The revaluation model is an alternative model allowed under IFRS, but not under US GAAP.
Under the revaluation model, an asset’s carrying value equals its fair value at revaluation date minus accumulated depreciation or accumulated impairment after the revaluation date. The use of the revaluation model may result in an increase in the value of an item of PPE.
A company need not elect the revaluation model for all its assets but must elect it at the class of assets level. For example, if a company decides to apply the revaluation model to buildings, it must revalue all buildings. While a company can apply the revaluation model to both tangible and intangible fixed assets, it is very rare for intangible assets, and also less common for PPE.
When an asset revaluation increases the carrying amount, the difference is recognized in equity as other comprehensive income on account of revaluation surplus. When the value of the asset subsequently falls, it is first written off against the revaluation surplus, and any excess impacts the profit and loss. Similarly, when initial revaluation results in a decrease in the carrying amount of the asset, the difference is charged to the income statement. When the asset recovers its value subsequently, the increase in value to the extent of initial loss recognized in respect of the asset is recognized as income, and any excess is recognized as a revaluation surplus.
Impact of revaluation on financial statements
Analysts need to look at the following possibilities when a company has revalued its assets.
- Positive revaluation surplus decreases a company’s leverage ratio, hence, the decision might be driven by a motivation to present reduced leverage.
- Negative revaluation adjustments routed through income statements may give the management an opportunity to engage in earnings management.
- Positive revaluation adjustments may decrease ROE, ROA, etc. because these decrease net income (due to higher depreciation) while at the same time increasing total assets (equity). Finally, the frequency of revaluations and the independence of the valuer are also important.