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BY
NELSON M. ANUMAKA
(MBA, B.Sc., ACA, ACIB)
ABSTRACT
A fixed asset that runs a full cycle of existence in a firm has three stages of life
for the purpose of management.
INTRODUCTION
Assets are the valuable possessions, especially properties that a person or a
company owns which are capable of yielding revenues. In other words, they are
investments in resources that are expected to generate future earnings through
operating activities. In accountancy parlance we can distinguish between five
groups of assets.
a. Fixed Assets: These are assets that are used over a long period of time.
Examples of fixed assets are Land and Buildings, Plant and Machinery,
Fixtures and Fittings, and Motor Vehicles.
tangible assets or real assets. They are gradually depreciated over time and
the company usually makes provisions out of profit on a yearly basis. These
groups of assets are replaced when they are worn out.
b. Financial Assets: These assets are usually traded on the Money Market
and floors of the Nigerian Stock Exchange as securities. These are the
investments in treasury bills, treasury certificates, Federal Government
Development Stocks, Ordinary and Preference shares and Debentures and
Bonds.
c. Intangible Assets:
Assets are reported in the balance sheet of the company. The balance sheet
is the financial statement showing assets, liabilities and the owners equity of
a firm on a specific date (Glautier and Underdown, 1976: 156). The balance
sheet of a firm consists of two sides the assets side and the liabilities and
the owners equity. Because all assets are financed by liabilities and owners
equity, the two sides of the balance sheet must agree, i.e. balance. The
accounting equation also called balance sheet identity is the basis of the
accounting system: Assets = Liabilities and Equity.
Liabilities are funding from creditors and represent obligations of a company
or, alternatively, claims of creditors on assets. Equity is the total of funding
invested or contributed by owners and accumulated earnings in excess of
distributions to owners since inception of the company. From the owners
point of view, equity represents their claim or interest on company assets.
In managing assets, two types of assets are of particular importance - fixed
and current assets. These assets are applicable in all businesses. Some
companies are known to thrive without financial assets, intangible assets and
fictitious assets but definitely not fixed or current assets.
This paper therefore, is going to look at fixed assets management from the
points of funding, preservation, and abandonment.
FUNDING
The point of funding is called investment appraisal. Investment appraisal is
defined as the quantitative methodology for assisting the economic viability
or otherwise of capital investment Projects (Brealey and Myers, 1996:293).
It is a long term planning for proposed capital outlays and their financing. It is
also called Capital Budgeting. The main techniques of capital investment
appraisal are the accounting rate of return, payback period, and the
discounted cash flow methods.
Average annual after tax profits are founded by adding up the after tax profits
expecting for each year of the projects life and dividing the total by the number of
years.
Average investment is found by dividing the initial investment by 2. This process
assumes that the company is using straight-line depreciation with no salvage
value.
Illustration
A firm, Okirie Enterprises has made the following financial information available.
Project cost: N400,000
Accounting Profits
Year 1
N200,000
200,000
200,000
200,000
N200,000
100%
In this illustration the company would recoup its initial capital outlay of N400,000
and still make a profit of N400,000 hence the 100% score in the ARR.
In the situations of uneven profits and Working Capital, the formular for
calculating the ARR is generally the same and may even be more sensible.
Illustration
A Company Modebe Limited has made the following data available to you.
Project cost:
N400,000
Working Capital
N40,000
Accounting Profit
Year 1
N200,000
240,000
280,000
80,000
= N220,000
2
ARR = 200,000
220,000
100
90.9% or 91%
In both illustrations, the projects are viable as the utility as expressed by the ARR
is very high. Again, a benchmark may be set against which the decision to
accept or reject a project proposal may be taken. All acceptable projects in this
case must have a return higher than, or equal to the benchmark.
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N400,000
4 years
Method of depreciation:
Straight line
Cash flows:
400,000/160,000
= 2 Years
Where the cash flows are not even or constant, the technique is to add up
the yearly cash flows including fractions where necessary until the initial
capital sum is recouped.
Illustration
A Company; Opted Limited has the following financial data:
Project cost:
N200,000
Method of Depreciation:
Straight Line
Working Capital:
N20,000
Cash flows:
Year 1
N80,000
N100,000
N120,000
N20,000
Required : Calculate the payback period for this project in the Company.
Solution
Capital sum invested initially = N200,000 + 20,000 = N220,000 less cash flows:
Year 1
2
N80,000
N100,000 = 180,000
Balance = N40,000
Year 3 = 40,000
120,000
:. Payback period = 2
= 1/3
The fraction is necessary because the 3rd cash flow of N120,000 is far greater
than the N40,000 required to finally recoup the initial capital outlay. In using the
payback period for evaluating projects for investment, the usual practice is to set
a benchmark in terms of the period required to recoup capital outlays.
The
results of the analyses are then compared with the benchmark to arrive at
decisions. If our calculated periods is within the benchmark period, the project is
acceptable but if other wise the project should be rejected.
b.
c.
then
d.
sum
up
the
present
values;
Illustration
A Company, Abokiya Limited, has the following cash flow data
Project cost:
N100,000
Method of depreciation:
Straight-line
Accounting Profits:
Year 1
N40,000
40,000
40,000
40,000
10%
and
Solution:
Step 1 calculation of cash flows
Cash flows = accounting profit + depreciation
Depreciation = Cost Salvage value =
100,000 =
Life span
N25,000
Accounting profits
40,000
40,000
40,000
40,000
+ Depreciation
25,000
25,000
25,000
25,000
65,000
65,000
65,000
65,000
Cash flow
Cash Flow
Discount Factor
1.00
NPV
(100,000)
(100,000)
65,000
0.9091
59,092
65,000
0.8264
53,716
65,000
0.7513
48,835
65,000
0.6830
44,395
NPV
N106,038
Notes
a. In the year of investment, the entire capital outlay is regarded as a cost
or loss - that is why it appears in bracket.
b. At the time of investment the value of the currency being used, in this
case the Naira, will not have been affected by depreciation or inflation
this is why the discounting factor remains a whole number.
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c. The discounting factor is obtainable from the NPV tables that are usually
found in Financial Management and Managerial Accounting textbooks.
Calculators may also be used to calculate them in the absence of tables.
d. The summation of the cash flows was N206,038 so when we deducted
the initial capital outlay of N100,000 we arrived at N106,038 which
represents the NPV for the Project.
e. When the NPV is positive as it is in this illustration, the project is viable
and should be accepted and vice versa.
= 2.06
N100,000
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N40,000
N40,000
N40,000
N40,000
= 2.5%
40,000
This figure will then be read off the annuity table to determine the appropriate
rate for the project. In this particular illustration the figure must fall along line 4
since the project has a life span of four years. The appropriate rate therefore
falls between 21% and 22% and when we found the average of the 2 we arrived
at 21.5%. The appropriate IRR for this project is 21.5%.
In the situation of uneven cash flows, there is no clear cut formular for finding the
IRR, so we usually resort to trial and error arrangement in order to try all possible
discounting factors until we arrive at the rate which will bring the NPV to zero.
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Illustration
A firm, Maverick Enterprises, has the following financial data:
Project cost N100,000
Annual Cash Flows:
Year 1
N35,000
30,000
28,000
35,000
Cash flows
(100,000)
1.0000
(100,000)
35,000
0.9091
31,819
30,000
0.8264
24,792
3.
28,000
0.7513
21,036
35,000
0.6830
23,905
NPV
NPV
1,552
The NPV in this trial is positive, so it is not equal to zero. This means that
we have not arrived at the appropriate IRR.
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Year
Cash flows
Discounting Factor
NPV
12%
0
(100,000)
1.0000
(100,000)
35,000
0.8992
31,252
30,000
0.7972
23,916
28,000
0.7118
19,930
35,000
0.6835
22,243
(N2,659)
NPV
The first trial resulted to a positive figure while the second result to a
negative figure. This means that the appropriate rate must lie somewhere
between 10% and 12% of the NPV table. We then need to reconcile the
two rates by the process of interpolation as follows:
12% NPV gives the sum of N (2,659)
10% ,,
,,
,,
,,
,, N1,552
2%
,,
,,
,,
,, N(4,211)
,,
Note that we subtracted 10% from 12% to get the 2%. When we subtracted
the positive N1,552 from the negative N2,659 we arrived at the negative
figure of N4,211.
10% + 1,552
1,552 + 2659
( 12% -10%)
10 % + 0.737
= 10.74%
PRESERVATION
Throughout the life of the fixed asset, appropriations are made out of
yearly profit in the name of provision for depreciation, which is meant to
assist the company in replacing the asset when it wears out or becomes
obsolete.
Depreciation
SAS 9 defines depreciation as an estimate of the portion of the historical
cost or revalued amount of fixed asset chargeable to operations during an
accounting period.
The main causes of depreciation include:
a.
b.
c.
d.
e.
effluxion of time
Many methods exist for providing for the depreciation of a fixed asset.
Management is at liberty to make choice of the method considered most
suitable to its operations, but once the choice has been made, the
consistency concept required that such a method be applied from year to
year.
The weakness of
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historical cost of the asset concerned and not replacement cost so that the
provisions are usually short of the amount required replacing the asset at
current cost. In spite of the obvious weakness of depreciation provision, it
serves as a reminder to management that once in the life of the business
a fixed asset will need to be replaced. Management is therefore put at
alert to prepare for the future.
Repairs and Services
A fixed asset as in the employment of a company needs to be maintained.
After acquisition, the assets cannot continue to work indefinitely without
repairs and services. The cost of maintenance may be material or
immaterial. It is material where the cost is such that it cannot be written
off within one accounting year. In this case it is to be amortized over a
number of years. In practice, when a situation like this occurs, the best
method to apply is to add up the new cost to the existing one so that
together they can form the new value of the asset. Provisions for
depreciation will now be based on the new value of the asset. On the
other hand, the cost of maintenance may be immaterial. If it is immaterial
the cost should be written off the profit and loss account and forgotten.
ABANDONMENT
This is the last point in the life of a fixed asset in the company. The
company at this stage has tapped all the potentials of the asset and a
continuing maintenance of the asset will be unnecessary cost to the
company.
CONCLUSION
Analysis prior to investment in fixed assets may not be the problem in the
Nigerian workplace.
It is the maintenance.
This makes
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REFERENCES
1. Anumaka, Nelson M. (2000) Managerial Accounting & Control, Matik
Education Books (MEB).
2. Brealey, R. A. and
Myers, S. C. (1996) -
3. Bolten, S. E. &
Conn, S.E. (1976)
5. Lindsay, R. &
6. Osaze, B. &
Anao, A. R. (1990)
Press.
8. Samuels, J. M. &
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