Revaluation of Long Lived Assets

There are two types of cost models used to report long-lived assets:
1. Historical Cost Model
2. Revaluation Cost Model

Historical Cost Model
Long lived assets are reported at: Historical Cost - Accumulated Depreciation/Amortization - Impairment Loss
Revaluation Cost Model
Long lived assets are reported at: Fair Value - Accumulated Depreciation/Amortization - Impairment Loss

• Under US GAAP only historical model is allowed.
• Under IFRS both models are allowed.

Important:

Treatment of Downward Revaluation of an Asset:

If an asset revaluation initially decrease the carrying amount of the asset (loss), the initial loss will be recognized in the income statement. Later, if an asset’s carrying amount increases due to increase in fair value, then the increase is recognized as gain in income statement to the extent of the loss previously recorded for the asset. Revaluation gains beyond the initial loss will bypass the income statement and be recognized in other comprehensive income (shareholders’ equity).

Treatment of Upward Revaluation of an Asset:

In contrast, if an asset revaluation initially increases the carrying amount of the asset (gain), the initial gain will bypass income statement and will be reported in other comprehensive income (shareholders’ equity) under the heading of revaluation surplus i.e.

· Shareholders’ equity increases

· Net income decreases due to higher depreciation expense.

· ROE decreases.

· ROA & Debt/capital ratio decrease.

Later, if an asset’s carrying amount decreases due to decrease in fair value, then this revaluation loss will first 

reduce other comprehensive income (shareholders’equity) to the extent of the previous gain reported then go to income.

NOTE: When an asset is retired or disposed off, then any related amount of revaluation surplus included in equity is transferred directly to retained earnings.

Effects of Asset Revaluation:

· Increase in carrying amount of an asset increases total assets and shareholders’ equity and thus reduce leverage.

· Decrease in carrying amount of an asset decrease net income.

· When asset revaluation decreases the carrying amount, ROA and ROE decline in the year of revaluation.

· But, due to lower total assets and shareholders’equity, in case of downward revaluation, company appears to be more profitable in the future years.

· Reversals of downward revaluation also go through income and increase earnings.