Asset Valuation

Asset Valuation

Team A's car dealership is a profitable venture. The lot of land is located in a prime location, and it was fortunate to obtain a sizeable parcel, which is perfect for the large fleet of cars it keeps on hand. The dealership sells new and used cars and also repairs cars and sells parts. There are three main parts to the business; the car dealership, the repair shop, and the body shop, each with an inventory of items and assets that need to be accounted for regularly.

Inventory Policies

With price changes in similar products occurring throughout the year, it becomes difficult to determine the value of goods. How should these values be determined? A company must choose the most applicable cost flow assumption to its specific inventory. These cost flow assumptions include:

1. First in, first out (FIFO). FIFO is the assumption that the first goods bought

are the first goods that will be purchased by the customer. This means that the goods that are the oldest will be the first to be sold.

FIFO applies to a few types of inventories in a car dealership, like the food and beverages the dealership might offer to potential customers, any vending machines available for employees, and any fluids or parts that might have expiration dates in the mechanic shop.

2. Last in, first out (LIFO). LIFO assumes that the last goods purchased will be

the first goods purchased by the customer. This means that goods purchased some time ago remain in inventory. In the car sales industry, parts like rims for tires Ð'- which can be extremely trendy today Ð'- would qualify for the LIFO cost flow assumption.

3. Average Cost. This method assumes that customers, in general, purchase a

variety of goods Ð'- some newer and some older. Because of this, the value of the inventory is an average of the various prices paid by the company. Office supplies qualify for the average cost method. For the most part, employees have no preference about which notebook or post-it pad to use, nor do they care when these items were purchased.

4. Specific identification. Automobiles comprise the principal inventory of a car dealership. As such, specific identification cost flow is Team A's choice as the most applicable inventory policy.

Specific identification involves cost and physical flow. When a company sells unique products, and the actual cost of each individual product can be determined, the specific identification method can be used. In the case of a car dealership, the actual cost of each automobile is charged to the cost of goods sold account when an automobile is sold. Therefore, no assumption is necessary because the actual costs can be easily identified.

Cars are considered "specifically identifiable products," (Marshall, p. 152) as each can be identified via a serial number. In addition, each automobile is purchased and sold by specific unit. Because the cost data associated with each, individual automobile is easily traced, an accurate determination of ending inventory levels or the cost of goods sold can be determined. Basically, when an automobile is sold, its cost is determined from the dealership's records, and then transferred from the Inventory account to the Cost of Goods Sold account. Ending inventory will reflect the cost of the automobiles held in inventory at the end of the year.

For example, Team A's dealership may have 7 cars for sale. Each of these automobiles differs somewhat, and each has a unique serial number making the cars specifically identifiable. Once one of the cars is sold, the cost of that car is pulled from the records and considered to be the cost of goods sold. The cost of the remaining 6 cars is considered inventory value.

Capitalization Policy

When items are bought for the dealership, the expenditures have to be assessed as either assets or expenses; when it is assessed as an asset, it is referred to as capitalizing the expenditure (Marshall, 2003, p. 188). If an item is going to have an economic benefit to the organization past the end of the fiscal year, then it is appropriate to capitalize it (instead of them); however, expenditures that are not material, for example general office supplies, and expenses for maintenance or normal repairs, for the asset should not be capitalized. Most organizations have a capitalization threshold; however, the IRS does not recognize it, nor try to class anything as "immaterial" (Tax Executive, 1997, p. 14). For the dealership, anything under $100 is considered immaterial, and therefore considered (Therefore that) the capitalization threshold set by the accounting department.

Some of the items that the dealership capitalizes are the land, inventory, the company cars used by management, computer equipment and office equipment, and the mechanic/body shop tools and equipment. All of these items are considered material, and all are expected to be in use beyond (past) this fiscal year. Capitalized assets are also eligible for depreciation, since they are supposed to be in use beyond (past) the fiscal year.

Depreciation is the allocation of the cost of an asset to the number of years that the expected life of the asset (Marshall, 2003, p. 188). There are several methods that can be utilized to depreciate assets, and the dealership uses them all.

The land, office equipment, mechanic/body shop tools and equipment are all depreciated using the straight-line method. This means that they will all depreciate at the same rate every year (Marshall, 2003, p. 191). This will decrease net income in the beginning years. However, over a long period of time, net income will increase.

The computer equipment, managers'