How is an Asset Valued, and How is it Reported?

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An asset either has a current or intrinsic value, for example cash, or it can be used to generate future revenues. In the case of footballers, as previously discussed, there are various ways that they can be seen to be valuable, key being of course the club’s ability to sell merchandise thanks to them. 

Irrespective of how much an asset was bought for or how much it cost to construct it, what is communicated to the balance sheet’s readers is that this asset will bring in revenues of at least the amount shown therein.

If, say, we report in the balance sheet the asset receivables, then we are implying that the amount shown is expected to be received in a reasonable amount of time, though we are estimating how much of this will be streaming in, e.g., if we face delays in payment from some of our customers – we need to be careful here as judgement is required. 

If that happens, then effectively we are overstating the value of assets in the balance sheet and, of course, reducing the value of costs in the income statement, thus increasing (should we say overstating?) reported profits. 

To further complicate things, we need to keep in mind that assets are generally carried in the balance sheet at cost less amortisation or depreciation. IFRS (International Financial Reporting Standards) require us to match the cost of the asset against the revenue it generates in that particular financial year – this is the Matching Concept at work. Additionally, to determine the “cost” of the asset, one more thing is required and that is the residual value of the asset at the end of its useful life.

So, to apply the matching concept and satisfy IFRS, the management of a firm have to estimate the useful life of the asset as well as the residual value. This requires judgement, and this is also where traps appear…

What does this mean if you are a shareholder? What are the implications of overvaluing assets for share prices? Have a look at our more detailed guide to International Financial Reporting Standards for Shareholders!


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