Explain the revaluation model and how assets are derecognised
The idea
Some standards permit long-lived assets to be carried at revalued amount rather than depreciated cost. An increase is normally recognised in other comprehensive income and accumulated in a revaluation surplus, except to the extent it reverses a previous decrease charged to income, in which case it goes to income. A decrease is charged to income except to the extent it reverses a previous surplus. Other standards do not permit revaluation at all. On disposal, the asset and its accumulated depreciation are removed and the difference between proceeds and carrying amount is a gain or loss in income.
A practice question
Where is an upward revaluation of a long-lived asset normally recognised?
- In net incomeWhy not: That would let a company report profit from simply holding an asset it has not sold. The surplus route keeps unrealised gains out of earnings.
- In other comprehensive income, accumulated in a revaluation surplus — correct
- Directly in share capitalWhy not: Share capital records what shareholders subscribed. A revaluation is not a contribution from owners.
Recognising unrealised increases in income would let a company report profit from holding an asset it has not sold. The surplus route keeps it out of earnings.
A harder one
An asset previously written down through income is revalued upward. Where does the gain go?
- Entirely to other comprehensive incomeWhy not: That ignores the earlier charge to income. A reversal goes back to where the loss was reported before anything is treated as a fresh surplus.
- Entirely to the revaluation surplusWhy not: The same omission stated differently — the surplus is where the excess goes, after the earlier income charge has been reversed.
- To income first, then to equity — correct
The gain goes to income to the extent it reverses the earlier charge, and to other comprehensive income beyond that. The symmetry is deliberate: a reversal is returned to wherever the original loss was reported before anything is treated as a fresh surplus.
The hardest tier
Why does the revaluation model complicate comparison between companies reporting under different standards?
- Because one carries property at current value — correct
- Because revaluation changes the depreciation methodWhy not: The method is chosen separately and is unaffected. What changes is the amount the method is applied to.
- Because revaluation is taxed differentlyWhy not: Tax treatment varies, but the comparability problem is in the reported asset base and every ratio built on it.
The other carries the same kind of property at decades-old cost, which makes asset-based ratios incomparable. Return on assets, asset turnover and every leverage ratio built on total assets are affected, and the difference is entirely one of measurement regime rather than anything about the businesses.
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