The standard of decline in the value of assets ( part 2 )

In the previous article we explained the decline standard of assets value and discussed all the included concepts . Now we will give examples of asset decline .

Example 1  of assets decline 

We will consider fixed assets first 

A practical example to explain 

The book value of the asset is 119000 and its fair value is 122000 with the deduction of sales cost and the value of using it 114000

The recoverable value is more than the fair value with the deduction of sales costs 121000

The result value  = 114000

The recoverable value = 121000

The book value is 119000

So there is no loss of decline because the book value of the asset is less than its recoverable value .

 

Example 2 of assets decline  

 An asset of 237000 as a book value  and its fair value minus sales costs is 207000 while its value in use is 205000 . So in order to  figure out the decline we should know that the recoverable value is 207000 . The book value is more than the recoverable value  , consequently there is a decline which equals 237000-2070030000 and it is listed as an expense in the income statement .

But if we follow the international standards that allow assets revaluation only if the company uses the  revaluation model  in asset measurement . As for the Egyption standard the revaluation model has been deleted. 

In this case we use   the revaluation model of the international standards with the treatment of any decline in the asset value then we revalue it as a revaluation loss .  

This loss is included in the income statement unless there is a surplus revaluation in the comprehensive income statement and the shareholders 

‘ rights change statement so as to deduct the loss from it first in the limits of the surplus . The remaining of the surplus is closed in the earnings and loss account as an expense . In our example there was a revaluation surplus of  12000 so 12000 is deducted from 30000 ( decline ).

The revaluation surplus is zero

The decline is 18000 subtracted from the income statement

The accounting treatment is 

300000    A / ASSET DECLINE ( revaluation loss)

30000    A / FIXED ASSET

The revaluation loss is closed with the surplus of previous years 

12000       A / REVALUATION SURPLUS 

18000       A/ EARNINGS AND LOSS    

30000        A/ ASSET DECLINE ( REVALUATION LOSS )

     Or the entry can be as follows 

12000        A / ASSET REVALUATION SURPLUS 

18000        A/  ASSET DECLINE LOSS

30000         A / FIXED ASSET 

Then we close the asset decline loss in the earnings and losses account 

18000            A/ EARNINGS AND LOSSES 

18000             A/ asset decline loss 

30000            A / fixed asset 

 

Example 3 of assets decline 

The book value of the asset is 115000 and the fair value minus sales costs is 117000while its value in use is 123000 . Here there is a revaluation surplus of 6000 , so it is clear that the recoverable value is 123000 which is more than the asset book value with 6000 . Therefore there is no decline loss .

 

Example 4 of assets decline

The asset book value is 83000 and the fair value minus sales costs is 75000 

Its value in use is 79000

The recoverable value is 79000

It is less than the book value with 4000 pounds .

Then the decline loss is the difference 4000 which is an asset decline loss

It is included in the income statement as an expense in the Egyptian and international  standards unless there is an evaluation surplus as shown in the above example . 

 

Example 5 of intangible assets decline 

El-ekhlas Company bought  El-nasr Company and the paid amount was 200 million=ns and the book value was 100 millions and the net definable assets ( with fair value ) 150 millions assuming that there are no minority interests .

Goodwill is the difference between the purchase price and the net fair  market value of assets 

If the paid amount is less than the market value then there is a positive goodwill and it is stated as a goodwill . Back to the example long term assets ( 200-150 )  = 50 millions  goodwill .

 

What about goodwill ?

If there is a decline in its value for example of 100 thousands during the following financial period  

The goodwill value is decreased with the amount of decline

But if the decline is repeated during a next period 

We won’t be able to recover the decline value in goodwill like other assets

Namely , goodwill has no recovery for decline value 

Goodwill has just decreased so it operates according to the new book value 

Therefore we should do an annual decline test 

If there is a decline   then reduce the book value . If there isn’t then the book value will be  fixed . 

But we can’t recover the decline in goodwill as explained before .

 

Another example of assets decline 

On reviewing the operating sector in a company  ,regarding the asset decline , the book value of the net operating sector assets was  35 million pounds  . The company presented two types of estimations 

First : future estimation which includes the estimated benefits from restructuring of 38 millions .

Second : present estimations state the estimated benefits from restructuring of 33 millions .

We should not consider the future estimation on calculating the asset value in use , so the value is 33 millions . Since the book value is greater then there is a decline loss of 2 millions which is included in the income statement as an expense .

 

An example of the assets decline loss 

 A company owns some old trucks and it can’t generate cash aside from its business and operating sectors . Also the trucks can only be sold in the  used car market .

Here the company can’t estimate the recovery value of the cars because it does’t obtain revenues and expenses separately , so the cars have to be merged with a suitable cash generating unit then the company estimates the recovery value  of this unit and the degree of decline in this value .

In other words all the cars must be combined and a value decline test is made . 

 

Assets decline example 

A bus company has contracted with a school to transport students . It contracted on its ten lines but there appears a line that loses because it gets students from a distant place . Meanwhile the company can’t end the contract of this line as  all the lines are set in one group in the contract .  Now can a test be made to decrease the value of this line ? Since all the 10 lines are grouped together , I test the asset decline of the whole group, not of  the line separately . That is I test the cash generating unit ( the ten lines ) .

 

Assets decline example 

A company bought a machine for 100 thousands L.E. whose  productive age was expected to be   10 years with no scrap value at the end of its age . In the beginning of the sixth year a decrease in demand took place as a result of the existence of new productions in the market which led to a decline in the asset value of 20 thousands but the asset is expected to last for five more years .

First at the end of the fifth year 

Gross depreciation = 10000 ✖ 5 =50000

Asset Book value at the end of the fifth year = 100000- 50000= 50000

The decrease is 20000

So the book value of the asset =50000-20000=300000

A five- year - depreciation is made 

The next item which is the assets value decline  

We explained the standard and learned that assets decline is

The book value of assets that is entered in the records with a greater value than that of the recovery value . In this case the asset is considered  declined. 

 

 What is meant by the decline of recovery value 

Recovery value is the net fair value of the assets ( clients ,  investments and other debit balances ) . The value of these assets is derived from trial balance minus the  clients’ debts 

Some companies list each item individually in the financial statements and some others list the gross inventory , clients and investments .

 

 Difference between book value and recovery value :

Decline of financial assets occurs if there is evidence of positive effect on the future  cash flow statement estimated from using the asset . The decline loss is measured by comparing the book value to the recovery value or the book value to the current value of estimated future cash flow .

 

Measuring the decline loss of a financial asset :

The present value of future cash flow is measured by using the actual interest price . The decline loss of a financial asset sale is measured by the use of the fair value while the book value of all assets is reduced through the deduction of decline loss except that of the decrease in the value   expected to  receive from the clients ( the decrease of clients’ receipts is similar to the uncertain collected debts ) . It’s better to show the decline in a free account when the client’s debt is un-receivable then it is written off and deducted from the decline account of the clients’ value . 
 

  The difference between the book value and the fair value at the end of financial year :

We will apply this practically . We add to the decline account  any previous received debts. Investment decline is different from investment revaluation  (which was discussed in the investments accounts before)  that is the difference between the book value and the fair value at the end of each financial year . If I had investments in my company with a book value of one million pounds and at the end of the period its fair value was one million or even one million and 200     whatever the estimation is .  These differences are listed in the income statement either  as  revenues or expenses as explained before . 

Back to the decline , it means that the amount of million pounds will decrease in the next financial year as a result of the increase in the interest prices and the inflation . In other words the future value of the million pounds will not be the same , they will be for example 800 thousands because of the inflation or the company expectation that the share value will decrease and in turn its investments will decrease too .

 

Now this decline loss is included in the income statement as the evaluation 

In the example =   100000-800000 = 200000

The investment's net value in the balance  = 800 thousands .

But in the following year if the decline value is recovered because of the decrease of interest prices or  oncrese of the investing company shares , then the delinr=e loss value is recovered in the limits of the deduction  . Namely it can’t be more than 200 thousands . This decline analysis is applied on each level independently . As explained before the investments for trade and available  sale investments .

 

The decline of  the non-financial assets :

The book value of the non-financial assets is reviewed other than the inventory and  deferred tax assets in the list of financial statements ,  in order to determine if there is a decline loss or not . The decline is declared if the book value of the asset or its cash generating unit is less than its recoverable value . 

 What is a  cash generating unit ?

It is the smallest set of certain assets that generates cash inflow . This set is  greatly independent  from  the cash flows from other assets or asset sets and the decline loss is included in the income statement .

The recoverable value of the asset or the cash generating unit is the greatest  among its value in use and its fair value minus sales cost .

The declared decline losses in previous periods for other assets are reviewed  in the financial statements .

What if there is an indicator of the decrease in loss value or it does not exist in the following years , undoubtedly this decline loss is reflected provided that  the book value doesn’t exceed its value  after depreciation deduction  . Unless the decline is declared , its value will be deducted in the income statement and added in the adjustment item on the net earnings before tax in the cash flow statement .

 

A practical example of assets decline :

A tourism transportation company bought a bus on 1/1/2002  for  100000 and its scrap value is  10000  L.E. with the average age of 10 years .  After the decrease in the customs taxes and sales taxes of imported cars at the end of 2004  , the company made a decline analysis on 31 /12 /2004 . The result was that the net market value of selling the bus is 59000 and the value in use  ,if the company kept using or renting it , is 56000 ( the present net value of future cash flow ) . 

If you know the following :

The decline analysis result in 2005 didn’t change 

Also it is the same on 31 december 2006 

So we need to prepare accounting entries of many cases in 2006 .

First we will calculate the annual depreciation till 2004 

= 100000- 10000 = 90000

the annual depreciation = 90000/ 10 = 9000 L.E.

Gross depreciation in 3 years 

2002- 2003-2004

Gross depreciation in 3 years  = 9000 ✖ 3 = 27000

The net book value = the actual cost - gross depreciation 

= 100000-27000 =73000 L.E.

As we mentioned before the recovery value is the greatest among the marketing value and the value in use which is bigger 

So 59000 is more than 56000

Now we want to decide if there is a decline or not 

This is if the book value of the asset is greater than its recovery value 

Applying this to our example 

The book value is 73000 and the recovery is 59000

So there is a decline in the value of 14000

Then as we explained before 

 The entry is

14000    A /  value decline loss

14000     A /  gross value decline loss 

The book value in the balance on 31 december 2004 

= actual cost - gross asset depreciation - gross asset decline ( value decline loss ) 

 Recovery value =100000-270000- 14000 =  59000 

This matches the principal account that the asset can’t be listed in the  ledgers with a greater value than the recovery or expected value .

 The depreciation of  the years 2005 and 2006 is calculated as the following :

=  (the remaining book value - scrap ) / number of remaining years

=(59000- 10000) / 7 

= 49000 / 7 =7000

So in both 2005 and 2006 = 7000

Then the gross depreciation till the end of 2006

= ( 7000 ✖ 2 )+ 27000 =41000

The book value at the end of 2006 

= actual cost - gross asset depreciation - gross value decline loss

= 100000- 41000- 14000 =  45000

 

  Now we will review the assumptions of value decline analysis

Each assumption in 2006  separately

The first assumption is

 

The recovery value is 40000 on 31 december 2006 

So there is a decline in the asset value as

= 45000-40000 = 5000

The entry will be 

5000 A  / VALUE DECLINE LOSS 

5000   a / GROSS VALUE DECLINE LOSS 

So the gross value decline loss = 14000 + 5000= 19000

The asset book value after the analysis is 

=100000- 41000-19000 = 40000

To  Calculate the asset depreciation in the following years 

Depreciation expense is  

(40000-10000) /5 =  6000

This is on the assumption that there will be no other decline

 

  The second assumption:

 

The recovery value of the asset in 31 december 2006 is 54000 

The book value at the end of 2006 is 45000

So the difference is 9000

Meaning that the asset recovery value is more than its book value 

Then there is no value decline , but if there was a value decline loss in the last year of 14000

The recovery value of this year is more than the book value ( that was deducted  before in 2004 ) 

The loss will be recovered in the limits of the declared decline in order not to exceed the decline value 

9000    A / ASSETS DECLINE VALUE  ( recovery earnings )

Of course the value decline recovery is listed in the profits and losses as a revenue 

Also it is deducted in the cash flow in the adjustments item of the net earnings before tax .

Then the gross value decline loss is reduced from 14000 to 5000

Because 9000 were deducted 

The actual asset value = 100000-41000- 5000 =54000

The depreciation in 2017 =  (54000-10000)/ 5 years = 8800

 

The third assumption :

 

The recovery value on 31 december is 66000

The book value = 45000

The difference = 21000

So there is no assets decline 

But if the loss of the last year  will be recovered  in the limits of the declared loss

14000   A/ GROSS ASSETS DECLINE LOSS 

14000    A /   RECOVERY OF ASSETS DECLINE LOSS ( recovery earnings )

The new book value of the asset =   100000-41000  = 59000

The depreciation in 2007 

= (59000-10000 )  /5 = 9800

Of course the depreciation expense changes on every decline and we have to adjust the gross depreciation which affects the retained earnings as we will explain in the standard of changes in policies and estimations .

  

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