Fixed assets such as buildings, machinery, and land can increase or decrease in value over time due to market fluctuations, inflation, or technological advancements. When an asset’s market value differs significantly from its book value, revaluation is necessary to reflect its fair value in financial statements. Below is a detailed example of how to record a revaluation of fixed assets in accounting.
1. Scenario: Revaluation of a Building
Company’s Asset Details:
- A company owns a building purchased for $500,000.
- The building has a useful life of 25 years and a residual value of $50,000.
- Depreciation is recorded using the Straight-Line Method.
- After 10 years, the company decides to revalue the building.
Step 1: Calculate the Book Value Before Revaluation
Annual Depreciation = (Cost – Residual Value) ÷ Useful Life
= ($500,000 – $50,000) ÷ 25
= $18,000 per year
After 10 years, the accumulated depreciation is:
Accumulated Depreciation = 10 × $18,000 = $180,000
Book Value Before Revaluation = Cost – Accumulated Depreciation
= $500,000 – $180,000 = $320,000
Step 2: Revaluation Increase
The company hires an independent valuer who determines that the fair market value of the building has increased to $600,000.
Revaluation Increase = New Value – Book Value
= $600,000 – $320,000 = $280,000
Step 3: Journal Entry for Revaluation Increase
Since the asset’s value has increased, the gain is recorded in the Revaluation Reserve under equity.
Journal Entry:
Debit: Building Account $280,000
Credit: Revaluation Reserve $280,000
Step 4: Adjusting Depreciation After Revaluation
After revaluation, depreciation is recalculated based on the new asset value.
New Annual Depreciation = (Revalued Amount – Residual Value) ÷ Remaining Useful Life
= ($600,000 – $50,000) ÷ 15
= $36,667 per year
2. Scenario: Revaluation Decrease (Loss on Revaluation)
Company’s Asset Details:
- A company owns machinery purchased for $200,000.
- The estimated useful life is 10 years, and the residual value is $20,000.
- Depreciation is recorded using the Straight-Line Method.
- After 5 years, the company revalues the machinery.
Step 1: Calculate the Book Value Before Revaluation
Annual Depreciation = (Cost – Residual Value) ÷ Useful Life
= ($200,000 – $20,000) ÷ 10
= $18,000 per year
After 5 years, the accumulated depreciation is:
Accumulated Depreciation = 5 × $18,000 = $90,000
Book Value Before Revaluation = Cost – Accumulated Depreciation
= $200,000 – $90,000 = $110,000
Step 2: Revaluation Decrease
The fair market value of the machinery has fallen to $80,000.
Revaluation Loss = Book Value – New Value
= $110,000 – $80,000 = $30,000
Step 3: Journal Entry for Revaluation Decrease
If a Revaluation Reserve exists, the loss is deducted from the reserve. If not, the loss is recorded as an expense.
Journal Entry:
Debit: Revaluation Reserve (if available) $30,000
OR
Debit: Revaluation Loss (Expense) $30,000
Credit: Machinery Account $30,000
Step 4: Adjusting Depreciation After Revaluation
After revaluation, depreciation is recalculated based on the new value.
New Annual Depreciation = (Revalued Amount – Residual Value) ÷ Remaining Useful Life
= ($80,000 – $20,000) ÷ 5
= $12,000 per year
3. Impact of Fixed Asset Revaluation on Financial Statements
A. Balance Sheet
- Asset values increase or decrease based on revaluation.
- Revaluation surplus (if any) is recorded in equity.
B. Income Statement
- If revaluation leads to a loss, it appears as an expense.
- Depreciation expense may increase after revaluation.
C. Cash Flow Statement
- Revaluation is a non-cash adjustment and does not impact cash flow directly.
4. Advantages of Fixed Asset Revaluation
- Ensures accurate financial reporting: Reflects the fair market value of assets.
- Enhances borrowing capacity: Lenders prefer updated asset valuations.
- Improves financial ratios: Increases Return on Assets (ROA) and solvency ratios.
5. Disadvantages of Fixed Asset Revaluation
- Complex process: Requires independent valuations and frequent assessments.
- Increases depreciation expenses: Higher asset values lead to increased future depreciation.
- Potential tax implications: Some tax authorities may impose taxes on revaluation gains.
Properly Managing Fixed Asset Revaluation
The revaluation of fixed assets ensures that a company’s financial statements reflect the true value of its assets. While it provides financial advantages, businesses must carefully manage depreciation adjustments and tax implications. Proper asset revaluation helps maintain transparency, improve borrowing capacity, and provide a more accurate representation of financial health.