Revaluation model - effect on depreciation

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Museau

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Hi guys,
Under IFRS, when a firm chooses to use the revaluation method for reporting long-lived assets, how does it affect the depreciation expense? Since the value of your asset will fluctuate one period from another (using market value), and you report the loss on the income statement (and revaluations in shareholder’s equity), is that going to be the equivalent of depreciation under the normal method?
Thanks!
 
  • When revaulation of assets is done, the increase in value of asset is credited to the ‘revaluation reserve.’ This revaluation reserve is treated as a capital reserve.
  • The increase in depreciation arising out of revaluation is debited to the revalution reserve and the normal revalution is debited to the profit & loss statement

Also, Law prohibits any disitributions of dividends from the revalution reserves


Hope this was helpful
 
My understanding below (no garantee.. plz correct me if I’m wrong):
“the value of your asset will fluctuate one period from another (using market value)”
-yes
“you report the loss on the income statement (and revaluations in shareholder’s equity)”
-Well… the initial writedown is recognized in the income statement.
(For revaluation): subsequent writeup is recognized in the income statement TO THE EXTENT OF the previous reported loss. Beyond that level, is called “revaluation surplus” and recognized in shareholder’s equity.
(See Scheweser Note Book #3 page 226 Question #7 for an example)
“is that going to be the equivalent of depreciation under the normal method?”
-Not equivalent. Regarding effect on Balance Sheet (asset valuation), just need to apply the updated estimate PROSPECTIVELY.
i.e. For current accounting cycle, update the carrying value of this asset (based on the revaluation). Depreciation will be affected accordingly (since the carrying value is changed).
 
Thanks for your answers!
What I don’t get is: since the book value of your LLA is defined by its market value, how can you depreciate it? You won’t be able to recognize a depreciation using the normal formulas (Straight line, ddb, etc…), since the book value for the next period will be equal to the market value, not book value minus accumulated depreciation. So does it mean that the depreciation expense is not calculated on this LLA, and that the change in market value “takes its place”?
Thanks again for your input
 
Good question! My understanding is, as you note, “when a firm chooses to use the revaluation method”.
According to the notes LOS 30g, “Under IFRS, firms have the option to revalue assets based on fair value under the revaluation model.”
So it means that there are two models:
1. revaluation model;
2. I’m not sure how to call it (perhaps “cost model”), but it’s:
historical costs - accumulative depreciation
IFRS allows the firm to use either one.
“So does it mean that the depreciation expense is not calculated on this LLA, and that the change in market value “takes its place”?”
I think here you are trying to integrate these two models. So, yes, the depreciation expense is IMPLIED in the change of market value.
 
Just add:
Say if we are calculating the current book value of the asset now, suppose it’s the end of the accounting period, we can:
One way - revaluation model: let market determine. So say we revaluate this asset now, based on fair value. This change in estimate will affect the balance sheet prospectively: in the next accounting period, we have UPDATED book value to begin with, and then we substract from it the depreciation during next accounting period.
The other way: find the book value at the beginning of the current accounting period, and substract by depreciation during this period. In this way, I 80% sure that we CANNOT revaluate HISTORICAL value (the book value at the beginning of the current period), we can only revaluate the current book value.
Depreciation models such as SL or DDB are just models. Companies can manipulate the asset value by:
1. change the accounting principles: depreciation models such as SL, DDB or units of production. or just assign depreciation expenses to each period according to management judgement, if allowed.
2. change the estimates. so here we change the carrying value of the asset, by revaluation.
Just my 2c. Open to discussion.
 
Thanks thulsy, I think you got it right, and you explain it very well.
I thought it would be done this way, but I find it weird that this fact is mentionned nowhere in the curriculum.
Thanks and good luck!
 
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