OCW041: Reporting and Analyzing Assets

Reporting Assets

A business must report an asset’s acquisition cost, how it is depreciated, any subsequent expenditures tied to it, and how it is disposed.

Learning Objectives

Explain how to value and report an asset from its acquisition to its disposal

Key Takeaways

Key Points

  • An asset ‘s value on a business balance sheet equals its acquisition cost, or the amount of cash and other property given up to acquire it and place it into operation.
  • When determining how to depreciate an asset, a business should consider the cost of the asset, its residual value, its useful life, and what depreciation method it wants to use.
  • If a business improves an asset’s ability to provide a service, it increases the asset’s value. If a business somehow extends a asset’s useful life, the asset’s value remains the same but its accumulated depreciation is decreased.
  • When disposing of an asset, the business must ensure that the asset’s depreciation accounts is up to date and then off the asset balance and its accumulated depreciation balance. It must also record any cash or property it received for the disposed asset and record any gain or loss it incurred.

Key Terms

  • depreciation: The measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.

Reporting Assets

One section of the balance sheet consists solely of the business’s property, plant, and equipment. To be included in this section of the balance sheet, the asset must last longer than a year, be tangible, be used in business operations, and cannot be held for resale. Common examples of items that would be included are buildings, machinery, and delivery vehicles. Accounting for these types of assets involves following four steps.

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Factory Workers Assembling an Engine: The equipment and plant used to product a business’s product must be recorded on its balance sheet.

Record the Acquisition Cost

The acquisition cost is how the asset is valued on a business’s balance sheet. The acquisition cost equals the amount of cash and other property given up to acquire it and place it into operation. All expenses that are normal, reasonable, and necessary to obtain and place the property into use are included in the acquisition cost. Costs associated with fixing used property so it can be used by the company are included in the acquisition costs. Unnecessary costs associated with initially transporting the property to where it needs to go is not included in the acquisition cost.

Record Depreciation

The act of using an asset can often cause it to lose value because it physically wears out the property. Or an asset can be inadequate for future needs or become obsolete. In all of these cases, the underlying value of the asset decreases over time. Depreciation is a measure of how property values decrease. Depreciation does not apply to assets that do not lose value over time, such as land.

Depreciation can be calculated different ways for different types of asset. However, there are four things that a business must consider when determining how it will depreciate the asset. The first is the cost of the asset. Next, how much will the company be able to sell the asset for when it is of no longer of use to the company, or its residual value? The value could be based on its scrap value or the fact that the asset may have value to others as is. The company should also determine how long it will be able to use the asset. This period is known as the asset’s useful life.

Finally a business must choose a depreciation method. The most common depreciation method type is “straight-line,” where the depreciation rate is calculated by subtracting the asset’s residual value from its acquisition cost and dividing the result by its useful life.

To insure that the balance sheet reflects the accurate value of its assets, a business will not decrease the value of each asset as it depreciates. Instead, it will record a negative asset balance called accumulated depreciation. By adding the accumulated depreciation with the asset’s value, a person reading the balance sheet will be able to determine the asset’s current value.

Record Subsequent Expenditures on the Asset

A business can spend money on an asset that will increase its overall value in one of two ways. The first is if the business improves the asset in some way that makes it more valuable. A way an asset may become more valuable is if the business somehow enhances the asset’s ability to provide services. For example, if a business installs GPS into one of its trucks so it can make deliveries more efficiently, the expenditure has improved the value of the asset. In that case, the cost of acquiring the improvement is added to the value of the asset account.

A business can also spend money on an asset that does not improve its ability to provide a benefit to the business but extends the asset’s useful life. For example, a business may give one of its trucks an overhaul so that it will last another five years instead of another two. In this case, the value of the asset account is not adjusted but its accumulated depreciation account is decreased.

Account for Disposal of Asset

Recording the disposal of an asset requires taking several steps. First, the business must ensure that the asset’s depreciation account is up to date. Then the business must write off the asset balance as well as its accumulated depreciation balance. Then it must record any cash or property it received in exchange for the asset. Finally, it must record any gain or loss it sustained on the disposal of the property.

Return on Assets

The Return on Total Assets ratio measures how effectively a company uses its assets to generate its net income.

Learning Objectives

State the formula to calculate return on total assets

Key Takeaways

Key Points

  • [latex]frac { Netquad Income }{ Averagequad Valuequad ofquad Totalquad Assets quad forquad Accounting quad Period } =[/latex] Total Return on Net Assets.
  • [latex]quad frac { Netquad Income }{ Averagequad ofquad Fixedquad Assets } =[/latex] Total Return on Net Fixed Assets.
  • The greater the value of the ratio, the better a company is performing. To accurately gauge a company’s performance, you need to put the value in context by comparing the ratio to the company’s past performance or to a competitor ‘s return on assets.

Key Terms

  • fixed asset: Asset or property which cannot easily be converted into cash, such as land, buildings, and machinery.
  • net income: Net income also referred to as the bottom line, net profit, or net earnings is an entity’s income minus expenses for an accounting period.

The Return on Total Assets ratio is similar to the Asset Turnover Ratio in that both measure how effective a business’s assets are in generating returns for the business. But while the asset turnover ratio is focused on the business’s sales, return on assets is focused on net income. Sales is a measure of how much money the company can generate while net income is a measure of how much the business earns after its pays all of its financial obligations.

A Sample Income Statement: Expenses are listed on a company’s income statement.

Return on Total Assets

[latex]frac { Netquad Income }{ Averagequad Valuequad ofquad Totalquad Assetsquad forquad Accountingquad Period } =quad Returnquad onquad Assets[/latex]

Return on total assets equals the total net income the business earns in a given accounting period divided by the average value of the business’s total assets for the same period. You calculate the average value of the total assets by adding the value of the business’s total assets at the beginning of the period and the value of the business’s total assets at the end of the period. You then divide the sum by two.

Return on Total Fixed Assets

[latex]Returnquad onquad Totalquad Fixedquad Assetsquad =quad frac { Netquad Income }{ Averagequad ofquad Fixedquad Assets }[/latex]

Return on Total Fixed Assets equals the business’s net income divided by the average value of the business’s total fixed assets for the accounting period. You calculate the average value of the business’s fixed assets by adding the value of the business’s total fixed assets at the beginning of the accounting period to the value of the total fixed assets at the end of the period. You then divide the sum by two.

Using Return on Assets to Assess Company Performance

The greater the value of the ratio, the better a company is performing. However, merely determining a business’s return on asset ratio is insufficient to get a good understanding on how a business is doing. To accurately gauge a company’s performance, you need to put the value in context. This is generally done by comparing the current return on assets ratio to the company’s past performance or to a competitor’s ratio.

Asset Turnover Ratio

The asset turnover ratio is a measure of how well a business is using all of its assets to generate sales.

Learning Objectives

State the formula to calculate the asset turnover ratio

Key Takeaways

Key Points

  • Asset [latex]quad Turnover quad =frac { Netquad Salesquad Revenue }{ Averagequad Totalquad Assets }[/latex].
  • [latex]quad frac { Netquad Sales }{ Averagequad Netquad Fixedquad Assets } =[/latex] Fixed Asset Turnover Ratio.
  • All Asset Turnover Ratios must be judged in context. This is generally done by comparing the ratio’s value to the business’s ratios in prior accounting periods or to its competitors ‘ asset turnover ratios.

Key Terms

  • fixed asset: Asset or property which cannot easily be converted into cash, such as land, buildings, and machinery.

Balance Sheet: The balance sheet is where you will find information regarding the value of the business’s assets, which is necessary to calculate the business’s asset turnover ratio.

It can be difficult to review a company’s balance sheet and get much meaning out of it with just a glance. While it may be impressive that a business has millions of dollars worth of equipment, it is hard to determine what that means from a business perspective.

One way of putting those values into context is to use them to generate ratios. One ratio that analysts use to evaluate a company’s strength is the asset turnover ratio.

Asset Turnover Ratio

[latex]Assetquad Turnoverquad =frac { Netquad Salesquad Revenue }{ Averagequad Totalquad Assets }[/latex]

The asset turnover ratio is a measure of how well a business is using all of its assets to generate sales. The ratio is calculated by dividing the total sales for the accounting period by the average value of the assets the business owned during the year. The average value is calculated by adding the value of assets the business owned at the beginning of the period to the value of the assets owned at the end of the period, and then dividing by two.

Fixed-Asset Turnover Ratio

[latex]Fixedquad Assetquad Turnoverquad =quad frac { Netquad Sales }{ Averagequad Netquad Fixedquad Assets }[/latex]

The fixed-asset turnover ratio is calculated in a similar manner, except instead of focusing all of the business’s assets, the ratio is calculated using the business’s fixed assets. This ratio measures how well a business is using its fixed assets to generate sales. To calculate the fixed asset turnover ratio, divide the total sales for the accounting period by the average fixed asset balance for the accounting period. The average fixed asset balance equals the beginning balance of fixed assets for the period plus the ending balance of fixed assets for the period, then dividing by two.

How to Use These Ratios

The higher the ratio, the better the business is performing in terms of sales. However, these ratios generally need context to better understand them. While a ratio may appear low by itself, it may actually be doing well overall. Generally, an analyst will compare a business’s asset turnover ratio to the business’s ratios from prior accounting periods or to the business’s competitor’s asset turnover ratio for the same period.


Source: Accounting