Revaluation Reserve

Introduction

The revaluation reserve is a financial accounting concept used to account for changes in the market value of a company’s assets. This reserve is part of shareholders’ equity and is typically shown in the equity section of the balance sheet.

What is Revaluation Reserve?

Revaluation reserve is an account within the equity section of a company’s balance sheet. It is used when a company revalues its fixed assets to reflect their current market value rather than their historical cost. When the value of these assets increases as a result of the revaluation, the difference is credited to the revaluation reserve. Conversely, if the value of the assets decreases, the loss would either reduce the credit in the revaluation reserve or be charged to the profit and loss account if there is no credit balance in the revaluation reserve. This accounting method helps ensure that the company’s balance sheet presents a more accurate reflection of its financial position.

Purpose of Revaluation Reserve

The primary purposes of maintaining a revaluation reserve include:

  1. Reflecting True Asset Value: To present a more accurate picture of a company’s financial health by reflecting the true market value of its fixed assets.
  2. Compliance with Accounting Standards: Accounting standards such as International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) often require revaluation of assets.
  3. Enhanced Borrowing Capacity: Demonstrating higher asset values can improve a company’s borrowing capacity by increasing its net asset base, which might be appreciated by lenders and investors.
  4. Preparation for Sale: Companies planning on selling assets may revalue them to ensure they bring in a fair market price.

Accounting Treatment

The revaluation process involves several important steps and considerations:

  1. Selection of Assets for Revaluation: Not all assets need to be revalued. Companies often choose to revalue property, plant, and equipment, or other significant long-term assets.
  2. Valuation Method: An independent valuer or an internal team typically conducts the revaluation. Methods used might include Market Value, Replacement Cost, or Income Approach.
  3. Journal Entries: Recording revaluation involves specific journal entries:
    • Increase in Value: 
       [Asset](../a/asset.html) Account                 Dr.
 [Revaluation](../r/revaluation.html) Reserve             Cr.
    • Decrease in Value: 
       [Revaluation](../r/revaluation.html) Reserve           Dr. (if there is a [credit](../c/credit.html) balance)
 [Profit](../p/profit.html) and Loss Account       Dr. (if there is no [credit](../c/credit.html) balance)
 [Asset](../a/asset.html) Account                     Cr.
  4. Depreciation Adjustment: When assets are revalued, future depreciation charges should be based on the revalued amount instead of the asset’s original cost.

Reporting and Disclosure

Companies are required to disclose details around the revaluation reserve in their financial statements. These disclosures often include:

  1. Revaluation Surplus: The amount of increase in revaluations, which is recognized in the revaluation reserve.
  2. Depreciation on Revalued Asset: Adjustments in depreciation charges due to revaluation.
  3. Impairment: Any impairment losses that are charged to the revaluation reserve.
  4. Movements in Reserve: Detailed reconciliation showing movements in the revaluation reserve during the reporting period.

Examples of Usage

Real Estate Companies

Real estate companies frequently use revaluation reserves because property values often fluctuate significantly. By revaluating their properties, these companies can show a more accurate reflection of their asset values. For instance, Segro, a real estate investment trust, has used revaluation reserves in their financial reporting:

Manufacturing Companies

Manufacturing companies with significant investments in plant and equipment also use revaluation reserves. For instance, Unilever has detailed disclosures on revaluation reserves:

Pros and Cons

Advantages

Disadvantages

Regulatory Framework

International Financial Reporting Standards (IFRS)

According to IFRS, particularly IAS 16, companies have the option to revalue their property, plant, and equipment. The revalued amount should be its fair value at the date of the revaluation, less any subsequent accumulated depreciation and impairment losses.

Generally Accepted Accounting Principles (GAAP)

In the United States, GAAP does not generally permit revaluation of fixed assets to their fair value, emphasizing historical cost. However, some exceptions exist, especially for industries where asset revaluation is more common, such as utilities and real estate.

Local Regulations

Individual countries might have localized versions of these overarching principles, affecting how revaluation reserves are treated. For example, in the UK, the Financial Reporting Standard (FRS) 102 provides guidance on asset revaluation practices.

Conclusion

Revaluation reserves offer a mechanism for companies to account for changes in the market value of their assets, reflecting more accurately their financial position. While offering several benefits like enhanced equity and improved borrowing capacity, it also introduces complexities and potential pitfalls. Proper accounting, regular valuations, and transparent disclosures can help in managing these revaluations effectively. As always, adherence to relevant accounting standards and local regulations is crucial to maintain the integrity and reliability of financial reporting.