The revaluation model for non-current assets enables businesses to adjust the value of their Property, Plant, and Equipment (PPE) to reflect current market conditions. When an asset’s fair value rises above its carrying amount, the increase is recorded as a revaluation surplus in Other Comprehensive Income (OCI) rather than as profit, since it represents an unrealized gain. This adjustment impacts future financial reporting, as depreciation is recalculated based on the asset’s new value, potentially increasing the annual charge. Companies can manage this by transferring part of the surplus to retained earnings, ensuring a consistent reflection of both realized and unrealized gains. When the asset is eventually sold, any remaining surplus is transferred to retained earnings to accurately capture the finalized gain. This approach provides a balanced and transparent view of a company’s long-term assets in its financial statements.
Non-current Asset Revaluation
Property, Plant, and Equipment (PPE) are long-term assets that a company owns and uses to generate income over time. These assets include land, buildings, machinery, and equipment, with a useful life exceeding one year. Initially, PPE is recognized at its cost, which includes all expenses incurred to bring the asset to its operational condition and location.
Over time, asset values may increase due to factors such as market demand, inflation, or improvements. If the fair market value of an asset surpasses its carrying amount (initial cost less accumulated depreciation and impairment), companies may choose to revalue the asset to reflect its current fair value. This is governed by accounting standards like the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP).
The Revaluation Model
Under the revaluation model, increases in an asset’s value are recognized as follows:
- The increase is credited to Other Comprehensive Income (OCI) and accumulated in equity under the heading revaluation surplus.
- The gain is categorized as unrealized until the asset is sold, ensuring that profit reports remain accurate.
This distinction between realized and unrealized gains ensures transparency. Users of financial statements can see the full economic value of a company’s assets without the misrepresentation of short-term profits.
Example Journal Entry for Non-current Asset Revaluation
Scenario:
- A company owns a building purchased for $500,000.
- Accumulated depreciation is $100,000.
- The building’s fair value after revaluation is $600,000.
Journal Entry:
Debit: Building $100,000
Debit: Accumulated Depreciation $100,000
Credit: Revaluation Surplus $200,000
Explanation:
The Building account is increased by $100,000 to match the new fair value. Accumulated depreciation is reset to zero, and the $200,000 increase is credited to the revaluation surplus under equity.
Impact of Non-current Asset Revaluation on Depreciation
When an asset is revalued, its new carrying value affects future depreciation charges. Depreciation is recalculated based on the asset’s fair value and remaining useful life.
Example:
- A machine was originally purchased for $50,000, with a 10-year life.
- After five years, it is revalued to $70,000.
- The new depreciation charge becomes $14,000 annually ($70,000/5 years), up from $5,000.
To account for this increased charge, a portion of the revaluation surplus may be transferred to retained earnings annually, using the following journal entry:
Journal Entry:
Debit: Revaluation Surplus $9,000
Credit: Retained Earnings $9,000
Consistent application of this transfer policy enhances the comparability of financial statements over time.
Disposal of a Revalued Asset
When a revalued asset is sold, the profit or loss on disposal is calculated as the difference between the net sale proceeds and the asset’s carrying amount.
Steps for Disposal Accounting:
- Determine the asset’s revalued carrying amount, factoring in accumulated depreciation.
- Calculate the net sale proceeds (sale price minus selling expenses).
- Recognize the profit or loss in the statement of profit and loss.
Additionally, any balance remaining in the revaluation surplus related to the disposed asset is transferred to retained earnings through the following journal entry:
Journal Entry:
Debit: Revaluation Surplus
Credit: Retained Earnings
This transfer reflects the realization of the gain, ensuring retained earnings represent actual, realized profits.
Challenges and Limitations of Revaluation
Revaluation offers advantages, including improved balance sheet representation and better alignment with current asset values. However, it also presents challenges:
- Subjectivity: Fair value estimates may vary due to market volatility.
- Cost: Regular valuations can be expensive, especially for specialized assets.
- Active Market Requirement: Reliable revaluations depend on the existence of active markets.
Companies must weigh these factors when deciding whether to apply the revaluation model.
Key Takeaways
- Definition: PPE assets, such as buildings and equipment, can be revalued to reflect current market conditions.
- Revaluation Impact: Increases in asset value are credited to Other Comprehensive Income (OCI) as unrealized gains.
- Depreciation: Post-revaluation, depreciation is recalculated based on the asset’s new carrying value.
- Disposal: Upon disposal of a revalued asset, the revaluation surplus is transferred to retained earnings.
- Challenges: Revaluation may require substantial costs, active markets, and periodic fair value adjustments.
Further Reading: