How are assets revalued? What are the pros and cons and limitations of this evaluation?
Asset revaluation is an adjustment made to the book value of a fixed asset by adjusting it with an increase or decrease depending on the fair market value of the fixed asset.
That is, the revaluation can reflect both the rise and depreciation in the value of fixed assets. The purpose for which the assets are revalued includes selling the asset to another business unit, merging or acquiring the company, etc.
What is asset revaluation?
Fixed asset revaluation is the process by which the carrying value of fixed assets is adjusted up or down in response to major changes in their fair market value. Revaluation is permitted under the IFRS framework but not under Generally Accepted Accounting Principles (GAAP) in the United States.
Simply put, revaluation of assets means a change in the market value of assets, whether it is increasing or decreasing. Generally, valuations of an asset are made when there is a difference between the current market value of the asset and its value on the company’s balance sheet.
1. According to accounting principles, all fixed assets should be recognized on the basis of its cost change over time. In addition, fixed assets must be revalued on the basis of cost or fair market value, whichever is lower.
2. According to IFRS, fixed assets must be recorded at initial real cost. Then, the companies are allowed to use the costing model or the revaluation model.
- In the cost model, the carrying value of assets is not adjusted and is depreciated over its useful life.
- In the revaluation model, the cost of an asset can be adjusted up or down, depending on the fair value. In this case, the revaluation of assets creates a reserve called “Revaluation Reserve”. When the value of assets increases, it is credited to the revaluation reserve and when debited too. We revalue fixed assets and intangible assets.
Methods of revaluation of assets
1- The indexing method
In this method, the indicator is applied to the cost of assets to find out the current cost. Index list issued by the statistical department.
2 – The current market price method
According to the prevailing market price of the assets
- Land and Building Revaluation – To get the fair market value of the building, we can use the values of the real estate/property dealers available in the market.
- Plant and Machinery – We can use the supplier to determine the fair market value of plant and machinery.
This method is generally used by the board of directors to revalue assets.
3- The evaluation method
In this method, the technical appraiser performs a detailed appraisal of the assets to find out the market value. A full appraisal is required when a company issues a fixed assets insurance policy. In this method, we must make sure not to over/underestimate the value of fixed assets.
There are some points that need to be taken into consideration while determining the fair market value of an asset and they are as follows:
- Fixed asset purchase date to calculate fixed asset age.
- Use assets such as 8 hours, 16 hours, and 24 hours
- The type of assets such as land, buildings, plant and machinery.
- the organization’s repair and maintenance policy for fixed assets;
- availability of spare parts in the future;
Calculation of depreciation under the asset revaluation method
The following is the formula for calculating depreciation expense under the revaluation method:
Depreciation expense = value of the asset at the beginning of the year + additions during the year – deductions during the year – value of the assets at the end of the year
Why don’t we revalue current assets as non-current assets?
The concept of asset revaluation is usually associated with non-current assets only. The main reason why the term “asset revaluation” may be associated with non-current assets is that International Accounting Standard (IAS) No. 16 uses this term. Therefore, asset revaluation usually refers to the revaluation of non-current assets.
But this does not mean that other assets such as current assets are not revalued after being recognized.
In short, revaluation is not related to fixed assets alone, current assets are also revalued, but certainly the nature of revaluation of non-current assets and the reasons differ from revaluation of current assets most of the time.
Also, gains on revaluation are not only recorded for non-current assets, there are many cases where gains are recorded in respect of current assets but they are not called “revaluation gains”.
- If the assets are revalued on the upward side, this will increase the cash profit (net profit plus depreciation) of the entity.
- Negotiating a fair price for the entity’s assets prior to merging with or acquiring another company.
- The credit balance of the revaluation reserve can be used to replace fixed assets at the end of their useful life.
- To reduce the leverage ratio (secured loan to principal).
- Tax Benefit: – leads to an increase in the value of assets; Hence the amount of depreciation will increase and thus lead to income tax deduction.
1. The company cannot revalue its fixed assets every year, or the cost of fixed assets may not decrease. In such a situation, the company cannot bear the depreciation.
2. The total depreciation charged on the revaluation of fixed assets does not show a systematic pattern.
3. The company spends a large amount on revaluation of fixed assets because this work needs the help of technical experts and the increase in expenses results in lower profit.
If the company performs a revaluation and this leads to a decrease in the book value of the revaluation of the fixed assets, then the downward value is debited in the profit or loss account. However, if the credit balance is available in the revaluation reserve for that fixed asset, we will debit the revaluation reserve instead of the profit or loss account.
Important points to note
The upward revaluation amount of fixed assets is added to the revaluation reserve, and this reserve cannot be used for profit distribution. The revaluation reserve is the capital reserve, and it can be used to purchase the revaluation of fixed assets;
In case of any increase in depreciation as a result of revaluation of assets, depreciation is debited to the revaluation reserve account;
Considering the appropriate method for revaluing the assets is the most important. The evaluation method is the most widely used method.
The entity must revalue its assets because revaluation provides the present value of the assets owned by the entity, and upward revaluation is beneficial to the entity; It can charge more upside depreciation and get tax benefits.
What is the purpose of revaluing assets?
The purpose of the revaluation is to enter the fair market value of the fixed assets into the books. This can be useful for deciding whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.
How do you calculate the revaluation of assets?
The options are:
1. Forcing the carrying amount of the asset to equal the newly revalued amount by proportionately restating the amount of accumulated depreciation; or.
2. Excluding accumulated depreciation against the gross carrying amount of the newly revalued asset. This method is the simplest alternative.
When should we reassess?
When the value of an asset increases, a revaluation is necessary. If the value of the asset decreases, then depreciation is necessary. Revaluation is the positive difference between an asset’s fair market value and its original cost less depreciation.
Can depreciated assets be fully revalued?
An asset that has been fully depreciated cannot be revalued due to the accounting cost principle.
What happens to fully depreciated assets?
A fully depreciated asset will remain on the company’s balance sheet at its salvage value each year after its useful life unless it is disposed of.