When a company revalues a property, plant, or equipment (PPE) asset, any increase in its fair value over the carrying amount is recorded as a revaluation surplus. However, once the revalued asset is disposed of, the surplus becomes a realized gain, making it inappropriate to keep the revaluation surplus account for that asset. At this point, the balance on the surplus account should be transferred to retained earnings, ensuring accurate equity reporting. This transfer decreases the revaluation surplus and increases retained earnings by the same amount, properly reflecting the gain in the company’s financial statements.
Disposal of Revalued Non-current Asset
When a company revalues a property, plant, or equipment (PPE), any increase in the fair value of the asset over its carrying amount is recorded as a revaluation surplus. This surplus represents an unrealized gain and is included in the equity section of the balance sheet. Proper handling of this surplus upon asset disposal is critical to ensure accurate financial reporting.
Understanding the Revaluation Surplus
The revaluation surplus arises when an asset’s fair value exceeds its carrying amount after revaluation. It reflects unrealized gains, which do not affect the income statement until the asset is disposed of. Once disposed of, these gains become realized and must be accounted for correctly.
Accounting for Disposal
Upon disposal of the revalued PPE, the balance on the revaluation surplus account should be transferred to retained earnings. This transfer ensures that realized gains are accurately reflected in the financial statements. The following journal entry accomplishes this:
Journal Entry:
Debit: Revaluation Surplus
Credit: Retained EarningsThis entry decreases the revaluation surplus and increases retained earnings by the same amount.
Why Transfer to Retained Earnings?
Continuing to keep a revaluation surplus account after the disposal of an asset would misrepresent the equity structure. Since the gain has been realized, the revaluation surplus must be closed out and disclosed in the statement of changes in equity.
Example Scenario
Let’s say a company revalued a PPE asset. The original cost was $100,000, and the carrying amount before revaluation was $70,000. After revaluation, the asset’s fair value was assessed at $120,000, creating a revaluation surplus of $50,000.
If the asset is disposed of, and the revaluation surplus account has a balance of $45,000, the company should make the following journal entry:
Journal Entry:
Debit: Revaluation Surplus $45,000
Credit: Retained Earnings $45,000This ensures that the $45,000 surplus is properly transferred to retained earnings, aligning the equity accounts with the realized gain.
Relevant Accounting Standards
This process is governed by international accounting standards such as IAS 16: Property, Plant, and Equipment. IAS 16 outlines how companies should handle revaluations and disposals, ensuring transparency and consistency in financial reporting.
Practical Considerations
- Ensure accurate tracking of revaluation surplus for each asset to simplify disposal accounting.
- Consult tax regulations to determine if gains from asset disposals are subject to taxation.
- Verify that the transfer of surplus is correctly reported in both the general ledger and financial statements.
Common Pitfalls to Avoid
- Failing to transfer the revaluation surplus upon disposal, leading to inaccurate equity reporting.
- Misinterpreting accounting standards, resulting in errors in the journal entries.
- Neglecting to disclose the movement of the revaluation surplus in the statement of changes in equity.
Visualizing the Process
A simplified process flow for revaluation surplus disposal:
- Revalue Asset: Asset’s fair value exceeds carrying amount.
- Record Revaluation Surplus: Increase equity by surplus amount.
- Dispose of Asset: Asset is sold, and proceeds are recorded.
- Transfer Surplus: Journal entry made to move surplus to retained earnings.
Key Takeaways
- Revaluation surplus arises when an asset’s fair value exceeds its carrying amount.
- Upon disposal, the surplus must be transferred to retained earnings.
- Journal entry on disposal: Debit Revaluation Surplus, Credit Retained Earnings.
- Proper handling ensures accurate financial reporting and compliance with IAS 16.
- Avoid errors by maintaining clear records and disclosures.
Further Reading: