What is the Revaluation Model?

Revaluation Model

The Revaluation Model is one of the models prescribed by certain accounting standards for measuring and reporting long-lived assets (like property, plant, and equipment) subsequent to their initial recognition at cost. Under this model, after an asset is initially recognized at its cost, it is subsequently carried at a revalued amount, which is its fair value at the date of revaluation minus any subsequent accumulated depreciation and accumulated impairment losses.

The Revaluation Model contrasts with the Cost Model, where assets are carried at their historical cost minus accumulated depreciation and accumulated impairment losses.

Key features of the Revaluation Model:

• Frequency of Revaluations: Revaluations should be performed regularly to ensure that the carrying amount does not differ significantly from that which would be determined using fair value at the end of the reporting period.
• Treatment of Revaluation Surplus: If an asset’s carrying amount is increased due to a revaluation, the increase is recognized in other comprehensive income and credited to a “revaluation surplus” under equity. If the revaluation reverses a revaluation decrease that was previously recognized in profit or loss, then the increase is recognized in profit or loss to the extent of any such previous loss.
• Decrease in Carrying Amount: A decrease in an asset’s carrying amount due to revaluation is first offset against any revaluation surplus related to this asset. Any excess decrease is then recognized as an expense.
• Depreciation: After revaluation, the asset’s annual depreciation expense might change since it will be calculated based on the revised carrying amount of the asset.
• Sale of Asset: When selling or retiring a revalued asset, any revaluation surplus in equity related to that asset can be transferred directly to retained earnings. It isn’t taken through the income statement.
• Documentation: Companies should adequately document the basis and rationale for determining the fair value of assets under the revaluation model.

The decision to use the Revaluation Model often depends on the accounting standards followed in a given jurisdiction, the type of asset, and the nature of the business. For example, International Financial Reporting Standards (IFRS) allow both the Cost Model and the Revaluation Model for property, plant, and equipment, whereas U.S. Generally Accepted Accounting Principles (GAAP) primarily use the Cost Model.

It’s worth noting that while the Revaluation Model can provide a more up-to-date and realistic value of assets, it can also introduce greater volatility into the financial statements, especially if the assets are subject to significant fluctuations in market value.

Example of the Revaluation Model

Prestige Properties, a real estate company, owns an office building in a prime business district. The company follows International Financial Reporting Standards (IFRS).

Year 1:

• Initial Purchase: Prestige Properties buys the building for $10 million.
• Depreciation: The building has an estimated useful life of 50 years with no residual value. Annual depreciation = $10 million ÷ 50 = $200,000.
• Year-end: Carrying amount of the building = Initial cost – Depreciation = $10 million – $200,000 = $9.8 million.

Year 3:

• Depreciation for Year 2 and Year 3: $200,000 * 2 = $400,000.
• Carrying amount before revaluation: $10 million – $600,000 (cumulative depreciation for 3 years) = $9.4 million.
• Revaluation: Due to rapid development in the area and increased demand for office spaces, the fair value of the building has gone up to $12 million. Prestige Properties decides to revalue the building to reflect this new value.
• Increase in Value: Revalued amount – Carrying amount before revaluation = $12 million – $9.4 million = $2.6 million.

Accounting Entries for Revaluation in Year 3:

• Debit Building (asset account) = $2.6 million (to increase the value of the building to its fair value).
• Credit Revaluation Surplus (equity account) = $2.6 million (this represents the increase in the asset’s value).

Post Revaluation:

• New Carrying Amount: The building’s carrying amount is now $12 million.
• Depreciation for subsequent years: The revised annual depreciation = ($12 million – 0) ÷ remaining useful life (47 years) = approximately $255,319 per year.

Note: If the revaluation had resulted in a decrease in the building’s value below its original cost, the decrease would have been charged as an expense to the profit or loss to the extent it exceeds any previous revaluation surplus in equity related to this building.

This example provides a step-by-step process of how the Revaluation Model works in practice. By revaluing the building, Prestige Properties has updated its financial statements to reflect a more realistic and current value of its asset. However, this also introduces new amounts for depreciation and changes in equity which need to be tracked and managed in subsequent periods.