The revaluation model is an accounting approach under which certain assets, typically fixed assets like property, plant, and equipment (PPE), are carried at a revalued amount. This revalued amount reflects their fair value at the date of revaluation, less any subsequent accumulated depreciation and impairment losses. This contrasts with the historical cost model, where assets are recorded at their original purchase price. The revaluation model falls under the broader category of accounting standards and is a key component of financial reporting, particularly under International Financial Reporting Standards (IFRS).
History and Origin
The revaluation model is principally governed by IAS 16 (Property, Plant and Equipment) within IFRS, which allows entities to choose between the cost model and the revaluation model for subsequent measurement of their property, plant, and equipment. The objective of IAS 16 is to prescribe the accounting treatment for these assets, ensuring that users of financial statements receive relevant information. IAS 16 was reissued in December 2003, with its provisions applying to annual periods beginning on or after January 1, 2005.4 The adoption of IFRS by many countries has increased the prominence of the revaluation model, as it offers a way to reflect current market values on the balance sheet rather than just historical costs. The emphasis on fair value accounting has been a significant topic in financial reporting discussions globally.3
Key Takeaways
- The revaluation model allows for assets to be presented at their current fair value rather than their original historical cost.
- It is an alternative to the cost model for the subsequent measurement of property, plant, and equipment under IFRS.
- Revaluations must be performed regularly to ensure the asset's carrying amount does not differ materially from its fair value.
- Increases from revaluation are typically recognized in a revaluation surplus account within shareholder equity.
- Decreases from revaluation are generally expensed in the income statement, unless they reverse a previously recognized revaluation surplus on the same asset.
Formula and Calculation
When an asset is revalued, its net book value is adjusted to its fair value. The accounting treatment depends on whether the revaluation results in an increase or a decrease in value.
Revaluation Increase:
If the carrying amount of an asset increases as a result of a revaluation, the increase is recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase is recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss.
Revaluation Decrease:
If the carrying amount of an asset decreases as a result of a revaluation, the decrease is recognized in profit or loss. However, the decrease is recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset.
The revalued amount of the asset can be determined using one of two methods:
- Proportional Restatement Method: Both the gross carrying amount and the accumulated depreciation are restated proportionately to the change in the gross carrying amount, so that the asset's carrying amount after revaluation equals its revalued amount.
- Elimination Method: The accumulated depreciation is eliminated against the gross carrying amount of the asset, and the net amount is restated to the revalued amount of the asset.
For example, if an asset with an original cost of $100,000 and accumulated depreciation of $30,000 (net book value $70,000) is revalued to a fair value of $90,000:
Under the elimination method:
Initial Net Book Value = $100,000 - $30,000 = $70,000
Revalued Amount = $90,000
Revaluation Increase = $90,000 - $70,000 = $20,000
This $20,000 would be credited to the revaluation surplus.
Interpreting the Revaluation Model
The revaluation model offers a more current representation of an entity's asset valuation on its balance sheet. This can provide stakeholders with a clearer view of the actual value of a company's non-current assets, which is particularly relevant for asset-heavy industries like real estate or utilities. When an asset is revalued upwards, it enhances the balance sheet by reflecting an increased asset base and a stronger equity position due to the revaluation surplus. Conversely, a downward revaluation, if it exceeds any existing surplus, can negatively impact current period profits. Regular revaluations are essential to ensure that the reported values remain close to fair value, providing a more transparent financial picture.
Hypothetical Example
Consider Company A, which owns a building acquired five years ago for $1,000,000. It has been depreciated by $200,000, leaving a net book value of $800,000. Due to a booming real estate market, an independent appraisal determines the building's fair value to be $1,200,000.
Under the revaluation model:
- The accumulated depreciation of $200,000 is eliminated, bringing the asset's gross carrying amount to $1,000,000.
- The asset's carrying amount is then adjusted to its fair value of $1,200,000.
- The revaluation increase of $400,000 ($1,200,000 - $800,000) is recognized.
- This $400,000 is credited to the revaluation surplus, a component of shareholder equity.
After revaluation, the building appears on the balance sheet at $1,200,000, and the company's equity reflects the revaluation surplus. Subsequent depreciation would be calculated based on the new revalued amount and the remaining useful life.
Practical Applications
The revaluation model is commonly applied by companies in jurisdictions that follow IFRS, especially those with significant holdings of property, plant, and equipment whose values tend to fluctuate. This includes industries such as real estate, transportation, and utilities. For instance, a real estate investment trust (REIT) might use the revaluation model to present its investment properties at current market values, offering investors a more up-to-date view of its underlying asset base. Companies often report "revaluation gains on investment properties" as part of their financial results.2 This practice provides more transparent and economically relevant information for investors, particularly in volatile markets.
Limitations and Criticisms
Despite its benefits, the revaluation model has certain limitations and faces criticism. One primary concern is the subjectivity involved in determining fair value, especially for specialized assets where an active market may not exist. This can lead to differing valuations and reduce comparability between companies. Frequent revaluations can also be costly and time-consuming, requiring professional appraisals. Furthermore, while revaluation increases boost equity, they do not represent realized cash flows, potentially misleading some users about a company's liquidity or distributable profits. Critics of fair value accounting, which underpins the revaluation model, argue that it can introduce excessive volatility into financial statements, particularly during periods of economic downturns, by forcing assets to be written down to potentially temporarily depressed market prices.1
Revaluation Model vs. Cost Model
| Feature | Revaluation Model | Cost Model |
|---|---|---|
| Measurement | Assets carried at fair value less subsequent depreciation and impairment. | Assets carried at historical cost less accumulated depreciation and impairment. |
| Balance Sheet | Reflects current market values, providing a more up-to-date asset picture. | Reflects historical acquisition costs, which may not represent current value. |
| Volatility | Can introduce volatility as asset values fluctuate with market changes. | Generally more stable as asset values do not change with market fluctuations (unless impaired). |
| Equity Impact | Revaluation gains go to revaluation surplus (equity); losses impact income statement or surplus. | No direct impact on equity from changes in market value, only from depreciation and impairment. |
| Applicability | Permitted under IFRS for property, plant, and equipment. Not generally permitted for upward revaluations under US Generally Accepted Accounting Principles (GAAP). | Permitted under both IFRS and US GAAP. |
The fundamental difference lies in how subsequent asset valuation is performed after initial recognition. While the revaluation model aims to provide a more relevant depiction of asset values, the cost model prioritizes reliability and verifiability based on transaction prices.
FAQs
What types of assets can be revalued using the revaluation model?
The revaluation model typically applies to classes of property, plant, and equipment (tangible assets) under IFRS, such as land, buildings, and machinery. It generally does not apply to intangible assets or current assets.
How often must revaluations occur?
Revaluations must be performed with sufficient regularity to ensure that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date. The frequency can vary depending on the volatility of the asset's fair value. For highly volatile assets, annual revaluations may be necessary; for others, revaluations every three or five years might suffice.
Does the revaluation model apply under US GAAP?
No, the revaluation model, which allows for upward adjustments of fixed assets to fair value, is generally not permitted under US Generally Accepted Accounting Principles (GAAP). US GAAP requires fixed assets to be carried at their historical cost less depreciation, with a provision for impairment losses but no upward revaluations.
How does a revaluation affect a company's profits?
A revaluation increase does not directly increase a company's reported profit in the income statement; instead, it typically goes to a revaluation surplus account within equity. However, if a revaluation decreases the asset's value, it is recognized as an expense in profit or loss, unless it reverses a previous revaluation increase on the same asset.