Revaluation - What is revaluation?
Revaluation is an adjustment made to the recorded value of an asset to accurately reflect its current market value.
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When purchasing a fixed asset, it is usually recorded at cost-price. It’s likely that the asset’s market value will change over time, so businesses can choose whether to continue measuring the asset on a historical-cost basis (the cost model) or whether to use the revaluation model, whereby financial records are updated to reflect assets’ up-to-date market value.
The revaluation model allows for both upwards and downwards adjustments to reflect both increases (appreciation) and decreases (depreciation) in the value of an asset, whereas the cost model only allows for downward adjustments to account for impairment losses.
Reasons for revaluation
The revaluation model can be helpful for businesses looking to:
- Prepare for the sale of an asset to another company.
- Negotiate a fair price before merging with, or being acquired by, another company.
- Show the up-to-date market value of assets which have increased in value since their purchase – for example, PP&E.
- Ensure enough funds are available to replace fixed assets at the end of their useful lives.
Reporting revaluation in accounts
Positive revaluation – i.e. when an asset’s book value is adjusted to reflect an increase in value – should not be recorded on the income statement. Instead, this gain should be credited to an equity account called revaluation surplus. This account contains all of the positive revaluations of a company’s assets until those assets are sold, given away, or otherwise disposed of.
In cases of negative revaluation – i.e. when an asset’s book value decreases due to impairment – the loss should be written off against any revaluation surplus. If the loss exceeds the surplus, or if there is no surplus, the difference should be reported as an impairment loss.
Revaluation and depreciation
After revaluation of an asset, depreciation should be based on the asset’s new value. This only applies going forward – you should not make any retrospective changes to any previous depreciation amounts.
Straight-line depreciation is the most common depreciation method. If you use this method, you should divide the new value by the remaining years in the asset’s useful life to work out the new depreciation cost.
Example of revaluation
A business purchases a piece of equipment for £10,000 in 2015 – it is expected to have a useful life of 10 years. In 2017, the business is bought by a larger company so they revaluate their assets to make sure they negotiate a fair price.
The equipment is found to have increased in value – it is now worth £12,000. £2,000 is recorded on the income statement, credited to the revaluation surplus account.
The equipment has 8 years remaining in its useful lifetime so, going forward, the depreciation cost should be £1,500 per year: £12,000 ÷ 8.