results of reevaluations of fixed assets and the task of improvement of appraisals and accounting thereof.
Deputy Chairman of the State Statistics
Committee of Russia M.N.Sidorov
Results of Reevaluations of Fixed Assets and Tasks of Improvement of Appraisals of and
Accounting for Fixed Assets
Russian statistical services have gained some experience of drawing up balances of fixed assets at their full and/or residual values, as well as in constant prices and in their average annual prices for appropriate years. Russian statistical services use continuous monitoring to generate data concerning the fixed assets of large and medium-sized businesses and agencies that is required for drawing up these balances. In 1999 data on small businesses may be generated through selective inspections. Data concerning the age structure of fixed assets that is not found in reporting documents is received through the use of mathematical/statistical methods based on perpetual inventory methods. Mathematical/statistical methods are also used to appraise what influence current and projected volumes of investments in capital assets make on the age parameters of equipment.
1. A major problem in the field of accounting for fixed assets that was addressed during recent years with the participation of the Russian State Statistics Committee was the problem of reappraisal of fixed assets to keep track of inflation.
As is known, reevaluations of fixed assets are needed because the value of fixed assets is reported in accounting and statistical records in acquisition prices that change because of inflation. Reevaluations make it possible to address periodically the mixed character of appraisal and to express the replacement value of fixed assets in prices that are common on the dates of such reevaluations.
Valuation of fixed assets in real prices is very important for the following: economic analysis and forecasting of the development and use of the economic potential; identification of parameters of investments, and setting depreciation policies at the macrolevel and microlevel. The value of fixed assets determines the size of property tax, depreciation charges, profit tax, etc.
While going over to a market economy, Russia has been facing high inflation, which is typical of a transition period, and reevaluations had to be made more frequently than during the earlier period: they were made on 01.07.1992, 01.01.1994 and from then on at the beginning of every year.
Reevaluations of fixed assets registered an increase in prices for products manufactured by the industries that create fixed assets. During 1991 through 1997 manufacturing prices rose 11,000 times over and prices of construction materials, 14,000 times over. In fact, prices increased even before 1991 (fixed assets were not revalued from 1973 to 1992).
Reevaluations of fixed assets took into account the fact that the replacement value of the older plant and equipment and buildings had increased more slowly than that of new facilities. This is why in the course of reevaluations the growth of the book value of fixed assets was behind the increase in prices of products used for building fixed assets.
The four successive reevaluations of fixed assets increased their book value 19, 20, 4 and 2.6 times over; and the total increase of the book value (with account of changes in their value that took place in the intervals between reevaluations) was 5900 times over (see Table below):
Full Book Value of Organizations’ Fixed Assets bn. denominated
rubles
increase, times over, from previous value
increase, times over, from 1.07.1992 before revaluation As of 1.07. 1992 before revaluation 2.2 1 As of 1.01. 1992 after revaluation 41.3 19 19 As of 1.01. 1994 before revaluation 63.5 29 1.5 As of 1.01. 1994 after revaluation 1277.7 578 20 As of 1.01. 1995 before revaluation 1184.7 536 0.9 As of 1.01. 1995 after revaluation 4729.3 2140 4 As of 1.01. 1996 before revaluation 4916.3 2225 1 As of 1.01. 1996 after revaluation 12936.2 5854 2.6
During the period of planned economy when the State set the prices of nearly all fixed assets, revaluers used manuals that listed price data for every model and kind of facility.
Following a transition to market pricing such data became unavailable, and reevaluations began to use indices for the reappraisal of value of fixed assets; such indices were applicable to large groups of fixed assets, i.e., buildings, structures and driving devices, metal-cutting machinery, plant and equipment for non-ferrous metallurgy, railroad rolling stock, computers, etc. These indices were based on statistical figures of prices of products used for the creation of fixed assets (products of machine manufacturing and construction materials industry) and prices of assembly/mounting works and equipment as part of capital expenditures. This methodology allowed a fast revaluation.
But while more and more fixed assets were revalued, more and more inaccuracies began to accumulate, distorting the replacement value of different facilities, because average revaluation indices were applied indiscriminately to entire groups of fixed assets. To rectify the situation, the Russian State Statistics Committee began to develop a more graduated system of reevaluation indices.
Besides, apart from the index method, reevaluations began to use a more accurate direct-appraisal method based on documentary data on market prices of new facilities similar to those that were reevaluated. For example, such reevaluations were based on opinions of appraisers who used cost-approach-to-value methods to reevaluate fixed assets.
Of the total value of fixed assets of large and medium-sized businesses that was reappraised on 01.01.1997, 40 percent of fixed assets was revalued by the index method; and nearly half (48 percent) of
fixed assets was revalued by the direct-appraisal method (appraisers were employed to revalue 44 percent of all assets).
2. With inflation dropping until mid-1998, problems began to surface that related to appraisal of and accounting for fixed assets because fixed assets were quite heterogeneous, in particular those of them that had been produced and acquired when the Russian economy was a planned economy managed in a centralized manner.
While some fixed assets are highly efficient, including modern plant and equipment, transportation vehicles and buildings and structures that ensure smooth operation, there is a good deal of physically and morally obsolete fixed assets. At the end of 1997 the average depreciation of Russian fixed assets was equal to 42 percent; and the share of fully depreciated plant and equipment was equal to 27 percent.
This problem is complicated because of the specifics of the formative period the Russian market economy is in the midst of.
While fixed assets were initially acquired in the planned economy environment, now they have to operate in a drastically different market environment. When it was decided to buy such fixed assets, market factors – a projected profitability of facilities, moral obsolescence factors, supply and demand, etc. – naturally could not by any means be identified or taken into account.
It is essential that reevaluations of fixed assets established their full replacement value, i.e., total costs the owner had to incur if it wanted to replace the existing fixed assets with similar new facilities at market prices and rates in effect on the date of revaluation, including the costs of acquisition (building), transportation, assembly (mounting) of facilities, etc.
The (depreciation-adjusted) residual replacement value of fixed assets was also determined. The extent of depreciation that had been charged under statutory (largely obsolete) rates and that had been assessed before the dates of reevaluations was not identified in the course of these reevaluations.
Thus, while some fixed assets could be used far more efficiently in a market economy environment than other fixed assets, cost-approach-to-value methods continued to be applied to all of them; this contradiction began to develop into quite a complication if one wanted to determine the real value of fixed assets. If some fixed assets are not used efficiently in a market environment, their appraisal at replacement value (i.e., based on present-day costs for the acquisition of new assets similar to those that are appraised) is inherently contradictory. An appraiser has to use present-day prices to appraise what was acquired in the past in a non-market environment – an operation that simply would not be carried out today because the parties would not stand to benefit from it. In principle it would make no sense to replace fixed assets that are not needed in a market environment with similar new assets that are not needed either.
To add insult to injury, a widespread valuation of fixed assets at market prices did not win widespread acceptance during the transition period either. A market price is understood as the most probable selling price of existing property on a free and competitive market. Such operation takes into account the following factors: supply of and demand for such assets; profits to be derived from their operation in the future; and actual depreciation of the assets (actual depreciation as opposed to that recorded in accounting books in accordance with average rates). A market value may be determined on the basis of the following three methods: cost approach to value, revenue to be derived from such assets in the future and comparison of sales.
It is common knowledge that in today’s Russia a large part of operations are loss-making ones; future revenues from the use of fixed assets, if any, cannot be predicted with any certainty and, therefore, they can rarely be used for appraisal purposes; and values arrived at by using cost approach to value are
too different from those arrived at by using the expected revenues method to be readily usable together for making a single market valuation of property.
Only a step-by-step divestiture of obviously inefficient fixed assets and a normalization of the economic situation may provide grounds for making more or less reliable forecasts as to what revenue can be derived from some fixed assets and as to the market value of such fixed assets.
For the time being there is a need to develop and use a compromise option during a certain transition period – for example, the book value of fixed assets may be determined on the basis of cost approach to value but using adjustments, reductions, coefficients that take into account – to some extent – different profitability and different adaptation of various sectors to the market economy.
3. Depreciation issues are connected with the problems of valuation and revaluation of fixed assets.
The depreciation standards that have been used until now are largely out of tune with the present-day service lives and depreciation periods of fixed assets. In actual fact, a large part of industrial equipment is used 2.5 times longer than depreciation standards say it should be used. To believe accounting books and records, more than ¼ of existing plant and equipment is 100 percent depreciated, which may indicate either that depreciation standards are overly stringent or that the time is ripe to replace obsolete equipment. Another confirmation of the same point is provided by statistics which says that only 50 percent of annual depreciation charges as assessed under the existing depreciation standards is used for investment purposes.
On the other hand the efficient service life of, for example, computing equipment (4 to 5 years) and its actual service life is now far shorter than its statutory depreciation period – a standard that is obviously obsolete (8 to 12 years).
In recent years normative acts were passed that allow organizations to use accelerated depreciation (declining-balance depreciation and the sum-of-the-year-digits depreciation method). There is a task on today’s agenda: to prepare new depreciation standards that are harmonious with international experience and the present-day rates of physical and moral obsolescence of fixed assets in Russia.
4. Changes in depreciation policies provided another incentive to statistics to pay attention, in addition to the full (gross) and residual (net) value of fixed assets, to the production value of fixed assets.
Hitherto Russia has been using the straight-line depreciation method to depreciate fixed assets, which does not address the problem of falling productivity of such fixed assets. Also, the duration of the periods when a fixed asset completes its service life does not coincide with its standard service life as determined under the efficient depreciation standards. Today facilities are used for far longer periods in Russia than they should be if their service lives were determined under statutory standards.
If the ongoing liberalization of depreciation polices gives organizations the right to use accelerated depreciation, this right will widen the gap, which is quite noticeable even today, between the residual value of fixed assets that shrinks fast when new depreciation methods are used at the beginning of the fixed assets’ service life and their production parameters that change more slowly during this period. There are reasons to believe that these characteristics deteriorate increasingly rapidly during the later stages in a fixed asset’s service life when idle time increases because of failures and repairs. The diagram below describes the expected dynamics of changes to the production characteristics of fixed assets and their residual value (if various depreciation methods are used):
'\QDPLFVRIFKDQJHRIUHVLGXDOYDOXHRIIL[HGDVVHWV
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7LPHIURPEHJLQQLQJRIXVH 5 H VL G X D O E R R N Y D OX H S UR G X FW LR Q Y D OX H D V R I IX OO E R 5HVLGXDOERRNYDOXHZKHQ GHSUHFLDWLRQLVFKDUJHG VWUDLJKWOLQHPHWKRG GHFOLQLQJEDODQFHPHWKRG DFFHOHUDWHGGRXEOHUDWH GHSUHFLDWLRQ VXPRIWKHGLJLWVPHWKRG SURGXFWLRQYDOXHRIIL[HGDVVHWVDetermination of the value of fixed assets that reflects their production characteristics (production value) is based on their capacity to produce some volume of product at some time. So if a facility could produce an unchanging volume of product during its entire service life until the very end of its service life, its production value would not decline during all this time. And if production volume falls at a steady rate during a facility’s entire service life, this means that at its mid-service life, a facility’s production value drops 50 percent.
From the point of view of methodology it makes sense to specify in what respect this indicator is different from the current production value of fixed assets. Presumably, at any given moment of time a facility’s production value depends on its current capacity to produce some volume of product; and its market value, on the revenue that the use of the facility is expected to generate.
In practice, in view of the difficulties of determination of changes in production volumes throughout a fixed asset’s service life, Russian statistics tries to determine how a fixed asset’s production value falls by using what may be called a “conventional normative approach.”
Initially, a fixed asset’s standard service life figures and associated adjustment coefficients are used to determine a fixed asset’s rated service life that is close to its actual service life. Then it is calculated what part of its service life has actually expired in proportion to its entire service life; and a special table is used to calculate the extent of analytic depreciation of the fixed asset in percentage points in relation to its full book value. The table takes account of the expected dynamics of changes in production rates of the fixed assets and, correspondingly, their production value. By subtracting the book value of analytic depreciation we arrive at the production value of fixed assets.
5. There is yet another approach to a search for ways to resolve today’s problems relative to the appraisal of and accounting for fixed assets in connection with a one-time survey (inventory, business survey) of fixed assets to promote their restructuring, improvement of use and re-invigoration of the secondary market of fixed assets.
As has been calculated on the basis of mathematical/statistical models, in Russia’s industry the share of equipment that is more than 20 years old rose from 15 percent in 1990 to 28.5 percent in 1997, i.e., nearly 100 percent, and the share of new equipment under 5 years of age fell more than 5 times during the period, i.e., from 29.4 percent to 5.4 percent.
The average age of industrial equipment was 16 years in 1997 as against 11 years in 1990.
Equipment is getting old because of a falling investment activity. The volume of investments from all financing sources in capital assets of businesses and agencies regardless their ownership status dropped (in comparable prices) 4.2 times from 1991 to 1997, and production investments fell 5.4 times.
On the other hand, the available reporting data and calculations do not provide a sufficiently full description of the existing fixed assets, in particular from the angle of expediency of their continued use. An inventory could generate data on their age structure, quality and actual level of use of fixed assets and the potential of their continued use.
An inventory could help businesses and agencies determine what fixed assets they really require. Data on unneeded fixed assets could, if the owners wished so, be recorded in a database specifying their selling prices, market prices and leasing terms. This would promote the formation of a secondary market of fixed assets and their redistribution in accordance with market principles.
A functioning secondary market would help some organizations divest unneeded fixed assets and other organizations would buy second-hand fixed assets at reasonable prices or would lease them on acceptable terms. Therefore, the volume of fixed assets organizations have would be tied to their needs, which would improve the utilization of fixed assets and the general financial and economic situation of organizations in different economic sectors.
In addition, the survey could generate statistical data that could be used by state authorities to improve the analysis and planning of various processes connected with fixed assets and would be of interest to investors.
The table below shows Russia’s macroeconomic figures.
trillion of rubles
1995 1996 1997
Gross domestic product *
1540.5 2145.7 2521.9
Fixed assets at full book value at year beginning 5182.0 13072.4 13286.3 Consumption of capital assets * 559.8 843.9 923.5 * in current prices
Director of the Department for Statistics of Fixed Assets
and Construction T.P.Voronina Executed by M.Yu.Gordonov
