understanding balance sheets

Ainsley1

Maybe not correct for this website in total but might be interesting to other investors? However I think there may well be some of you knowledgeable posters who might post the answer......

In a general way to understand businesses that could form part of investments I thought it would be good to learn more about accounts.......Not an area that I have significant experience in!!

On reading up on balance sheets I understand (I hope) the need to record assets and their depreciation. There is a lot written on it. However for fixed assets I have not located much about assets that appreciate (such as property over time, art, wine etc.). How should that be shown on a balance sheet?
Also I note assets can be valued on an historical or current basis. Why and what is the benefit of either?

Not really key to making my investment decisions but of interest to aid understanding.

Apodemus

When a fixed asset rises in value (or is assumed to have risen) this is normally shown in the balance sheet as a figure under "Revaluation Reserve"

EdGasket

More important is earnings and are they growing, how much cash they have, net assets (not goodwill), and how much debt. You can get a net assets value figure from advfn but its not always accurate and based on last full year accounts.

Property companies usually quote a NAV value in their results headlines.

LHW99

Find accounts a difficult read myself, but was once told to always start at the back and work forwards!

dadyhacker18

Historical cost accounting is less subjective as it is what the business has paid for the item. It also is attractive to businesses that prefer not to continually revalue their assets which can be costly if a third party expert is involved.

Fair value accounting tries to value assets at an arms-length - i.e. what an independent third party would value the item at. This is attractive to businesses who like to show what their assets are worth currently but it can be costly where a third party expert is required. Some businesses must show certain assets and liabilities at fair value, for example those that apply International Financial Reporting Standards (IFRS) - ordinarily businesses that are listed on a stock exchange. Investment property would be held at fair value.

We are seeing more fair value accounting recently because there has been a significant change to the accounting standard regime in the UK. FRS 102 which replaced the existing suite of standards, also requires more assets and liabilities to be fair valued.

Apodemus

LHW99 wrote: »

Find accounts a difficult read myself, but was once told to always start at the back and work forwards!

That is good advice, so much of the interesting stuff is in the notes to the accounts.

Ainsley1

Thanks for the responses.

More important is earnings and are they growing, how much cash they have, net assets (not goodwill), and how much debt. You can get a net assets value figure from advfn but its not always accurate and based on last full year accounts.(

appreciated Ed but question just part of the learning process.

I like the idea of starting at the end and working backwards, all I have to do is realise what the end is!:rotfl:

So I not understand where any revaluation should be shown.
On the choice of 'historic' be 'fair value' (I called it current value) I can understand that one is effectively fixed in history and the other could be more variable ( being possibly subjective) I can only see that fair value might be better as it shows a probably more accurate reflection on the current value of the assets and how much profit is being made from those assets.
Surely an organisation with a profit from a fair value set of assets is performing better than one with the same level of profit based on historical values where assets have, since that original historical cost, risen substantially in value (consider as one example a company holding lots of real estate over many a year that has risen in value several times over the years as probably will have the rent)

That is the only thing that immediately springs to mind but there must be others? Ignoring international aspects, is there not any considered good or best practice?

Ainsley1

Further thought, if my asset was 'cash' I would be more content earning 5% on £1M than on half of that value (if that is what I originally invested)
.......I could wish!:eek:

dadyhacker18

Property businesses are required to hold property that generates rental income at fair value so that situation shouldn't really arise. You are more likely to see historical cost accounting in properties that a business uses for its own purpose and not as an investment.

Remember all we are talking about here is how you measure assets, liabilities and profits, ultimately business performance is about the cash returns a business makes for its investors through dividends and realisation of assets.

It's true fair value is often regarded as the best way to show a more accurate value of assets and liabilities but the power of keeping things simple must not be under estimated. The fair value of a property is arguably easy to establish but when you start to fair value derivatives or indeed individual clauses in contracts, that's when it starts to get subjective and fair value can mean very different things to even different experts. Take a look at the financial instruments note in the financial statements of a bank.... I spend a lot of my time during the working day advising clients on how to account for various items and without a doubt fair value of certain items is a very tricky area.

In terms of best practice, there is a huge shift in accounting standards towards fair value so the ability to choose historical cost is far less now than it was a few years ago.

Heedtheadvice

Often had some similar thoughts to Ainsley so this thread is helping me too!

AndyT678

Ainsley1 wrote: »

I can only see that fair value might be better as it shows a probably more accurate reflection on the current value of the assets and how much profit is being made from those assets.
Surely an organisation with a profit from a fair value set of assets is performing better than one with the same level of profit based on historical values where assets have, since that original historical cost, risen substantially in value (consider as one example a company holding lots of real estate over many a year that has risen in value several times over the years as probably will have the rent)

Don't forget that for many businesses the worth is in the brand(s) they own the value of which might not appear on the balance sheet at all. Unilever doesn't have a market cap >£120bn because they own a bunch of property.