Assets Revaluation: The Revaluation ModelAnother approach to Asset Valuation

Fixed assets such as buildings, machinery, and equipment are valuable properties.

They often don’t come cheap, and as such, require a considerable amount of investment.

It’d be a shame if you were to incorrectly account for them, wouldn’t it?

That’s why it’s important to know the proper way to record them in your books.

By default, we record fixed assets at cost.

That means that whatever a business pays for to make the assets available for use, that will be the asset’s value in its books.

This includes the purchase price of the asset, as well as other costs such as transportation and installation costs.

Gradually the value of the asset decreases via depreciation.

Eventually, it will lose all its value either through use or aging.

The only time that an asset’s value is reviewed and updated is if there is impairment.

Otherwise, the original cost of the asset less accumulated depreciation will be its book value.

This straightforward approach of accounting for the asset’s value is what we refer to as the cost model.

The main draw of the cost model is its consistency and simplicity.

Since the book value of an asset is mainly dependent on its original cost, it’s seldomly revalued.

However, this straightforward approach does not often offer an accurate value of fixed and other long-term assets.

The prices of assets are likely to change over time – and they rarely go down.

More often than not, they go up. And the cost model does not capture this increase in the price of an asset.

Thankfully, there’s another accounting approach for an asset’s valuation.

We refer to it as the revaluation model.

In this article, we will be discussing what the revaluation model is and how it affects an asset’s valuation.

What is Asset Revaluation?

Before we go with the discussion about the revaluation model, we need to answer the question “what is asset revaluation?” as well as its follow-up question “what is its purpose?”.

Answering these questions will help you in understanding why you should consider using the revaluation model.

So, what is asset revaluation?

For a quite literal and shot definition, it is the act of reviewing and updating an asset’s value.

To elaborate, asset revaluation adjusts the carrying value (or book value) of a fixed asset so that it represents its current fair market value.  

Depending on the fair market value of the asset, assets revaluation may make an upward or downward adjustment.

For example, let’s say that an asset has a carrying value of $120,000 and its fair market value is $150,000.

Asset revaluation will make an upward adjustment of $30,000 so that the carrying value of the asset becomes $150,000.

What’s the purpose of asset revaluation?

It’s mainly to update the value of a long-term asset so that it reflects its market value.

Oftentimes, the price of an asset changes depending on several factors (e.g. inflation, a surge in demand, low supply, etc.).

And as such, there is a need to revalue an asset so that its carrying value reflects these changes.

The Revaluation Model

The revaluation model is an accounting approach where the carrying value of a fixed or long-term asset is regularly adjusted so that it reflects its fair market value.

Just like the cost model, we initially record the asset’s value at its cost.

But unlike the cost model, we subsequently revalue the asset at sufficiently regular intervals depending on its fair market value.

Ideally, we do asset revaluation once a year, but it can be more or less frequent than that.

If once a year isn’t viable, at least once every three to five years should suffice.

The main draw of the revaluation model is that fixed assets and other long-term assets are presented in the financial statements at their fair market value rather than just their historical cost.

As such, it presents a more accurate picture of the business’s financial position compared to the cost model.

The catch in using this approach is that the business must do asset revaluation at subsequently regular intervals.

This may result in an additional expense as the business would have to employ certain procedures to determine the asset’s fair market value.

In contrast, a business that uses the cost model would not have to do this.

Do note though that the revaluation model is only available for businesses that follow the IFRS.

While the GAAP allows asset revaluation, it is only done when there is an impairment to the asset’s value.

In contrast, the IFRS, through the revaluation model, allows asset revaluation whenever there’s a change in the asset’s fair market value, be it an increase or a decrease.

As such, under the GAAP, impairment for assets cannot be reversed.

Under the IFRS, if an asset’s value is reduced, it can still be reversed if its fair market value increases in a subsequent period.

Cost Model vs Revaluation Model

So, which accounting approach should you use for asset valuation?

The cost model or the revaluation model?

Well first off, if your business is following the US GAAP, then your only choice is to use the cost model.

This question only really applies to users of the IFRS.

Since the revaluation model revalues an asset depending on its market value, it may be the preferable choice if the business has assets that regularly change in market value.

Take for example land and other real estate properties.

The value of land has been constantly increasing over the years.

The revaluation model can reflect this increase in value.

The revaluation model may also be preferable if the business frequently sells its fixed or long-term assets even before they are fully depreciated.

Since the revaluation model presents an asset at its fair market value, the business would know for how much it can sell its assets.

In contrast, the cost model is well-suited for businesses that want a simplistic approach to asset valuation.

It’s also preferable if the business frequently fully utilizes its fixed or long-term assets.

Since it does not intend to sell its fixed assets, it doesn’t always need to know the fair market value of said assets.

Ultimately, the choice of using the cost or revaluation model is at the discretion of the business’s management.

Both methods are accepted by the IFRS, so it’s not like using one over the other isn’t allowed.

Just be mindful that when using the revaluation model, it must reliably viable to determine the market value of the business’s fixed or long-term assets.

It can only be effective if the market value estimates are accurate and reliable.

Accounting for an Asset Using the Revaluation Method

Accounting for asset acquisition is the same whether using the cost model or the revaluation model.

That is, the business records the asset at cost (purchase price plus other costs necessary to make the asset available for use).

For example, company MT acquires a piece of equipment for a total cost of $250,000.

The journal entry for this asset acquisition under the revaluation model would be:

Subsequently, the business will have to revalue the asset.

If the revaluation results in an increase in the carrying amount of the asset, the business must include the increase in its other comprehensive income.

Additionally, it should accumulate the increase in the “revaluation surplus” account, which is an equity account.

However, if the increase reverses a previous decrease that has been recorded in profit or loss due to revaluation, the business should recognize it in profit or loss to the extent of the previously recorded loss.

This effectively eliminates the effects of the loss (or partially if the increase in value does not fully cover it).

On the other hand, if the revaluation results in a decrease in the carrying amount of the asset, the business has to recognize the decrease in its profit or loss.

However, if there is an existing balance for the revaluation surplus of the asset, the business includes the decrease in its other comprehensive income instead.

If the balance of the revaluation surplus is less than the decrease in value, the excess decrease is to be included in the profit or loss.

Upon derecognition of the asset, any remaining revaluation surplus related to it is transferred to the retained earnings.

Accounting for Accumulated Depreciation with the Revaluation Model

There are two approaches to dealing with an asset’s accumulated depreciation using the revaluation model:

• Adjust the gross book value of the asset and its accumulated depreciation proportionate to the increase or decrease in value; or
• Eliminate the accumulated depreciation and adjust the gross book value of the asset so that it’s equal to its fair market value

Of the two, the second approach is the simpler method.

You only need to determine the asset’s fair market value, compare it to its carrying value, and then record the difference as an increase or decrease.

Also, the accumulated depreciation related to the revalued asset will be eliminated.

For example, let’s say that you have a piece of machinery that has an original acquisition cost of $5,000,000.

It has a useful life of 5 years and is currently in its 2^nd year. The asset does not have a salvage value.

Assuming that you use the straight-line method of depreciation, the asset should have an accumulated depreciation of $2,000,000.

This means that it has a net carrying value of $3,000,00.

As per research, the asset has a fair market value of  $4,500,000.

Adjust the gross book value of the asset and its accumulated depreciation proportionate to the increase or decrease in value

Using the first approach requires a bit more computation.

We need to determine the proportionate increase or decrease in the gross book value.

To do this, divide the difference between the asset’s carrying value and fair market value over its carrying value:

Rate of increase/decrease = (Fair Market Value – Carrying Value) ÷ Carrying Value

In this case, the rate would be:

($4,500,000 – $3,000,000) ÷ $3,000,000 = 50%

Then we apply the rate to the asset’s gross book value and accumulated depreciation:

Adjustment to Gross Book Value = $5,000,000 x 50%

= $2,500,000

Adjustment to Accumulated Deprecation = $2,000,000 x 50%

= $1,000,000

Thus, the journal entry should be:

The new carrying value asset should be equal to its fair market value.

The adjusted gross book value of the asset is $7,500,000 ($5,000,000 + $2,500,000).

Its adjust accumulated depreciation is $3,000,000 ($2,000,000 + $1,000,000), which makes its adjusted carrying value $4,500,000 ($7,500,000 – $3,000,000).

Eliminate the accumulated depreciation and adjust the gross book value of the asset so that it’s equal to its fair market value

Using the second approach, the journal entry to record the asset revaluation should be:

The journal entry debits accumulated depreciation of $2,000,0000 to completely eliminate it.

It credits $500,000 to machinery to adjust the gross book value to its market value ($4,500,000 – $5,000,000).

After the recording of the journal entry, the asset should have a gross book value of $4,500,000.

As you can see, no additional computation is needed which makes the approach the simpler of the two.