Describe the Revaluation Model

The revaluation model is an alternative to the cost model. It is used for the periodic valuation and reporting of long-lived assets.

Whereas IFRS permits the use of either the revaluation model or the cost model, US GAAP doesn’t allow the revaluation model.

The Model Explained

Under the revaluation model, the carrying amounts are the fair values at the date of revaluation less any subsequent accumulated depreciation or amortization. The model makes it possible for the values of long-lived assets to increase to amounts that are higher than their historical costs.

The revaluation model may only be used if the fair value of the assets can be measured reliably. As a result, it can be used for classes of intangible assets only if an active market for the assets exists. It is rarely used either for tangible or intangible assets, but more so for intangible assets.

Whether an asset revaluation affects earnings depends on whether the revaluation initially increases or decreases the carrying amount of the asset class. If the carrying amount of an asset class is initially decreased, the decrease is recognized in profit or loss on the income statement. Subsequently, if the carrying amount of the asset class increases, the increase is recognized in profit or loss. This, nonetheless, depends on the extent to which it reverses a revaluation decrease of the same asset class that was previously recognized in profit or loss. An increase above the reversal amount will not be recognized in the income statement. Instead, it will be directly allocated to equity in a revaluation surplus account. An upward revaluation will be given the same treatment as an amount that is more than the reversal amount.

When an asset is retired or disposed of, any related revaluation surplus which is included in equity will be transferred directly to retained earnings.

Financial Statement Considerations

• Asset revaluations that increase the carrying amount of depreciable long-lived assets will increase total assets and shareholders’ equity.

• Asset revaluations that result in a decrease in the carrying amount of depreciable long-lived assets will reduce net income. In the year of the revaluation, profitability measures such as return on assets and return on equity decline. However, the company may appear more profitable in future years due to the lower asset and shareholders’ equity values. Reversals of downward revaluations will also go through income, thereby increasing earnings.

• Asset revaluations that increase the carrying amount of an asset initially increase depreciation expense, total assets, and shareholders’ equity. Profitability measures such as return on assets, and return on equity will therefore decline.

• Appraisals of the fair value of long-lived assets involve considerable judgment and discretion.

Question 1

Which of the following statements inaccurately describes the revaluation model?

1. The revaluation model can be used even if the fair value of the assets cannot be measured reliably.
2. If the carrying amount of the asset class is initially decreased, the decrease is recognized in profit or loss on the income statement.
3. The carrying amounts of assets are the fair values at the date of revaluation less any subsequent accumulated depreciation or amortization.

Solution

The correct answer is A.

The revaluation model may only be used if the fair value of the assets can be measured reliably.

Options B and C provide accurate statements.

Question 2

The use of the revaluation model requires or allows all of the following, except:

1. The use of the model on intangible assets.
2. The existence of an active market for the asset.
3. The selective use of the model to evaluate specific assets.

Solution

The correct answer is C.

Under IFRS, a company is allowed to use the cost model for some classes of assets and the revaluation model for others. Nonetheless, the company must apply the same model to all assets within a particular class of assets. Besides, it must revalue all items within a class to avoid selective revaluation.