MODULE 2.

ASSET VALUATION METHOD

Learning Objectives:

After successful completion of this module, you should be able to:

 Enumerate the importance of asset valuation

 Calculate asset values using the methodologies discussed

Importance of Asset Valuation

Asset valuation plays a key role in finance and consists of subjective and objective
measurements. The value of a company's capital assets is straightforward to value, based on the book
values and replacement costs. The value can easily be ascertained on tangible assets. However, there
is no figure on the financial statements that tell investors exactly how much intangible assets like brand or
intellectual property are worth. Companies can overvalue goodwill in an acquisition as the valuation of
intangible assets is subjective and can be difficult to measure.

There are many reasons for valuing assets, some of which are the following:

a). Right Price

Asset valuation helps identify the right price for an asset when it is offered to be bought or sold
because the buyer won't need to pay more than the asset's value, nor will the seller be paid less than the
asset's value.

b). Taxes

Taxes is inherent to a property and by doing asset valuation, taxes are considered and calculated
accurately.

c). Company Merger

In merging two companies of acquiring company, asset valuation is important because it helps
both parties size up the business.

d). Loan Application

Asset valuation is needed for the lender to determine the loan amount that can be borrowed by a
company by offering its assets as collateral.

e). Audit

Public companies are regulated. which means that they need to present audited financial reports
to the investors. Part of the audit process involves verifying the value of assets

Methods of Asset Valuation

Cost Method

This is the easiest way of asset valuation where the value of the asset is based on the carrying
cost or purchase price and replacement costs.

Tangible assets refer to assets that are physical or that can be seen, which have been purchased to
produce products or services.
To compute for the value of a tangible asset

- Refer to the balance sheet and get the total assets.

- From the total assets, deduct the total value Of the intangible assets.
- Then deduct the total value Of the liabilities. What is left are the net tangible assets or asset
valuation.

Consider the following simple example: Php 5,000,000

Balance sheet total assets (Php 1,500,000)
Less: Total intangible assets (Php 1,000,000)
Total liabilities Php 2,500,000
Total tangible assets

Intangible assets are assets that take no physical form. They may include patents, logos,
franchises, and trademarks. For example, a multinational company with assets of Php 15 billion goes
bankrupt one day, and none of its tangible assets are left. It can still have value because of its intangible
assets, such as its logo. patents or trademarks that many investors and other companies may be
interested in acquiring.

Market Value Method

This method bases the value of the asset on its prevailing market price or its projected price when
sold in the market. In the absence of similar assets in the market, the replacement value method or the
net realizable value method is used.

Base Stock Method

This method requires a company to keep a certain level of stocks whose value is assessed based
on the value of a base stock. This accounting method is used in valuing inventories by carrying on the
books a minimum quantity of a commodity at the same low fixed price from year to year and valuing the
quantity in excess of the minimum at a separate price which is usually the lower Of cost Or market value.

Standard Cost Method

This method uses expected costs instead of actual costs, often based on the company's past
experiences. The costs are obtained by recording differences between expected and actual costs,

Example:

Levis, Inc. purchases its denim from a local supplier with terms of net 30 days, FOB destination
point. This means that title to the denim passes from the supplier to Levis when Levis receives the
material. When the denim arrives, Levis will record the denim received in its Direct Materials Inventory at
the standard cost of Php3 per yard and will record the liability at the actual cost for the amount received.
Any difference between the standard cost of the material arid the actual cost of the material received is
recorded as a purchase price variance.

Illustration 1 .

Let's assume that on January 2, 2019 Levis ordered 1 000 yards of denim at Php2.90 per yard.
On January 8, 2019 Levis receives 1,000 yards of denim and an invoice for the actual cost of Php2,900.
On January 8, 2019 Levis becomes the owner of the material and has a liability to its supplier. On
January 8 Levis Direct Materials Inventory is increased by the standard cost of Php3,000 (1,000 yards of
denim at the Standard cost of Php3 per yard), Accounts Payable is credited for Php2,900 (the actual
amount owed to the supplier) and the difference of Php100 is credited to Direct Materials Price Variance,
The entry looks like this:
 The Php100 credit to the price variance account communicates immediately (when the denim
arrives) that the company is experiencing actual costs that are more favorable than the planned, standard
cost.

Illustration 2.

In February, Levis orders 3,000 yards Of denim at Php3.05 per yard. On March 1 , 2019 Levis
receives the 3,000 yards Of denim and an invoice for Php9,150 due in 30 days. On March 1, the Direct
Materials Inventory account is increased by the standard cost of Php 9,000 (3,000 yards at the standard
cost of Php3 per yard), Accounts Payable is credited for Php9,150 (the actual cost of the denim). and the
difference of Php 150 is debited to Direct Materials price Variance as an unfavorable price variance:

After the March transaction is posted. the Direct Materials Price Variance account shows a debit
balance of Php50 (the Php100 credit on January 2 combined with the Php150 debit on March 1). A debit
balance in a variance account is always unfavorable—it shows that the total of actual costs is higher than
the total of the expected standard costs. In other words, your company's profit will be Php50 less than
planned unless you take some action.

ACTIVITIES/ ASSESSMENTS

Answer the following exercise

Exercise No. Mod 2-1 (Essay)

Answer the following questions:

a. Why we need to value?

b. Why valuation matters to business people?
c. Why do people perform valuations?
d. How and when to apply valuation principles?