Revaluation of Fixed Assets
Revaluation of fixed assets is the process by which the carrying value of fixed assets is adjusted upwards or downwards in response to major changes in its fair market value. Revaluation is allowed under the IFRS framework but not under US GAAP.
IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets specify two models for subsequent accounting for tangible and intangible fixed assets respectively.
Under the cost model, the carrying value of fixed assets equals their historical cost less accumulated depreciation and accumulated impairment losses. There is no upward adjustment to value due to changing circumstances.
Axe Ltd. purchased a building worth $200,000 on January 1, 2008. It records the building using the following journal entry.
The building has a useful life of 20 years and the company uses straight-line depreciation. Yearly depreciation is hence $200,000/20 or $10,000. Accumulated depreciation as at December 31, 2010 is $10,000×3 or $30,000 and the carrying amount is $200,000 minus $30,000 which equals $170,000.
We see that the building remains at its historical cost and is periodically depreciated with no other upward adjustment to value.
Revaluation model under IFRS
In revaluation model, an asset is initially recorded at cost just like in the cost model. Subsequently, the carrying amount is adjusted for any change in the asset value. The difference between the cost model and the revaluation model is that the revaluation model allows both downward and upward adjustment in value of an asset while cost model allows only downward adjustment due to impairment loss.
Upward revaluation is not considered a normal gain and is not recorded in income statement rather it is directly credited to a shareholders' equity account called revaluation surplus. Revaluation surplus holds all the upward revaluations of a company's assets until those assets are disposed of.
The required journal entries are explained in the example below.
Consider the example of Axe Ltd. as quoted in case of cost model. Assume on December 31, 2010 the company intends to switch to revaluation model and carries out a revaluation exercise which estimates the fair value of the building to be $190,000 as at December 31, 2010. The carrying amount at the date is $170,000 and revalued amount is $190,000 so an upward adjustment of $20,000 is required to building account. It is recorded through the following journal entry:
Depreciation after revaluation
Depreciation in periods after revaluation is based on the revalued amount. In case of Axe Ltd. depreciation for 2011 shall be the new carrying amount divided by the remaining useful life or $190,000/17 which equals $11,176.
Reversal of revaluation
If a revalued asset is subsequently valued down due to impairment, the loss is first written off against any balance available in the revaluation surplus and if the loss exceeds the revaluation surplus balance of the same asset the difference is charged to income statement as impairment loss.
Suppose on December 31, 2012 Axe Ltd. revalues the building again to find out that the fair value should be $160,000. Carrying amount as at December 31, 2012 is $190,000 minus 2 years depreciation of $22,352 which amounts to $167,648.
The carrying amount exceeds the fair value by $7,648 so the account balance should be reduced by that amount. We already have a balance of $20,000 in the revaluation surplus account related to the same building, so no impairment loss shall go to income statement. The journal entry would be:
Had the fair value been $140,000 the excess of carrying amount over fair value would have been $27,648. In that situation the following journal entry would have been required.
|Accumulated Impairment Losses||7,648|