By Yuriy Smirnov Ph.D.
If the revaluation model is used by an entity as an accounting policy, assets are carried at their fair value. In other words, the carrying amount of an asset can be adjusted both upward and downward if there is an indication that it differs materially from an asset’s fair value.
IFRS regulates accounting for property, plant, and equipment (PPE) on the basis of IAS 16. Any entity can set up either a cost model or a revaluation model as an accounting policy, applying it to the entire class of Property, Plant, and Equipment.
The revaluation model allows carrying an item of property, plant, and equipment at its fair value or value in use, whichever is higher. Reversal of impairment loss is permitted and not limited by the amount of accumulated impairment losses in the past as in the cost model.
US GAAP prohibits using the revaluation model as an accounting policy!
After an item of property, plant, and equipment is recognized as an asset, it must be measured at it full cost, which includes purchasing price, transportation cost, discounts, custom duties, assembly and installation cost, professional fees, and any other directly attributable costs.
The entry in the general journal debits PPE account (e.g., buildings, office equipment, land, machinery, or fixtures) and credits Cash or Accounts Payable.
Unlike the cost model, the revaluation model allows entities to recognize revaluation gains if the fair value of an item of property, plant, or equipment exceeds its carrying amount at the revaluation date, and the revaluation gain must be recognized. It requires a single entry in the general journal where the debited account is PPE, and the credited account is Revaluation Reserve.
Under the revaluation model, revaluation loss must be recognized if the fair value of an item of property, plant, and equipment is less than its carrying amount, but the way it should be treated depends on whether or not loss is recognized first or there is a previously accumulated revaluation reserve.
If any revaluation reserve has accumulated in the past, the revaluation loss should be recorded in the general journal as follows:
When any revaluation reserve has accumulated in the past, the way revaluation loss should be recorded depends on whether or not its amount exceeds the reserve.
If the revaluation reserve accumulated in the past for the specific item of PPE exceeds its revaluation loss, a single entry must be made in the general journal.
If any revaluation loss for a specific item of PPE exceeds its revaluation reserve accumulated in the past, a double entry must be recorded in the general journal.
The revaluation reserve is debited for the amount of revaluation reserve accumulated in the past, impairment loss is debited for the difference between revaluation loss and revaluation reserve accumulated in the past, and the related PPE account is credited for the amount of revaluation loss.
Please note that impairment loss can be noted by either crediting the relevant PPE account or the accumulated impairment losses account.
The revaluation model allows restoration of impairment losses, but how it should be treated depends on whether or not gain on revaluation exceeds their amount.
If gain on revaluation is less than accumulated impairment losses of a related item of PPE, a single entry is required.
If the difference between the fair value and the carrying amount exceeds the accumulated impairment losses of a related item of PPE, a double entry must be made in the general journal. The first one debits Accumulated Impairment Losses for its whole balance and credits Gain on Revaluation. The second entry recognizes revaluation surplus by debiting the Asset account and crediting the Revaluation Reserve for the remaining difference.
Please note that if the Accumulated Impairment Losses account is not used as accounting policy, the relevant PPE account is debited for the whole amount!
After an item of property, plant, and equipment is recognized as an asset, an accountant estimates its residual value, useful life, and selects the appropriate depreciation method. At the end of each accounting period, a proportion of depreciable amount should be assigned as depreciation expense as follows:
Under the revaluation model, the depreciation schedule must be adjusted after the revaluation has taken place.
An impairment loss decreases the depreciable amount; thus, depreciation expense should be reduced proportionally.
In contrast, an impairment gain increases the depreciable amount, and depreciation expense must be increased proportionally, but the excessive depreciation (difference between adjusted depreciation expense and its historical value) must be transferred to retain earnings at the end of the accounting period. The journal entry is as follows:
Hotroad LLC acquired a new asphalt mixing plant for $300,000 on 1st of January 2016. The transportation cost amounted to $15,000, and assembly and installation cost was $35,000. Management of the company estimates the useful life of the plant as 7 years at no residual value and selects the straight-line depreciation method. The revaluation model is used as accounting policy.
The IAS 16 requires the plant to be measured at its full cost of $350,000 ($300,000+$15,000+$35,000).
Assuming that Hotroad LLC prepares financial statements annually and the straight-line depreciation method is selected, the amount of annual depreciation expense is $50,000.
Annual depreciation expense = $350,000 ÷ 7 = $50,000
At the end of 2016, $50,000 must be assigned to depreciation expense as follows:
On 1st January 2019, the revaluation is made, and the fair value of the asphalt mixing plant is measured as $220,000. On the same date, the carrying amount of the plant is $200,000: $350,000 less accumulated depreciation of $150,000 (3 years at $50,000 per year). As the fair value exceeds the carrying amount by $20,000, the revaluation gain must be recognized and recorded in the general journal as follows:
After revaluation, the annual depreciation expense must be adjusted as follows:
Annual depreciation expense = $220,000 ÷ 4 = $55,000
Please note that at the end of 2019 the excessive depreciation of $5,000 ($55,000-$50,000) must be transferred from Revaluation Reserve to Retained Earnings as follows:
Assume that the next revaluation is made in two years on 1st January 2021, and the fair value of the asphalt mixing plant is measured as $80,000. As it is less than the carrying amount $110,000 (initial cost of $350,000 plus revaluation gain of $20,000 less accumulated depreciation $260,000) at the same date, the revaluation loss of $30,000 must be recognized.
For 2 years, $10,000 ($5,000 each) of Revaluation Reserve was transferred to Retained Earnings, so the balance of Revaluation Reserve on 31st December 2020 is $10,000 (initial balance of $20,000 less $10,000 transferred to Retained Earnings). As the amount of revaluation reserve is not sufficient to cover revaluation loss, the impairment loss of $20,000 must be recorded.
The annual depreciation expense should be adjusted as follows:
Annual depreciation expense = $80,000 ÷ 2 = $40,000
Xander LTD has acquired a water filter machine on 1st January 2014. Its cost was $100,000, the useful life was estimated as 5 years, and the residual value is $10,000. Management of the company decided to use the straight-line depreciation method and the revaluation model as accounting policy.
After 1 year on 1st January 2015, the fair value of the machine was estimated as $75,000. The carrying amount on the same date was $82,000 (initial cost of $100,000 less accumulated depreciation of $18,000).
Annual depreciation expense = ($100,000-$10,000) ÷ 5 = $18,000
Since the fair value of the water filter machine is less than its carrying amount, the revaluation loss of $7,000 ($75,000-$82,000) should be recognized.
The impairment loss affected the depreciable amount and depreciation expense as follows:
Depreciable amount = $75,000 – $10,000 = $65,000
Annual depreciation expense = $65,000 ÷ 4 = $16,250
Assume that on 1st January 2016 the fair value of the water filter machine was estimated as $67,000. The carrying amount on the same date was $58,750 ($75,000-$16,250). As the fair value exceeds the carrying amount, the revaluation gain of $8,250 must be recognized by a double entry.
The first entry restores impairment losses of $7,000 recognized in the past, and the second entry recognizes the machine’s appreciation of $1,250 over its historical cost less accumulated depreciation.
After the revaluation gain was recognized, the depreciable amount and annual depreciation expense should be adjusted as follows:
Depreciable amount = $67,000 – $10,000 = $57,000
Annual depreciation expense = $57,000 ÷ 3 = $19,000