Valuation of Tangible Assets: Land, Plant and Inventory

Understand Valuation of Tangible Assets

Key rules to remember

Depreciated replacement cost (DRC)

DRC = Replacement cost new − Physical deterioration − Functional obsolescence − Economic obsolescence

Use for plant, machinery and specialised buildings. If a question gives a total depreciation percentage, apply it to replacement cost new.

Straight-line physical depreciation

Depreciation % = Age ÷ Total useful life × 100

Use effective age (condition-based) if the question gives it instead of actual age.

Cost of replacement with price index

Replacement cost new = Historical cost × (Current index ÷ Index at purchase)

Use when no current quote is given. Index trending is only an estimate.

Net realisable value (NRV)

NRV = Estimated selling price − Cost to complete − Selling costs

Compare with cost item by item or group by group, not on the grand total of unrelated items.

Inventory carrying value

Lower of cost and NRV

This is the usual accounting rule under Ind AS 2. For fair value purposes, follow the basis stated in the question.

Building value (cost method)

Value = Land value + (Replacement cost of building − Depreciation)

Value land separately by market comparison. Do not depreciate land.

Capitalised rental value

Value = Net annual income ÷ Capitalisation rate

Net income is after outgoings such as property tax and maintenance.

Scaling by capacity (cost approach)

Cost of new asset = Cost of known asset × (New capacity ÷ Known capacity)^n

Use only if the question gives the exponent n. Often n is given as 0.6.

How to solve Valuation of Tangible Assets questions

1. 1Identify the asset class and the purpose of valuation (sale, insurance, merger, balance sheet). This fixes the basis of value.
2. 2Choose the approach the question points to: market for land and standard assets, cost for plant and special buildings, income for rented property.
3. 3Collect the inputs: current cost or price, age, useful life, condition, selling price, costs to sell.
4. 4For plant, compute replacement cost new first, then deduct each form of depreciation or obsolescence in the order given.
5. 5Value land and building separately. Never depreciate land.
6. 6For inventory, compute cost and NRV for each item or group and take the lower. Adjust for obsolete or slow-moving stock.
7. 7Add up the values and state the total clearly with the basis of value.
8. 8Add one line of comment or recommendation, such as the key assumption or sensitivity.

Quickest way: Three-line check for plant and inventory problems

Common mistakes in Valuation of Tangible Assets

• Depreciating land along with the building.

  Students treat the property as one asset and apply a single depreciation percentage.

  Fix: Split the property. Land stays at market value. Only the building is depreciated.

• Applying depreciation to historical cost instead of replacement cost new.

  Book depreciation habit from financial accounting carries over.

  Fix: In the cost approach, first update to today's cost of a new equivalent asset. Then deduct depreciation from that figure.

• Comparing total cost with total NRV for inventory.

  It saves time and looks reasonable.

  Fix: Compare cost and NRV item by item or by similar groups. Take the lower for each and then add.

• Forgetting to deduct costs to complete and selling costs in NRV.

  Students stop at the expected selling price.

  Fix: Always write NRV = selling price − cost to complete − selling costs as the first line.

• Ignoring obsolescence when only physical wear is given by age.

  Age and life give an easy percentage, so other adjustments are skipped.

  Fix: Read the question for lower output, technology change or weak demand. Deduct those as separate adjustments.

• Not stating the basis or premise of value.

  Students jump straight to numbers.

  Fix: Open with one line: fair value, value in use or liquidation value. Marks are often given for this.

Worked examples