What is Income approach to fixed asset revaluation?

After initial recognition at cost if the carrying value of an item (of property, plant and equipment) is significantly different from the value measured on fair value basis then revaluation of asset is required. The reason is if asset is still carried at old value financial statements might give distorted view of assets.

Assets are mostly revalued on market value basis i.e. the price of the similar asset in the market. However, determining fair value of asset on market information may not be possible for some asset. Such assets are recognized by IAS 16 as specialised assets.

Examples of specialized assets include software developed in-house, assets of unique nature such as digging machines like Krupp, TBMs, vessels like Knock Nevis a.ka, Seaswise giant etc. Usual examples of such assets are governmental projects like treatment plans, power generation facilities etc.

In such cases IAS 16 allows fair value to be determined on:

  • depreciated replacement cost basis
  • income basis

Under income approach fair value is determined by calculating present value of future economic benefits or future cash flows or future incomes expected from the use of the asset. In other words this approach suggest the use of discounted cash flows technique. Simply put the cash flows that will be generated by using the asset to produce goods or in provision of services and ultimately residual value at the end of its useful life are all discounted to present date. The sum of such values is then used to determine fair value of asset.

However, International Financial Reporting Standards (IFRSs) including IAS 16 does not provide any guidance on how to apply income approach for fair value measurement. Due to this confusion surrounds on application of “secondary” methods of fair value measurement.

But how future benefits are defined? Are the real cash flows or earnings? Are they gross or net cash flows/earnings. And as this is all future related what effects the future earnings or cash flows whether such effects should be considered while determining fair value. These questions make this approach quite difficult to implement. But if primary method of fair value measurement i.e. market value basis does not work then we have to rest with income approach despite its pitfalls.

Determination of fair value among accountants in the absence of market information is becoming a hot topic. And many are inclined to use depreciated replacement cost basis as it provides better valuation basis. However, there are cases in which only income approach can help to determine fair value of asset. But one thing remains clear that even if value is determined under using alternative basis i.e. other than market value basis the valuation shall remain in line with market valuation basis as it is the recommended fair value measurement basis.

2 COMMENTS

    • For which system you need sample audit programme?

LEAVE A REPLY

Please enter your comment!
Please enter your name here