketing, which the company treats as consumption rather
than investment. In addition, Tetrylus spends on licence fees for software that is
sub-licensed to customers – this is recorded as a cost of sale in Figure 8.4.
t
..................Content has been hidden....................
You can't read the all page of ebook, please click here login for view all page.