What is the Business Meaning of Appreciate?

To achieve transparency and accuracy in reporting, accountants sometimes have to report that assets gained or lost value.

In economics, finance, investing, and business in general, the term appreciate means an increase in value, almost always referring to the value of an asset. A company can properly say that its real estate holdings (assets) are appreciating. The firm cannot properly say that its debts (liabilities) are appreciating.

Accountants also describe appreciation as an increase in asset value, but they further qualify the definition when referring specifically to an asset's balance-sheet book value.

 

 

 

Other Meanings for Appreciate

Most people are also comfortable using the term more broadly when speaking outside of a business context. In non-business usage, of course, appreciate also means:

• To be grateful.
  "I appreciate your help."
• To be fully aware of something.
  "I appreciate the high risk in what we are doing."
• To value highly.
  "We appreciate every penny we earn."

These latter meanings are absent in business discussions.

• In business, appreciate means only to gain or to increase in value.
  "Property values in this neighborhood appreciate at a high rate."

Explaining Appreciation in Context

This article further defines and illustrates appreciation and related terms as they appear in financial accounting and business generally. Terms such as the following have to do especially with the value of assets:

Appreciate

Depreciate

Depreciation Expense

Impairment

Return on Assets (ROA)

Return on Capital Employed

Balance Sheet

Asset Revaluation

Book Value

Carrying Value

write-down

Residual / Salvage Value

Fair Value

Recoverable Value

Pricing Strategy

Mark to Market Rule

Lower of Cost or Market

Amortization Expense

• What is the business meaning of appreciate?
  • Define Appreciation in Accounting.
• What do depreciation and impairment mean in business?
  • Define Depreciation and Impairment in Accounting.
• Appreciation, depreciation, impairment, and asset revaluation in financial accounting.
  • Why are asset values important? 
  • How do accountants revalue assets?
  • Are depreciation and amortization expenses revaluation?
• Appreciation and impairment revaluation examples.
  • Writing down inventory. Revaluation example 1.
  • Writing off an Account receivable. Revaluation example 2. 
  • Impairment of a capital fixed asset (building). Revaluation example 3.
  • Appreciation of marketable securities. Revaluation example 4:

Related Topics

• For a complete overview of asset accounting, see the article Asset.
• The article Write Off covers writing off Accounts receivable, and Inventories in more depth.
• The article Allowance for Doubtful Accounts explains the revaluation of Accounts Receivable.
  
  

In general,, the term depreciate is more or less the opposite of appreciate. Like appreciate, depreciate has a broader meaning in general business usage but a narrower and more specific meaning in accounting.

In general usage, depreciate can refer broadly to any reduction in asset value. The market value of most automobiles, for example, depreciates over time as they move from the dealer showroom to the highway, to the used-car lot. Exceptions are the in-demand classic or antique cars, which tend to appreciate over time. Automobile collectors sometimes say (rightly or wrongly) that "Buying a Ferrari or a Rolls Royce is always a sound investment because these cars do not depreciate. They only appreciate."

Why Are Asset Values Important?

In private industry, company owners, investors, and managers have a keen, ongoing interest in tracking the values of company assets. Asset values are key when evaluating a company's financial performance, financial position, and prospects for the future:

• Profitability metrics such as Return on Assets (ROA) and Return on Capital Employed (ROCE) measure the firm's ability to earn profits with its asset base.
• Activity metrics such as Inventory turns, and Total Asset Turnover measures a company's ability to use assets efficiently.
• The values of Current assets such as Accounts Receivable and Inventories contribute to measures of company liquidity such as Working Capital and the Current Ratio.
• Leverage metrics such as the Debt to Assets Ratio or the Debt to Equity Ratio compare the funds supplied by lenders (liabilities) to the funds that owners supply (equities). The comparison shows how lenders and owners share business risks and rewards.

These financial metrics are all, in essence, different ways of asking how effectively—or how successfully—the company is using its asset base.

• Management relies on metrics for strategic decision making and for setting performance targets.
• Investors rely on metrics for making buy, sell and hold decisions.
• Industry analysts use metrics for comparing companies and making recommendations.

The total book value (carrying value) in different balance sheet asset categories is central to all of the above metrics.

Reasons for Value Change Are Public Knowledge

Officers of public companies know they must let shareholders and the public know specifically why the company's metrics have change. This means they must explain why they revalue assets.

Here, for example, are a few lines from General Electric's 2013 Form 10-K (filed in February 2014):

"Property, plant, and equipment totaled $68.8 billion at December 31, 2013, an increase of $0.2 billion from 2012, primarily reflecting an increase in machinery and equipment at GE, partially offset by a decrease in equipment leased to others principally at our GECAS aircraft leasing business.

This decrease included impairment losses on our operating lease portfolio of commercial aircraft of $0.7 billion and $0.2 billion in 2013 and 2012, respectively. Impairment losses in 2013 incorporated management’s downward revisions to cash flow estimates based upon shorter useful lives and lower aircraft residual values from those indicated by our third-party appraisers, reflecting the introduction of newer technology, fleet retirements, and high fuel prices and operating costs."

Risks and Rewards of Asset Ownership Belong to Owners

The reason that G.E. gives for revaluing Property, plant, and equipment is interesting. Referring to aircraft the company owns and leases to airlines, G.E. cites recent changes in operating conditions that impact asset value: useful lives estimates, fuel costs, and lower residual values. The firm made the original valuation appraisals before these changes.

Incidentally, this example also illustrates an important reason why some airlines prefer to lease rather than own the aircraft they fly. With a so-called operating lease, lessees (the airlines) have the right to use assets (aircraft), while the risks and rewards of ownership remain with the lessor (G.E. Capital).

Accountants define asset revaluation as the process of changing asset book values upwards or downwards, to report values more realistically. Revaluation is the company's formal announcement that earlier asset values and metrics are no longer accurate or realistic.

Initial Asset Book Value

Assets receive initial book value (carrying value) when firms acquire them. Over time, of course, an asset's real value to the company can rise, as with appreciation, or fall as with impairment. The firm may use several different indicators to represent the asset's new, more realistic value:

• The asset's current market value.
• Its current replacement cost.
• New estimates for useful life or residual value.
• Estimates of its contribution to future earnings.
• The judgment of a professional appraiser.

When it is Time to Revalue Assets

In any case, there may arise a substantial difference between asset value by these measures, on the one hand, and asset book value on the other hand. The discrepancy puts the company Balance sheet at odds with an important and universally recognized accounting imperative: financial accounting reports must be realistic, verifiable, and objective.

• Asset values that are unrealistically high or low can produce a picture of earnings and financial position that can mislead owners, investors, and company decision makers.
• Auditors, regulators, and investors expect realistic, credible asset values which they can verify.

In pursuit of realistic, verifiable, and objective reporting, therefore, accountants sometimes choose to revalue assets. The purpose of asset revaluation is to present:

• More accurate financial metrics, such as Return on Assets (ROA), Return on Equity (ROE), or Return on Capital Employed (ROCE).
• A basis for conserving funds to replace certain fixed assets when they reach the end of their economic lives or service lives. When a company uses a "Provision for depreciation" account, and when assets appreciate substantially, provisions using historical cost figures may be unrealistically low.
• A more accurate fair market value for assets that substantially appreciate after purchase. Asset categories most likely to appreciate substantially in this way include artistic assets (e.g., paintings), investments in corporate stock or other securities, and real estate (e.g., land and buildings).

Exercising Leeway in Revaluing

Additionally, a company may exercise available leeway in accounting standards to "shape" or "position' itself with owners, potential investors, potential business partners, or potential lenders. The company may revalue assets, as allowed, to:

• Decrease the company Debt to Equity Ratio (leverage).
• Facilitate the sale of assets.
• Increase the possible borrowing ceiling possible with lenders.
• Improve the terms for internal or external reconstruction.
• Improve the company's negotiating position before a merger or acquisition by another company.
  

Are Depreciation Expense and Amortization Expense "Revaluation?"

The book value of most fixed assets is routinely reduced, annually, by depreciation expense. Depreciation is a prescribed, planned, and standardized process for reducing the book value of certain tangible assets, year by year, across their depreciable lives. The result is lower reported income and tax savings for owners (for more on this subject, see the article Depreciation). Depreciation expense normally takes the asset book value from its initial value, down to a residual value (salvage value), or down to 0.

A similar process called amortization applies to the values of so-called definite intangible assets, that is, intangible assets that have a limited life, such as the purchase of the right to use a patent for a specific time (see the article Amortization).

Amortization and depreciation (in the accounting sense) change the book value of assets, but this change is not qualify as revaluation. Depreciation and amortization expenses stem from the idea that these assets have a limited useful life, during which owners use up or deplete asset value.

It is nevertheless possible for firms to revalue assets undergoing depreciation or amortization. When this occurs, depreciation or amortization continues, using the remainder of the depreciable life to bring the (new) book value down to the (new) residual value (see Revaluation example 3, below, for an illustration).

Revaluation examples below show revaluation principles at work and a few ways revaluation can impact the accounting system.

In reviewing the examples below, remember that appropriate accounting method for a given setting can differ from what is shown here, depending on factors such as:

• The asset category.
• The reasons for acquiring and holding the asset.
• The methods by which the firm capitalizes the asset.
• The year of acquisition.
• The reporting jurisdiction (country in which assets reported)

The Global Trend Toward Uniform Accounting Standards

On one hand, there is a global trend towards a single set of internal accounting standards. As of early 2022, accounting in 166 or more countries follows more or less closely standards issued by the International Accounting Standards Board (IASB) and its oversight body, the International Financial Reporting Standards Foundation(IFRS). Their International standards reports appear in numbered series, such as IAS Standards 1 through 41 (1975-2003) and the current series, IFRS 1 through 15 (starting in 2003), The standard IAS-16, for example, outlines a revaluation model for adjusting asset the book values of fixed assets upwards and downwards.

On the other hand, globalization is by no means complete, and many nations issue their amendments and qualifications to the IFRS standards. For example, fixed assets reported in the United Kingdom, Australia, India, and many other countries can be revalued upwards or downwards, as provided by IAS-16. In the United States, however, the US Federal Accounting Standards Board (FASB) prohibits fixed-asset revaluation upwards.

In brief, asset revaluation calls for a thorough and detailed knowledge of country-specific GAAP (Generally Accepted Accounting Principles), country-specific regulatory requirements, and country-specific tax laws.

Inventories are normally appear under the balance sheet category Current assets. Retail businesses report merchandise inventory while manufacturing companies typically further classify inventory assets as either raw materials, work in progress, or finished goods (for more on this subject, see the article Inventory). In any case, firms initially report inventory value at cost, but inventory value can change upwards due to appreciation or downwards due to impairment (spoilage, theft, obsolescence, or general reduction in market demand).

Writing Down Inventory at Blackberry

In December 2012, for instance, Research in Motion (RIM) of Canada took a write-down of $485 million on its inventory of unsold Blackberry Playbook tablet computers. This act was an unavoidable recognition by RIM (Now renamed Blackberry) that the tablets in stock would never bring in enough sales revenues to earn the value originally appearing on the balance sheet. In this case, the market value that RIM could expect to realize from the tablets fell below the company's Cost of goods sold (COGS). In brief, RIM's inventory revaluation was the result when management declared impairment.

RIM"s write-down was large and unusual, but the loss nevertheless did not qualify as an "Extraordinary" loss. Accounting standards bodies view losses of this kind as "ordinary" because they do occur from time to time in the industries in which RIM operates. It is important to note, however, that inventory revaluation in smaller increments can occur every reporting period for companies that apply the Lower of Cost or Market Rule (LCM Rule) to inventory valuation.

Registering Inventory Impairment in the Accounting System

Inventory impairment (loss) normally works in the accounting system with transactions such as these:

"Loss on Inventory" is an expense account, for which a debit increases account balance. "Inventory" is an asset account, for which a Credit decreases account balance. If the loss was due to the application of the LCM rule, the "Loss on inventory" account might carry the name "Loss on inventory due to LCM."

Inventory write-down Impact on Financial Statements

Income Statement I/S Impact

"Loss on inventory" is an expense category account. The impairment loss can appear on the I/S, either as a component of "Cost of Goods sold," above Gross Profit or as a loss expense appearing after Gross profit, under Operating expenses. For large write-downs (such as the RIM example), the impairment will more likely appear under Operating expenses.

Balance sheet B/S Impact

The "Inventory" account receiving debit above is an asset category account, appearing directly on the balance sheet. The balance sheet figure appearing at period end reflects the adjustment downward (credit) above.

Statement of Changes in Financial Position SCFP Impact

"Loss on inventory" appears with other noncash expenses on the SCFP under "Sources of cash," serving ultimately to lower reported cash inflows.

Accounts receivable is another current asset that can suffer impairment and require revaluation. Accounts receivable assets lose value when it becomes clear that certain customers are not going to pay for goods or services they have purchased.

Creating an Account Receivable

Consider, for instance, a manufacturer selling goods to another company. In this case, the seller delivers goods to the buyer, along with a $137,000 invoice. When the sale closes, the seller can recognize sales revenues and new value in Accounts receivable as shown:

The seller, Grande Corporation, debits (increases) an asset category account, Accounts receivable, by the sale price, $137,000. At the same time, Grande credits (increases) a revenue category account, Sales Revenue, by the same amount.

The Life of the Creditor-Debtor Relationship

While the bill is unpaid, seller and buyer have a creditor-debtor relationship. The seller holds $137,000 in Accounts receivable and the buyer carries an additional $137,000 in its Accounts Payable—a Current liability account for the buyer. What happens next depends on whether or not the buyer pays.

If the buyer pays the invoice with cash, the seller retains the $137,000 asset value by moving it from one asset account to another. Here, the seller debits (increases) a Cash account and credits (decreases) Accounts receivable:

What Happens If the Buyer Never Pays

For this example case, however, assume the buyer does not pay the invoice. Instead, this buyer declares bankruptcy and goes into liquidation. The buyer informs the seller, moreover, that asset liquidation will not produce funds to cover outstanding debts. As a result, the seller concludes that the buyer will never pay the outstanding $137,000.

In such cases, the buyer can begin the write-off process by recognizing a Bad debt expense and an Allowance for doubtful accounts, as shown:

Here, Bad debt expense account balance increases with a debit transaction. "Allowance for doubtful accounts is an asset category account, but it is also a contra asset account.  This account's value thus increases with a credit (opposite to the impact in a normal asset account).

Before the end of the accounting period, the seller completes the revaluation and write off process by lowering (crediting) the Accounts receivable balance, reflecting the new reality:

Accounts Receivable Write-Down and Bad Debt Expense on Financial Statements

Remember finally, that the seller increases (credits) a Sales revenue account when the original sale closes.

Later, however, it is natural to ask the obvious question: Is not the seller overstating sales revenues now, considering that $137,000 in Accounts receivable will never appear? Non-payment notwithstanding, however, the end-of-period Sales revenue figure stands as written. The seller has earned these revenues, after all, regardless of whether or not the buyer ever pays.

The write-down, however, will impact financial statements through Allowance for doubtful accounts and Accounts receivable accounts as follows:

Income Statement I/S Impact

On the I/S, "Bad Debt Expense" appears with expense items under "Operating expenses, " where the expense results in lower reports for operating profit and bottom-line net profit.

Balance Sheet B/S Impact

The Balance sheet account "Accounts receivable increases with a debit transaction when the original sale closes. And, the Inventory account debit above is an asset category account, appearing directly on the balance sheet. the balance sheet figure reported at the period end reflects the adjustment downward (credit) shown above.

Statement of Changes in Financial Position SCFP Impact

"Bad debt expense" appears on the SCFP along with other noncash expenses under "Sources of Cash," serving ultimately to lower reported cash inflows.

Accounting standards in most places mandate that companies revalue fixed assets when they lose value due to impairment, as in the GE example above. Revaluation for these assets can be a complex issue, however, because the process sometimes calls for recalculation or estimation of factors such as future depreciation, amortization, carrying value, recoverable value, salvage value, or cash flow contributions to operations.

Recognizing Impairment

Consider, for instance, the experience of Grande Corporation, illustrating the general rule that impairment is to be recognized when asset carrying value is greater than recoverable asset value:

• Grand Corporation purchases an office building on 1 January 2004, for $3,800,000. For capitalization of a building asset, the initial book value (historical cost) may include besides purchase price, other direct costs of acquisition, such as the $100,000 that Grande pays for site improvements and renovation, plus another $100,000 for professional services (lawyers, architects, and building contractors). Grande, therefore, capitalizes this building at acquisition with an initial book value of $4,000,000.
• Grande estimates that the building's useful life will extend to 31 December 2024 (a 20-year life). Grande also estimates that salvage value after 20 years would be negligible (0). The Initial depreciable value was, therefore, the same as the initial carrying value. As a result, the firm's accountants calculate straight-line depreciation for a 20-year depreciation life.
• On December 31, 2009, after five years in service, the city government starts highway renovation projects that reduce in access to the building and reduce space for employee parking, which lowers building value.

Calculations to Answer Impairment Questions

Can Grande Corporation now declare impairment and lower the building's carrying value? If so, by how much? The company can answer these questions by calculating (estimating) six figures:

Estimate 1. Current Carrying Value

Grande expected to depreciate the building's initial depreciable value of $4,000,000 with straight-line depreciation over 20 years. Depreciation expense each year would thus be$4,000,000 / 20 = $200,000. At the end of 2009, after 5 years of depreciation, total accumulating depreciation was 5 x $200,000 = $1,000,000. Current carrying value was therefore the initial carrying value less accumulated depreciation:
$4,000,000 – $1,000,000 = $3,000,000.

Estimate 2. Fair Value (Less Selling Costs)

After the actions of city government, Grande Corporation estimates that it can now sell the building for no more than $2,000,000, and further that the costs of making it sellable and selling it would include another $100,000. The building's fair value less selling costs is thUS$ 2,000,000 – $100,000 = $1,900,000.

Estimate 3. Value in Use

Grande Corporation estimates that if it continues to own and operate the building for the rest of its useful life, the building will help in generating cash flows with a present value of $2,400,000.

Estimate 4. Recoverable Value

Owners can now take the Recoverable Value as the higher of the two figures immediately above, that is, the higher of "Fair value less selling costs" or "Value in use." From the examples above, the recoverable value is thus $2,400,000.

Estimate 5. Impairment Value

Grande Corporation can in this case now report an impairment loss calculates as carrying value less recoverable value, that is, 3,000,000 – $2,400,000 = $600,000.

Estimate 6. Post-impairment depreciation expense

After recognizing impairment, the remaining depreciable value is now the previous carrying value less impairment, that is, $3,000,000 – $600,000 = $2,400,000. With straight-line depreciation for the remaining 15 years of useful life, annual depreciation expense is now $2,400,000 /15 = $160,000. Note that the pre-impairment annual depreciation expense was $200,000

Transactions to Register Impairment

Grand Corporation registers the impairment with transactions such as these:

Impairment loss expense is an expense account, for which a debit increases value. Accumulated depreciation is a contra asset account, for which a credit also increases value (opposite to the credit impact in a normal asset account).

The Impact of Fixed Asset Impairment on Financial Statements

Income Statement I/S Impact

On the I/S, "Impairment loss expense" can appear with expense items under "Operating expenses, " which lowers operating profit and bottom-line net profit.

Straight-line depreciation will continue for the remaining 15 years of useful life, creating depreciation expense each year on the I/S. The new annual depreciation expense of $160,000 will appear each year instead of the previously applied $200,000 annual expense.

Balance Sheet B/S Impact

When the firm declares impairment with the transactions above, the new Balance sheet carrying value of the asset becomes the previous carrying value less impairment. Here, this asset's contribution total Fixed Assets (or to Property Plant and Equipment) is $3,000,000 – $600,000 = $2,400,000.

Straight-line depreciation will continue for the remaining 15 years of useful life, increasing Balance Sheet Accumulated depreciation by the new annual depreciation expense ($160,000).

Statement of Changes in Financial Position SCFP Impact

Depreciation expense appears each year along with other noncash expenses on the SCFP under "Sources of Cash," serving ultimately to lower reported cash inflows.

Companies in all industries sometimes hold as investments the financial securities issued by other companies. Among these holdings, marketable securities are securities for which (a) there is an accessible, active market, and (b) the company intends to sell or may sell when it is advantageous to do so.

The example below illustrates appreciation and revaluation for one class of marketable securities, Trading securities. Trading securities may be either equity, or debt securities the firm expects to hold for short-term gains. Trading security portfolios typically involve frequent, active buying and selling to make a profit. Not surprisingly, trading securities thus appear on the balance sheet as Current Assets.

Exercising the Mark to Market Rule

For this example, assume that the owner, Grande Corporation, has chosen to value its trading securities holdings through the Mark to Market Rule. Grande chooses Mark to Market instead of its other option, the Lower of Cost or Market Rule.

Trading securities first enter the accounting system in a balance sheet assets account where they are receive value just as most other assets receive initial value—at acquisition cost. For a $100,000 acquisition of equity securities cash purchase, aexpecting the firm will these securities as trading securities, the acquisition transactions could be as follows.

Note that the acquisition occurs in the middle of a reporting period, Q4 FY 20YY. At acquisition, the Grande debits (increases) the Current asset account Marketable securities, while crediting (decreasing) another Current asset account, Cash on hand.

Now assume that the market value of these securities increases by $5,000 by the end of the quarterly reporting period. Under the Mark to market rule, the firm will recognize appreciation and revaluation with two more transactions at the end of Q4:

The two transactions above complete the revaluation process. "Marketable securities" is a Current asset account, for which a debit increases value. Unrealized holding gains is an equity account, which increases with a credit transaction.

The Impact of Marketable Securities Appreciation on Financial Statements

Income Statement I/S Impact

The revaluation transactions illustrated above have no impact on revenue or expense accounts, and thus no impact on the I/S.

Balance Sheet B/S Impact

Both transactions above impact the two Balance sheet accounts given, "Marketable securities" and "Unrealized holding gain."

Statement of changes in Financial Position SCFP Impact

The revaluation transactions appearing above have no impact on revenue or expense accounts, and thus no impact on the SCFP. The impact on the SCFP will occur later time, however, if the owners sell the securities for cash. In that case, owners can now realize the gain, and the SCFP will register the cash flow.