The most significant investment that production companies have is found in the acquisition of fixed assets, since without them the operation of this would be virtually impossible.
The level of assets that a manufacturing company maintains depends in part on the nature of the production processes. Apart from raw materials, the major contributions to the production process are factory costs and labor. As for most of the factory expenses are attributed to the plant and equipment.
The objective of this article is to consider the most important aspects in the acquisition, maintenance, replacement, administration and financial implications of the fixed asset within the company.
Introduction:
Some firms need high levels of fixed assets and relatively low labor contributions for the production of goods. This type of company is called “ Capital intensive ”, a clear example of this type of company is the one that provides electric service. Conversely, companies that need a high labor contribution and low fixed assets to obtain the products are known as " Labor intensive ", an example of this type of organization is seen in the companies that manufacture electrical equipment that they need a large number of workers for the assembly and welding of the pieces.
Fixed assets are referred to as " profit-producing assets ", since it is generally these that provide the basis for the company's ability to generate profits. Without plant and equipment, the company would not be able to carry out its daily tasks, nor produce the products that generate its income. Current assets do not give the manufacturing company the ability to generate profits.
Sorting:
There are two main classes of fixed assets: one is the plant and the other is the equipment.
Fixed asset management:
Since investments in fixed assets represent significant cash outlays made by manufacturing firms, they should pay close attention to decisions made regarding the purchase value of the asset and the possible future expenditures that must be made for their installation, maintenance, operation etc. As it is known, fixed assets have a useful life of more than one year, which is why they can represent long-term financial commitments for the company.
As time passes, fixed assets become old and obsolete, therefore, according to their useful life, they should depreciate, to recover their value in the future and adjusting them for inflation, an example of this is presented below:
Example: 01/01 / XX machinery is purchased for $ 8,000,000.
a.- Calculate the depreciation value of the machinery for period 1.
b.- Calculate the value of the accumulated depreciation of the machinery in the last year if the inflation is:
| Year | PAAG |
|
one |
10% |
|
two |
12% |
|
3 |
14% |
|
4 |
13% |
|
5 |
18% |
|
6 |
9% |
|
7 |
eleven% |
|
8 |
10% |
|
9 |
fifteen% |
|
10 |
twenty% |
Solution:
a.- As the machinery depreciates in 10 years, we have:
(8,000,000 * 1 year) / 10 years = 800,000
b.-
| Year | one | two | 3 | 4 | 5 |
| PAAG | 10% | 12% | 14% | 13% | 18% |
| Historical cost | $ 8,000,000.00 | $ 8,800,000.00 | $ 9,856,000.00 | $ 11,235,840.00 | $ 12,696,499.20 |
| a.- X Inflation | $ 800,000.00 | $ 1,056,000.00 | $ 1,379,840.00 | $ 1,460,659.20 | $ 2,285,369.86 |
| Total | $ 8,800,000.00 | $ 9,856,000.00 | $ 11,235,840.00 | $ 12,696,499.20 | $ 14,981,869.06 |
| Dep. Period | $ 880,000.00 | $ 985,600.00 | $ 1,123,584.00 | $ 1,269,649.92 | $ 1,498,186.91 |
| Accumulated Dep. | $ - | $ 880,000.00 | $ 1,971,200.00 | $ 3,370,752.00 | $ 5,078,599.68 |
| a.- X inflation | $ - | $ 105,600.00 | $ 275,968.00 | $ 438,197.76 | $ 914,147.94 |
| Total | $ 880,000.00 | $ 1,971,200.00 | $ 3,370,752.00 | $ 5,078,599.68 | $ 7,490,934.53 |
| Year | 6 | 7 | 8 | 9 | 10 |
| PAAG | 9% | eleven% | 10% | fifteen% | twenty% |
| Historical cost | $ 14,981,869.06 | $ 16,330,237.27 | $ 18,126,563.37 | $ 19,939,219.71 | $ 22,930,102.66 |
| a.- X Inflation | $ 1,348,368.22 | $ 1,796,326.10 | $ 1,812,656.34 | $ 2,990,882.96 | $ 4,586,020.53 |
| Total | $ 16,330,237.27 | $ 18,126,563.37 | $ 19,939,219.71 | $ 22,930,102.66 | $ 27,516,123.20 |
| Dep. Period | $ 1,633,023.73 | $ 1,812,656.34 | $ 1,993,921.97 | $ 2,293,010.27 | $ 2,751,612.32 |
| Accumulated Dep. | $ 7,490,934.53 | $ 9,798,142.36 | $ 12,688,594.36 | $ 15,951,375.77 | $ 20,637,092.40 |
| a.- X inflation | $ 674,184.11 | $ 1,077,795.66 | $ 1,268,859.44 | $ 2,392,706.36 | $ 4,127,418.48 |
| Total | $ 9,798,142.36 | $ 12,688,594.36 | $ 15,951,375.77 | $ 20,637,092.40 | $ 27,516,123.20 |
At the end of the useful life of the machinery, the adjusted historical cost must be the same as that of the accumulated depreciation adjusted for inflation. In this case, the final value is $ 27,516,123.20.
The higher the ratio of fixed assets to total assets, the more a company is in the capital intensive category
Capitalizable disbursements:
A capitalizable outlay is a disbursement made by the company from which it is expected to generate benefits in a period of time greater than one year. Disbursements on fixed assets are capitalized disbursements.
The basic reasons for a capitalizable outlay are to acquire, replace or modernize fixed assets or to obtain less tangible benefits over a long period of time.
Expenditures to acquire assets:
The most common reason for a capitalizable outlay is the acquisition of fixed assets. These expenditures occur especially when a company is growing or when it reaches the period of obsolescence of the plant and equipment.
An example of this expenditure occurs when the company that is operating at its maximum capacity and cannot meet the demand for the products it markets, can then think of management making two decisions; an acquire new fixed assets or repair the ones you have. For this reason, it must evaluate the alternative projects of the capitalizable disbursement.
Expenditures for asset replacement:
The decision to replace your fixed assets is more noticeable in mature companies, which have a wide market level and therefore production, this decision is almost always made by the financial manager, since he is in charge of determining whether the disbursement capitalizable is made by the total failure of the machinery or by the lack of capacity of the plant to produce what is necessary.
The expenditure must be evaluated in the sense that it is more beneficial for the company, if it is better to acquire a new asset or the utility of repairing it is viable compared to the purchase.
Another important aspect in this analysis, is that the production of the plant should not be paralyzed so that the financial administrator considers the replacement of the asset, this must take place according to the useful life of the fixed asset, the person responsible for administration must take the necessary measures, periodically evaluating the operation of each of these.
Finally, it should be borne in mind that if the company is not up to date with current technology, it could be relegated, lose productivity and be out of the market.
Expenditures for modernization:
Fixed asset modernization is often a replacement alternative. Companies that need additional production capacity may find that both replacement and modernization of existing machinery are adequate solutions to the problem of productive capacity.
Modernization may involve rebuilding, repairing, or supplementing an existing machine or installation. For example, if a drilling press that exists in the company could be modernized by replacing the motor with a programming control system, it would be better and more beneficial for the firm to adopt this system than to acquire a new drill.
Comment: Taken from "fundamentals of financial management."
The decisions made by the CFO must be made according to the costs and benefits offered to the organization, since the cost of modernizing a machine or a physical medium can be justified by the benefits but by the costs.
Relative importance of capitalized disbursements
The volume of capitalized disbursements can vary significantly, this because the actual outlay and the importance of the fixed asset determine the organizational level at which the capitalizable disbursement decision is made.
