The revaluation model is an alternative to the cost model and 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, the revaluation model is not allowed under US GAAP.
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 creates the possibility for the values of long-lived assets to increase to amounts which are greater than their historical costs.
The revaluation model may only be used if the fair value of the assets can be reliably measured. 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 for either 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 an asset class’ carrying amount. If the carrying amount of the 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 to the extent that it reverses a revaluation decrease of the same asset class that was previously recognized in profit or loss. An increase in excess of the reversal amount will not be recognized in the income statement but instead will be directly recorded to equity in a revaluation surplus account. An upward revaluation will be treated the same as the amount which is in excess of 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 which result in an increase in the carrying amount of depreciable long-lived assets will increase total assets and shareholders’ equity.
- Asset revaluations which 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 which increase the carrying amount of an asset initially increases 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.
Which of the following statements inaccurately describes the revaluation model?
A. The revaluation model can be used even if the fair value of the assets cannot be reliably measured.
B. If the carrying amount of the asset class is initially decreased, the decrease is recognized in profit or loss on the income statement.
C. The carrying amounts of assets are the fair values at the date of revaluation less any subsequent accumulated depreciation or amortization.
The correct answer is A.
The revaluation model may only be used if the fair value of the assets can be reliably measured. Choices B and C provide accurate statements.
The use of the revaluation model requires/allows all of the following, except for:
A. The existence of an active market for the asset.
B. The selective use of the model to evaluate specific assets.
C. The use of the model on intangible assets.
The correct answer is B.
Under IFRS, a company is allowed to use the cost model for some classes of assets and the revaluation model for others, but the company must apply the same model to all assets within a particular class of assets and must revalue all items within a class to avoid selective revaluation.
Reading 28 LOS 28h:
Describe the revaluation model