Revaluation of fixed assets - AbsoluteAstronomy.com

In finance

Finance

"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...

, a revaluation of fixed assets is a technique that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation

Depreciation

Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

, where the recorded decline in value of an asset is tied to its age.

Fixed assets are held by an enterprise for the purpose of producing goods or rendering services, as opposed to being held for resale in the normal course of business. For example, machine

Machine

A machine manages power to accomplish a task, examples include, a mechanical system, a computing system, an electronic system, and a molecular machine. In common usage, the meaning is that of a device having parts that perform or assist in performing any type of work...

s, building

Building

In architecture, construction, engineering, real estate development and technology the word building may refer to one of the following:...

s, patent

Patent

A patent is a form of intellectual property. It consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention....

s or license

License

The verb license or grant licence means to give permission. The noun license or licence refers to that permission as well as to the document recording that permission.A license may be granted by a party to another party as an element of an agreement...

s can be fixed assets of a business.

The purpose of a revaluation is to bring into the books the fair market value

Fair market value

Fair market value is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or...

of fixed assets. This may be helpful in order to decide whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.

Reasons for revaluation

It is common to see companies revaluing their fixed assets. It is important to make the distinctions between a 'private' revaluation to a 'public' revaluation which is carried out in the financial reports. The purposes are varied:

To show the true rate of return on capital employed.
To conserve adequate funds in the business for replacement of fixed assets at the end of their useful lives. Provision for depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

based on historic cost will show inflated profits
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...

and lead to payment of excessive dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

s.
To show the fair market value of assets which have considerably appreciated since their purchase such as land and buildings.
To negotiate fair price for the assets of the company before merger with or acquisition
Takeover
In business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...

by another company.
To enable proper internal reconstruction, and external reconstruction.
To issue share
Share (finance)
A joint stock company divides its capital into units of equal denomination. Each unit is called a share. These units are offered for sale to raise capital. This is termed as issuing shares. A person who buys share/shares of the company is called a shareholder, and by acquiring share or shares in...

s to existing shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....

s (rights issue
Rights issue
A rights issue is an issue of additional shares by a company to raise capital under a seasoned equity offering. The rights issue is a special form of shelf offering or shelf registration. With the issued rights, existing shareholders have the privilege to buy a specified number of new shares from...

or follow-on offering
Follow-On Offering
A follow-on offering is an issuance of stock subsequent to the company's initial public offering. A follow-on offering can be either of two types : dilutive and non-dilutive. A secondary offering is an offering of securities by a shareholder of the company...

).
To get fair market value of assets, in case of sale and leaseback
Leaseback
Leaseback, short for sale-and-leaseback, is a financial transaction, where one sells an asset and leases it back for the long-term; therefore, one continues to be able to use the asset but no longer owns it...

transaction.
When the company intends to take a loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....

from bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

s/financial institutions by mortgaging its fixed assets. Proper revaluation of assets would enable the company to get a higher amount of loan.
Sale of an individual asset or group of assets.
In financial firms revaluation reserves are required for regulatory reasons. They are included when calculating a firm's funds to give a fairer view of resources. Only a portion of the firm's total funds (usually about 20%) can be loaned or in the hands of any one counterparty
Counterparty
A counterparty is a legal and financial term. It means a party to a contract. A counterparty is usually the entity with whom one negotiates on a given agreement, and the term can refer to either party or both, depending on context....

at any one time (large exposures restrictions).
To decrease the leverage ratio (the ratio of debt to equity).

Methods of revaluation of fixed assets

The common methods used in revaluing assets are:

Indexation

Under this method, indices are applied to the cost value of the assets to arrive at the current cost of the assets. The Indices by the departments of Statistical Bureau or Economic Surveys may be used for the revaluation of assets.

Current market price (CMP)

Land values can be estimated by using recent prices for similar plots of land sold in the area. However, certain adjustments will have to be made for the plus and minus points of the land possessed by the company. This may be done with the assistance of brokers and agencies dealing in land, or by a licensed appraiser
Appraiser
An appraiser , is one who sets a value upon property, real or personal. In England the business of an appraiser is usually combined with that of an auctioneer, while the word itself has a similar meaning to that of "valuer." In the United States, the most common usage relates to real estate...

.
Buildings values can be estimated by a realtor (real estate dealer) or Chartered Surveyor
Chartered Surveyor
Chartered Surveyor is the description ofProfessional Members and Fellows of the RICS entitled to use the designation in Commonwealth countries and Ireland...

(in the UK
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...

) in a similar manner to land.
Plant & Machinery): The CMP can be obtained from suppliers of the assets concerned. However, with efflux of time, many earlier brands are not available in the market due to closure of companies manufacturing them. Similarly, there is change in the models manufactured by a company from time to time. Comparison of assets to most similar types available for sale, new or used, can provide an estimate of value.
CMP of an existing asset = CMP of comparable new asset x Remaining useful life of asset / Original useful life of asset.

Appraisal Method

Under this method, technical experts are called in to carry out a detailed examination of the assets with a view to determining their fair market value. Proper appraisal is necessary when the company is taking out an insurance policy for protection of its fixed assets. It ensures that the fixed assets are neither over-insured nor under-insured. The factors which are considered in determining the value of an asset, are as follows:

Date of purchase.
Extent of use i.e. single shift, double shift, triple shift.
Type of asset. Whether the asset is a general purpose or special purpose asset?
Repairs & Maintenance policy of the enterprise.
Availability of spares in the future, mainly in the case of imported machines.
Future demand for the product manufactured by an asset.
If the asset is part of a bigger fixed asset, the life of the latter is crucial.

Selective revaluation

Selective revaluation can be defined as revaluation of specific assets within a class or all assets within a specific location.

A manufacturing company may have its manufacturing facilities spread over different locations. Suppose it decides to undertake a revaluation of its plant & machinery. Selective revaluation will mean revaluing specific assets (such as boiler, heater, central air-conditioning system) at all locations, or revaluing all items of Plant & Machinery at a particular location only. Such revaluation will lead to unrepresentative amounts being shown in the Fixed Assets Register

Fixed Assets Register

A fixed asset register is an accounting method used for major resources of a business.Fixed assets are those such as land, machines, office equipments, buildings, patents, trademarks, copyrights, etc...

(FAR). In case of revaluation of specific assets of a class, while some assets will be shown at a revalued amount others will be shown at historic cost. The same will happen in case of revaluation of all assets of plant & machinery at a particular location only.

It is not consistent to value and depreciate fixed assets using different bases. Therefore, selective revaluation is generally not considered best practice.

Preliminary considerations

Revaluation will typically require liaison between the company's Production Department, Accounts Department, Technical Department and external appraisers. To commission the project they should set out their conclusions to the following questions:

Why is the revaluation necessary?
What is the most suitable method, taking into account the type of fixed assets, statutory requirements, availability of required information? Should the values arrived at by one method be crosschecked with the values derived from another method?
What assets are to be revalued?
What is the period within which the revaluation has to be completed?
What guidelines should be laid down for the revaluation?
What modifications will be required in the FAR to show revalued figures in place of historic figures? Similarly, depreciation will be computed twice. One taking into account the historic cost, and the other as per revalued figures.

Upward revaluation

The FASB in the U.S. does not allow upward revaluation of fixed assets to reflect fair market values although it is compulsory to account for impairment in fixed assets (downward revaluation of fixed assets) as per FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

In other countries, upward revaluation is mainly done for fixed assets such as land, and real estate whose value keeps rising from year to year. It seems the concept of upward revaluation of fixed assets such as real estate has not been widely welcomed by a majority of companies in USA on account of fear of paying higher property and capital gains taxes. Further, the provision against upward restatement ensures conservative valuation.

The United Kingdom, Australia, and India allow upward revaluation in the values of fixed assets to bring them in consonance with fair market values. However, the law requires disclosure of the basis of revaluation, amount of revaluation made to each class of assets (for a specified period after the financial year in which revaluation is made), and other information. Similarly, law prohibits payment of dividend out of any reserve created as a result of upward revaluation of fixed assets. The law in Australia has been amended recently to allow for the payment of dividends from the increase in value of non-current assets in certain instances where a company meets other liquidity tests (see section 254T of the Corporations Act 2001 (Cth)).

Important Points

The increase in value of fixed assets because of revaluation of fixed assets is credited to ‘Revaluation Reserve
Reserve (Accounting)
In financial accounting, the term reserve is most commonly used to describe any part of shareholders' equity, except for basic share capital. Sometimes, the term is used instead of the term provision; such a use, however, is inconsistent with the terminology suggested by International Accounting...

’, and is not available for distribution as dividend. Revaluation Reserve is treated as a Capital Reserve.
The increase in depreciation arising out of revaluation of fixed assets is debited to revaluation reserve and the normal depreciation to Profit and Loss account.
Selection of the most suitable method of revaluation is extremely important. The most used method is the appraisal method. Methods such as indexation, and reference to current market prices are also used. However, when these methods are used they are crosschecked with the values arrived at by using the appraisal method.
When any asset is sold that has previously been revalued, the revaluation within the carrying value is debited to the Revaluation Reserve.
When assets are revalued, every Balance Sheet shall show for a specified period of years, the amount of increase / decrease made in respect of each class of assets. Similarly, the increased / decreased value shall be shown in place of the original cost.
In case of land and buildings, revaluation is desirable as their value generally increases over time, and is carried out every 3 to 5 years. In case of plant & machinery, revaluation is carried out only if there is a strong case for it. In case of depreciable assets such as vehicles, furniture & fittings or office equipment, revaluation is not carried out.
Revaluation should not result in the net book value of an asset exceeding its recoverable value.

Downward revaluation

Revaluation does not mean only an upward revision in the book values of the asset. It can also mean a downward revision (also called impairment) in the book values of the assets. However, any downward revision in the book values of the assets is immediately written off to the Profit & Loss account.

Successive revaluations

On upward revaluation of a fixed asset which has been previously subject to downward revaluation, an amount of the upward revaluation equal to the amount previously expensed is credited back to the Profit & Loss Account.

Example:

Machinery ‘A’ is purchased on 01-04-1999 for $100,000. It is depreciated using the Straight Line Method at the rate of 10% p.a.

PARTICULARS	First Revaluation	Second Revaluation
Nature of Revaluation	downward	upward
Date of Revaluation	01-04-2001	01-04-2004
Gross Cost	100,000	93,750
Less: Depreciation	20,000	46,875
Net Book Value	80,000	46,875
Revalued - Appraisal Method	75,000	55,000
Increase / (Decrease) in Net Book Value	(5,000)	8,125
Debit to Profit & Loss a/c	5,000	0
Credit to Profit & Loss a/c	0	5,000
Credit to Revaluation Reserve	0	3,125