Free «Valuation and Accounting for Assets and Working Capital Hyundai and Kia Motors» UK Essay Paper
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This report will cover depreciation and impairment of long-term assets. Definition of the terms will be given. Accounting concepts which work in hand with depreciation and impairment will be discussed. Depreciation and Impairment methods used by Hyundai and Kia Motors will be identified. Companies will be analysed and compared for the 2011 and 2010 year periods. In the end we will conclude our findings.
Depreciation and Impairment
Depreciation is a method that allows spreading cost of a tangible asset over its useful life. Depreciation expense shows the amount of the asset’s value that has been used up (Investopedia, 2013). For example when a new car is used for 1 year, it undergoes physical damage (wear and tear) and changes in demand, obsolescence. All these factors reduce the value of the car and this reduction is incorporated as the depreciation expense in the income statement and a contra asset in the balance sheet. “Impairment of assets is the diminishing in quality, strength, amount, or value of an asset. The impairment value is measured by comparing the value of the fixed asset or income-generating unit with its recoverable amount (the highest value that can be obtained from selling the fixed asset or income-generating unit)” (Qfinance, 2012). Long term assets may undergo impairment (decline) in value for a number of reasons, including bad management, increased competition, and technological innovation. For example we own an electric car and due to technological development a new electric car model comes out, with higher energy efficiency and higher speed capability. In this case our care would have to be impaired and reduced in value, as it became obsolete and its price has gone down.
The four main accounting concepts thatthat prescribe the use and recognition of depreciation and impairment:
- Going concern: assume that the continuity of the business, indefinitely. The long-term assets will be used all through its useful life and the purchase cost of that asset should be spread out throughout that period, rather than being charged on the day of purchase.
- Prudence: caution and prudence should be applied when estimating value, do not over value assets. Depreciation and impairment methods enable us to treat long-term assets with caution. They ensure prudent value estimation of that asset through gradually diminish value of that asset as its useful life decreases and, in case of some unexpected reductions in value (eg. Becoming obsolete) asset is further reduced to its recoverable amount (impaired).
- Matching: income should be offset by all expenses involved in production of that income. Thus a purchase of a long term asset should not be fully charge in the year of purchase, as it will serve the business and generate revenues for a few years. Depreciation and impairment methods provide the tools to proportionately spread the cost of that asset, through its useful life.
- Consistency: accounting methods must be used on a consistent basis. The set standards for depreciation methods and the ‘IAS 36’ impairment of assets standard facilitate consistency. (Riley, 2012).
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These accounting concepts enable us to prepare true and fair value financial statements and reports, and depreciation and impairment facilitate the application of these concepts.
Depreciation and Impairment Policy at Hyundai and Kia Motors
Hyundai depreciates its long-term assets using the straight-line method, and estimates the useful lives of the assets using a table, see Appendix 1.The company re-evaluates its depreciation method, and estimated useful lives and remaining amounts at the end of each reporting period. At the end of each reporting period the company assessed if any circumstances arise that the asset may require impairment. If such circumstances do arise, Hyundai assesses the asset’s recoverable (higher of fair value less selling cost and value in use) amount to estimate the amount loss. Kia Motors uses the same depreciation method as Hyundai however the assets useful lives table differs, see Appendix 2. Impairment is treated on the same basis as well, see Appendix 2.
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Kia Motors and Hyundai Financial Analysis
For all calculations see Appendix 9. Kia Motors received 11.29% a return on assets (ROA) in 2011 and 10.27% in 2010. Hyundai’s ROA was 7.40% and 6.34% in 2011 and 2010, respectively. Both companies have improved their return on assets through the 2010 year period. Kia Motors seems to be using its assets more efficiently.
If we exclude depreciation expense and impairment charges, Kia Motors ROA would slightly improve to 11.51% and 10.53% in 2011 and 2010. If the same is done for Hyundai, it would improve much more significantly to 8.94% in 2011 and 8.09% in 2010. This show that Hyundai depreciated and impaired a higher portion of their asset, compared to Kia Motors.
In 2011 and 2010, Kia Motors had a working capital ratio of 0.97:1 and 0.84:1 respectively, while Hyundai’s ratios were 1.48:1 and 1.38:1 respectively. In both years, Hyundai’s current assets could cover current liabilities, unlike Kia Motors. Kia Motor’s had 46 inventory turnover days in both years, while Hyundai has 38 days in both years. This is an impressive turnover, considering that they are selling cars, which usually are not easy to sell. Both companies’ accounts receivable days are similar for both periods and are less than a month. Kia Motors has a better trade credit arrangement compared to Hyundai, with 52 days compared to 40 days in 2011 and 61 days compared to 44 days in 2010.
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Depreciation and Impairment play an important role in implementation o of key accounting concepts. Application of these accounting concepts allows improving financial statement reports preparation, by providing more accurate value. Kia Motors and Hyundai motors use same straight-line method for depreciation, and equally treat impairment. Both companies use IFRS standards and IFRS has a universal accounting standard to treat impairment, IAS 36. So there is no surprise, that they have same policy for impairment. Kia Motors receives higher return on asset compared to Hyundai, thus is more efficient in managing the assets. In 2010 and 2011, Hyundai had higher depreciation and impairment charges in proportion to total assets, compared to Kia Motors. Hyundai proved to be more liquid based on working capital ratios. Both companies turned over their inventory within a 2 month period. Both companies collect their customers earlier than they have to pay to suppliers, such arrangement reduces liquidity risk. Kia Motors has a slightly better trade credit arrangement than Hyundai. Overall Kia Motors seems to be more efficient than Hyundai, whereas the latter’s current ratios are significantly better than Kia Motor’s.
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