Replacing Assets: Replacement Value
One measurement of a business’s worth in dollars is its book value — the cost of all assets less all accumulated depreciation. The following information should help you consider the cost of replacing assets used in a business.
Pairing fixed asset accounts
Most companies pair each fixed asset account with its own accumulated depreciation account, both of which are included in the company’s Chart of Accounts. Your office furniture asset account, for example, is paired with an account called accumulated depreciation- office furniture. The asset account less the accumulated depreciation equals the office furniture’s book value.
Accounting systems commonly give each fixed asset account its own accumulated depreciation account; those account titles usually include a dash like the one in accumulated depreciation- office furniture.
Forecasting spending on fixed assets
Suppose you’re in the market for a car repair shop. The big assets on the books are large pieces of equipment, such as hydraulic lifts for vehicles, and lots of other tools and equipment. All these items are listed as fixed assets on the balance sheet, each with its own accumulated depreciation account.
A potential buyer most likely wants to buy the business and use it to generate earnings over many years. Big considerations include when each asset needs to be replaced and how much the replacement asset will cost. The prospective buyer can scan the fixed asset listing and make a judgment on each asset. Assets with a large amount of cost posted to accumulated depreciation probably need to be replaced soon.
An analyst can estimate each asset’s replacement cost and the year of replacement. That list represents the required cash flow to maintain the assets needed to operate the business. The listing’s total dollar amount, plus the initial purchase price of the business, is the total investment required to buy and maintain the business. At that point, the investor can decide whether the business is worth the investment.