REVALUATION OF FIXED ASSETS
I. DEFINITION OF REVALUATION OF FIXED ASSETS
:-
The process of increase or decrease carrying
value of the fixed asset, in case of major change(s) in fair market value of
that fixed asset is known as Revaluation of a fixed asset. It is a technique
that accurately define true value of the fixed assets (or capital goods) of an
organization’s business. The purpose of Revaluation of fixed assets is to bring
fair market value of the asset into books of accounts of an organization.
Fixed asset :-
An asset held by an organization for the
purpose of producing goods or rendering services, but not held for resale
purpose is known as Fixed asset. For example, Buildings, Machineries, Patents,
etc.
Carrying value :-
Nothing, but book value of an asset. The
value is based on the original cost of an asset less Depreciation Amortised /
impairment costs made against that asset.
Fair market value :-
The price at which a seller can sell their
goods or services to a buyer is known as Fair Market Value (FMV). In simple
words, FMV is nothing, but Current Market Price (CMP). The fair market value is
calculated based on the growth rate, profit margins, and potential risk of a company.
Impairment :-
A permanent reduction in the value of fixed
asset or an intangible asset which occur as the result of an unusual (un common
/ rare) cases due to changes in legal or an economic condition, customer
demands, and damage of assets, etc.
II. REASONS FOR REVALUATION OF FIXED ASSETS
:-
(a) to conserve adequate funds in the
business for replacement of fixed assets at the end of their useful lives.
(b) Provision for depreciation, based on
historical cost, will show increased profit, and lead to payment of excessive
dividend.
(c) when a company wants to take a loan from
banks or financial institutions by mortgaging its fixed assets, the Revaluation
of fixed assets would enable the company to get a higher amount of loan.
(d) To show the true rate of return on
capital employed,
(e) To negotiate fair price for the assets of
the company before merger or acquisition by another company.
(f) To get fair market value of assets, in
case of sale and or lease back transactions.
(g) To decrease the leverage ratio i.e. debt
to equity.
III. CLASSIFICATION OF VALUATION OF FIXED
ASSETS :-
The valuation of fixed assets can be done by
any method of below explained :-
A. COST MODEL :-
Fixed assets are carried at their cost (book
value) i.e. [historical cost i.e. original cost of an asset - (Accumulated
Depreciation + impairment losses)].
B, REVALUED MODEL :-
Fixed asset is initially recorded at cost,
but subsequently it’s carrying amount is increased to the fixed asset for any
appreciation in value of that fixed asset. The difference between cost model
and Revalued model is that Revalued model allows both upward and downward
adjustment in value of fixed asset, whereas cost model allows that only downward
adjustment due to an impairment loss of the fixed asset. The Revaluation of
fixed assets can be measured by any of the below suitable methods.
1. Indexation method :-
Under this method, indices are applied to the
cost value of the fixed assets to arrive the current cost of the fixed assets.
The Indices are used by Statistical Bureau departments of the country, or
Economic Surveys for the revaluation of fixed assets.
2. Current Market price method :-
Under this method, Land, Buildings, Plant
& machineries are using the current market price as mentioned below for their
revaluation.
(a) Land :-
The price estimated by using recent prices
for similar plots of land sold in the area after certain adjustments will have
to be made by the company. This can be done with the assistance of real estate
brokers and agencies.
(b) Buildings :-
The price estimated by using latest price for
similar buildings purchased / sold in that area. This can be also done with the
assistance of real estate brokers.
(c) Pant & Machinery :-
The price estimated by using current market
price obtained from suppliers of those fixed assets. If those brands are not
available in the market due to closure of the companies who manufacturing them,
then it is compared to value of similar asset’s prices.
3. Selective Method :-
Under this method, the price estimated by
using only a specific asset in a class of assets of a specific location.
4. Appraisal model :-
Appraisal method is also known as Evaluation
method or Assessment Method or Pricing method.
Under this method, the technical experts
required to carry out a detailed examination of the fixed assets to determining
their fair market value. For example, a complete estimation (evaluation) is
required when the organization is taking out an insurance policy for protection
of its fixed assets. We ensure that the fixed assets are not over / under
insured under this method. The below factors affecting in determining the
revaluation of fixed assets :-
(a) Date of purchase of fixed assets (for
calculating the age of those assets),
(b) Usage of an assets i.e. 8 hours, 16 hours
and 24 hours (Generally 1 Shift = 8 Hours),
(c) Purpose of an assets (General purpose or
special purpose),
(d) Repairs & Maintenance policy of the
organization,
(e) Availability of Spare Parts in the future
especially in the case of imported machineries,
(f) Future demand for the product(s)
manufactured by an asset.
Upward Revaluation :-
The increased value of the fixed asset over
that asset’s carrying value (book value) is called as upward amount of
Revaluation of that fixed asset. Upward revaluation can be used mainly for
fixed assets such as land, and real estate whose value will be raised year to
year. The upward value of fixed asset has to be credited to Revaluation Surplus
/ reserve (which is capital reserve), and it should not be used for dividend
distribution. The increased value of depreciation arising out of revaluation of
fixed asset is debited to revaluation surplus (reserve), and the normal depreciation
amount to profit and loss account.
Downward Revaluation :-
The decreased value of the fixed asset over
that asset’s carrying value (book value) is called as downward amount of
Revaluation of that fixed asset. The downward value of fixed asset has to be
debited to Revaluation Surplus / reserve (which is capital reserve). The downward
revision value, first, need to adjust with Revaluation surplus if available,
still it is there, then transfer to profit and loss as “impairment loss".
Reversal of Revaluation :-
Revalued amount is subsequently valued down
due to an impairment. The loss is first write off against any balance available
in the Revaluation surplus, and if the loss exceeds that of Revaluation
surplus, then the balance of same asset is charged to profit & loss account
as impairment loss. We should not consider the upward adjustment of Revaluation
amount as normal gain, and the same should not show in profit and loss account.
IV. CASE :-
XYZ company purchased a machinery on 01st
January 2017 for $100,000 and its useful life is 10 years. Assume that Straight
line method is using for calculation of Depreciation.
Then, Depreciation per year =
Original cost of an asset / number of years of useful life i.e.
= $100,000 / 10 years
= $10,000
The journal entry for purchase of an asset
(machinery) is :-
|
01-Jan-17
|
Machinery A/c
|
Dr
|
$100,000
|
|
Bank A/c
|
Cr
|
$100,000
|
|
(Being Asset purchased)
|
|
|
On 01st January 2019, Revalued, and fair market
value of the machinery have fixed on that date is $85,000 . The journal entries
will come as below for year 2017 and 2018 :-
|
31-12-2017
|
Depreciation A/c
|
Dr
|
$10,000
|
|
Machinery A/c
|
Cr
|
$10,000
|
|
(Being Depreciation
provided)
|
|
|
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31-12-2018
|
Depreciation A/c
|
Dr
|
$10,000
|
|
Machinery A/c
|
Cr
|
$10,000
|
|
(Being Depreciation
provided)
|
|
|
So, the Machinery A/c is showing the balance
on 01st January 2019 as $80,000. As said above, the Revalued amount
of the machinery on 01st January 2019 is $85,000, but actual
carrying amount of that machinery on 01st January 2019 is only
$80,000. The difference i.e. the excess amount over carrying cost of the
machinery (85,000 – 80,000) is $5,000 which would have been transferring
to Revaluation surplus A/c by passing below journal entry.
|
01-Jan-19
|
Machinery A/c
|
Dr
|
$5,000
|
|
Revaluation Surplus A/c
|
Cr
|
$5,000
|
|
(Being difference amount
transferred)
|
|
|
On 01st January 2020, again
Revalued, and fair market value of the machinery have fixed on that date is
$70,000 .
Now, it should be note that the depreciation
needs to calculate on the Revalued amount, and should not calculate on original
cost of the asset in Revaluation model. Thus, the depreciation for the year
2019 will be calculate as per below :-
Depreciation = Revalued amount of the fixed
asset / Number of remaining periods of useful life i.e. 85,000 / 8 years = $10,625
Then, the Machinery A/c will show the balance
as $74,375 (1,00,000 – 10,000 – 10,000 – 10,625) on 01st January
2020, and Revaluation Surplus A/c is as below.
|
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Dr.
|
Revaluation
Surplus A/c
|
Cr.
|
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Date
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Description
|
Amount
|
Date
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Description
|
Amount
|
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01-Jan-19
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By Machinery
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$5,000
|
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31-Dec-19
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To Balance c/d
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$5,000
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$5,000
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$5,000
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01-Jan-20
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By Balance b/d
|
$5,000
|
As said above, the Revalued amount of the
machinery on 01st January 2020 is $70,000, but actual carrying
amount of that machinery on 01st January 2020 is only $74,375. The
difference i.e. the less amount over carrying cost of the machinery (70,000 –
74,375) is $4,375 which would have been transferring to ‘Revaluation
Surplus A/c’ by passing below journal entry.
|
01-Jan-20
|
Revaluation Surplus A/c
|
Dr
|
$4,375
|
|
Machinery A/c
|
Cr
|
$4,375
|
|
(Being difference amount
transferred)
|
|
|
Note :-
If the Revalued amount is less than the
actual carrying cost of the asset, first, we need to adjust that loss amount
against any Revaluation surplus amount of that same asset, still any balance
after the adjustment also, then that amount need to transfer to profit and loss
account as “Impairment loss”.
Suppose, in the above case, the Revalued amount
is fixed $69,000 instead of $70,000. Then, the difference i.e. the less amount
over carrying cost of the machinery (69,000 – 74,375) is $5,375 which
would have been transferring to ‘Revaluation Surplus A/c’. But, in this case,
the revaluation $5,375 against Revaluation surplus, the remaining balance after
adjustment i.e. (5,375 – 5,000) $375 need to transfer to Impairment loss.
The journal entry for this transaction will come as mentioned below :-
|
01-Jan-20
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Revaluation Surplus A/c
|
Dr
|
$5000
|
|
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Impairment loss A/c
|
Dr
|
$375
|
|
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Machinery A/c
|
Cr
|
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$5000
|
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Accumulated Impairment
losses A/c
|
Cr
|
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$375
|
|
(Being loss of Revalued
amount adjusted)
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------------------------------- The end -------------------------
Thank you,
Chandra Sekhar Reddy
Author and Sole proprietor,
SCR Gallery
Website : https://www.scrgallery.com
Blogger : https://scrgalleryindia.blogspot.com
E-mail : scr@scrgallery.com
