Fixed Assets and Depreciation
By: Dave Thomsen, Partner | email
Over the past few years or so, issues have arisen in our world of accounting for cooperatives that have brought the way we historically looked at property, plant and equipment, and the depreciation of those assets, under question. The first issue came about a few years ago when the loan commitments required to finance cooperative operations became so large that your lender saw it necessary to share some of the risk involved in certain loan packages. Thus, fixed asset appraisals became the norm in many cases. A second issue has occurred with new accounting standards related to mergers and the requirement to recognize business combinations at fair value.
Textbook Depreciation: Most accountants were taught in school to compute depreciation in the following manner: “Asset Cost” less “Salvage Value” divided by the “Useful Life of the Asset.” For example, a steel grain bin built for a cost of $500,000 with a scrap value of $25,000 that will be used for 25 years would have an annual depreciation expense of $19,000 and would have at least some book value for 25 years. However, in most cases today, salvage value is routinely ignored and the estimated useful life is based more on acceptable IRS tables than on the actual life the asset is used to produce income.
Actual Practice: Most of our cooperative audit clients take a “conservative” approach to depreciating their fixed assets. In the example above, the salvage value would be ignored and the $500,000 bin would depreciated over 10 years based on the IRS class life tables amounting to annual depreciation of $50,000. The asset is fully depreciated after 10 years and for book purposes has no value for more than half of its actual useful life.
Why do we do this? The accelerated depreciation expense lowers the bottom line thereby reducing income and income available for patronage dividend allocations, saving the cooperative cash. However, this conservative approach may be distorting the real value of the balance sheet by recognizing no or less than actual value of assets the company owns. Depending on the circumstances, appraisals may be necessary to give companies credit for the unrecognized value of those assets, or major adjustments will be required under the new fair value requirements in accounting for future mergers.
Maybe its time to re-think this process as we look at ways to further strengthen balance sheets and search for the right mix of allocated and unallocated members’ equity. We can still use these conservative ideas for tax purposes, but we must also consider alternatives to bring book balance sheets more in line with actual values. We are available if you would like to discuss this issue further and will be encouraging this debate as we begin our upcoming audit engagements.