How To Make Revaluation Account

How to Make a Revaluation Account: A Comprehensive Guide

Understanding how to prepare a revaluation account is crucial for anyone involved in accounting or finance. This comprehensive guide will walk you through the process step-by-step, explaining its purpose, the necessary steps, and addressing common questions. We'll delve into the theoretical underpinnings and provide practical examples to solidify your understanding. This detailed explanation will equip you with the knowledge to confidently prepare a revaluation account in various scenarios.

Introduction: What is a Revaluation Account?

A revaluation account is a temporary account used to record the changes in the value of assets and liabilities. It's primarily used when a company decides to revalue its fixed assets, such as property, plant, and equipment (PP&E), to reflect their current market value or fair value. This revaluation is often necessary due to factors like inflation, changes in market conditions, or significant improvements to the asset. The account helps to accurately reflect the true financial position of the company on the balance sheet. The purpose of this process is to provide a more realistic picture of the company’s net worth. This is particularly relevant for long-term assets, whose book value might significantly differ from their current market value over time. Understanding how to prepare this account accurately is essential for accurate financial reporting.

When is a Revaluation Account Necessary?

A revaluation account is necessary under several circumstances:

• Changes in Market Value: When the market value of an asset significantly differs from its book value (historical cost). This is particularly true for assets like land or buildings, whose values can fluctuate considerably.

• Depreciation Adjustments: To adjust for any under- or over-depreciation of fixed assets. While depreciation is usually a systematic process, unforeseen circumstances or changes in asset lifespan might necessitate revaluation.

• Asset Improvements: Substantial improvements to an asset, increasing its value and useful life, necessitate a revaluation to reflect the enhanced worth.

• Periodic Revaluations: Some companies adopt a policy of periodically revaluing their assets, usually at the end of a financial year, to keep their balance sheet up-to-date and reflect the true financial position.

• Mergers and Acquisitions: In the event of a merger or acquisition, a revaluation of assets might be needed to determine the fair market value of the acquired company's assets.

• Legal Requirements: Certain regulatory bodies or accounting standards may mandate the revaluation of assets under specific conditions.

Steps to Prepare a Revaluation Account

The process of creating a revaluation account involves several steps:

1. Determine the Current Fair Value: This is the most crucial step. The company needs to determine the current market value of the asset being revalued. This might involve obtaining independent valuations from professional appraisers or using market data for similar assets. It’s essential to use a reliable and verifiable method to ensure the accuracy of the revaluation.

2. Calculate the Revaluation Amount: This is the difference between the asset's current fair value and its book value (original cost less accumulated depreciation). This amount determines the entry in the revaluation account.

3. Prepare the Journal Entry: The journal entry depends on whether the revaluation results in an increase or decrease in the asset's value:

   • Increase in Value:

     • Debit: Revaluation Account (for the increase in value)
     • Credit: Revaluation Reserve (a component of equity)

   • Decrease in Value:

     • Debit: Revaluation Reserve (if a reserve exists to cover the loss)
     • Debit: Income Statement (Profit and Loss Account) (if no reserve exists to cover the loss)
     • Credit: Revaluation Account (for the decrease in value)

4. Adjust the Balance Sheet: After the journal entry, the balance sheet needs to be adjusted to reflect the new value of the asset. The asset account is updated with the new value, and the revaluation reserve (for increases) or income statement (for decreases) is accordingly affected.

5. Disclosure in Financial Statements: The revaluation should be adequately disclosed in the financial statements, including a note explaining the methodology used to determine the fair value, the date of revaluation, and the impact on the financial position.

Example of a Revaluation Account

Let's illustrate this with a concrete example. Suppose a company owns a building with a book value of $100,000 (original cost of $150,000 less accumulated depreciation of $50,000). A professional valuation determines the current market value to be $130,000.

Increase in Value:

• Revaluation Amount: $130,000 (Market Value) - $100,000 (Book Value) = $30,000

• Journal Entry:

  • Debit: Revaluation Account $30,000
  • Credit: Revaluation Reserve $30,000

• Balance Sheet Adjustments:

  • Building account increased to $130,000
  • Revaluation Reserve increased by $30,000

Decrease in Value:

Now, let's assume the market value was determined to be $80,000 instead.

• Revaluation Amount: $80,000 (Market Value) - $100,000 (Book Value) = -$20,000

• Journal Entry (Assuming sufficient Revaluation Reserve):

  • Debit: Revaluation Reserve $20,000
  • Credit: Revaluation Account $20,000

• Journal Entry (If no sufficient Revaluation Reserve):

  • Debit: Revaluation Reserve (if any existing balance)
  • Debit: Profit and Loss Account (for the remaining loss) $20,000
  • Credit: Revaluation Account $20,000

• Balance Sheet Adjustments:

  • Building account decreased to $80,000
  • Revaluation Reserve decreased (or Profit & Loss is impacted).

Revaluation Account vs. Depreciation Account

It's important to distinguish between a revaluation account and a depreciation account. A depreciation account systematically allocates the cost of an asset over its useful life. It reflects the gradual decline in the asset's value due to wear and tear, obsolescence, or usage. A revaluation account, on the other hand, adjusts the asset's value to reflect its current market value, irrespective of its accumulated depreciation. While depreciation is a systematic expense, revaluation is a one-time adjustment reflecting market changes.

Accounting Standards and Revaluation

The treatment of revaluations varies across different accounting standards. International Financial Reporting Standards (IFRS) generally allow for the revaluation of assets to fair value, but require that the entire class of assets be revalued, not just individual items. U.S. Generally Accepted Accounting Principles (GAAP) are generally more restrictive on asset revaluations, typically only permitting revaluations in specific circumstances and often requiring impairment testing. It's crucial to adhere to the relevant accounting standards when preparing a revaluation account.

Frequently Asked Questions (FAQs)

Q1: What happens to the Revaluation Reserve after the revaluation?

A1: The revaluation reserve remains in the equity section of the balance sheet. It represents the accumulated increase in the value of assets due to revaluation. It's not available for distribution as dividends until the asset is eventually sold or disposed of.

Q2: Can I revalue assets every year?

A2: While you can revalue assets frequently, it's often not necessary or practical. Frequent revaluations can lead to volatility in the financial statements and might not accurately reflect the company's long-term financial position. The decision to revalue should be based on significant changes in market value or other relevant circumstances.

Q3: What if the revaluation results in a loss?

A3: If the revaluation reveals a loss (the market value is lower than the book value), the loss is typically recognized in the income statement (Profit and Loss account). If a revaluation reserve exists from previous increases, the loss can be offset against that reserve up to its balance.

Q4: Who determines the fair value of an asset?

A4: The fair value of an asset is usually determined by qualified professionals, such as independent valuers or appraisers, using appropriate valuation techniques. The method used should be disclosed in the financial statements.

Q5: What is the impact of revaluation on tax liabilities?

A5: Revaluations can have tax implications. Increases in asset values might lead to higher tax liabilities in the future, while decreases might offer tax benefits. Tax advice should be sought to understand the tax implications of asset revaluations.

Conclusion: Mastering Revaluation Accounts

Preparing a revaluation account accurately is essential for maintaining the integrity of a company's financial statements. It ensures that the assets are recorded at their current market value, providing stakeholders with a more realistic view of the company's financial position. While the process might seem complex initially, understanding the steps involved, the reasoning behind them, and the accounting standards involved will empower you to confidently handle revaluations. Remember to consult with accounting professionals for complex scenarios or when dealing with significant asset values. This guide provides a solid foundation for understanding and preparing revaluation accounts, helping you navigate this crucial aspect of financial accounting. By consistently applying the principles outlined above, you can contribute to more accurate and reliable financial reporting.