The 2015 Amendments to the IFRS for SMEs has now allowed an option to use the revaluation model for property, plant and equipment (PPE) in applying Section 17 Property, Plant and Equipment. Even though many entities around the world have been asking for it, some may not fully comprehend all aspects relating to the revaluation of PPE. The purpose of this short series of four articles is to explain how a revaluation should be recognised (the debits and credits for a revaluation surplus and a revaluation deficit (/impairment)), the presentation thereof (looking at the financial statements) and some concluding considerations (to revalue or not).
The revaluation model is different to the cost model for measuring assets as the relevant asset is remeasured to its fair value at specific intervals. The “cost” of the asset is replaced with its “revalued amount”. After a revaluation, the asset is still depreciated under the normal concepts of depreciation and the asset is still tested for an impairment loss, when appropriate. Even though the fair value of the asset is used, the revaluation model is different to the fair value model, in that depreciation and impairment losses are not recognised under the fair value model. The fair value model also requires remeasurement to fair value at every reporting date, whereas a revaluation may be performed at specific intervals (not necessarily at every reporting date). Fair value adjustments under the fair value model are usually recognised within “profit or loss” (P/L), whereas the adjustments for a revaluation are usually recognised within the so-called “other comprehensive income” (OCI) (with some exceptions as will be illustrated in the second article).
Recognising a revaluation
The 2015 Amendments stipulates the following principles for the recognition of a revaluation: “If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus.” Wow! Did you notice when to adjust P/L or OCI as a result of a revaluation? The following diagram may help:
The diagram shows the recognition of depreciation (the diagonal lines) from the cost of an item of PPE to its residual value. At specific dates, the PPE is revalued from its carrying amount to its revalued amount (indicated with a star). The red brackets indicate where (in which section of the statement of comprehensive income) such adjustment is to be recognised (in OCI or P/L).
The accounting treatment of a revaluation of an item of PPE is best explained in an example.
Assume the following information: A company acquired an administrative building on 1 January 2013 for R2 000 000. The residual value of this building is R0 and the useful life is 20 years. These estimates never changed. The company uses the building evenly over time. From this information it follows that the annual depreciation amounted to R100 000 ((cost of R2 000 000 – residual value of R0) / 20 years) under the cost model. In applying the 2015 Amendments to the IFRS for SMEs, the company adopted the revaluation model for PPE and revalued its building at 31 December 2017 to the fair value of R2 100 000. At this date the carrying amount (under the cost model) was R1 500 000 (2 000 000 – (100 000 x 5 years)). The tax effect (deferred tax) is ignored for the sake of simplicity. Please note that deferred tax should be recognised for these temporary differences.
The journal entry for the revaluation will be as follows:
Dr PPE @ carrying amount (2 100 000 – 1 500 000) R600 000
Cr Revaluation surplus (OCI) R600 000
Note that the Standard does not indicate how the carrying amount (the two ledger accounts for “cost” and “accumulated depreciation”) should be treated and it is assumed that an entity should develop its own accounting policy for adjusting the two separate accounts.
From 31 December 2017 there are 15 years remaining and the company recognises depreciation of R140 000 ((revalued amount of R2 100 000 – residual value of R0) / 15 years remaining) for 2018 and onwards. Note that the depreciation on the building is now R40 000 higher than in the past as a result of the upwards revaluation. Even though the Standard (refer to paragraph BC212 to the 2015 Amendments) does not require or prescribe a transfer from the revaluation surplus (in equity) to retained earnings, or specify how such transfer should be calculated, such a transfer while the asset is being used, would make sense and is common practice. In line with full IFRSs, the amount for the transfer within equity could be calculated as the (after tax) difference between the depreciation based on the revaluation model and that on the cost model for the period while the asset is being used. The journal entry for the annual transfer from the revaluation surplus will then be as follows:
Dr Revaluation surplus (equity) (140 000 – 100 000) R40 000
Cr Retained earnings (equity) R40 000
Note that any balance on the revaluation surplus should also be transferred to retained earnings on the disposal of a revalued asset, if such policy has been chosen.
From the example it is evident that the revaluation increase is, in this case, recognised in OCI, as there were no prior impairment losses that were recognised in P/L. Furthermore, the depreciation expense is now higher as a result of the higher revalued amount. As a result, the amount of this excess could now be transferred back from the revaluation surplus to retained earnings, but such a transfer may only be recognised within equity (in the statement of changes in equity) and may not be recognised in an entity’s profit or loss.
The presentation of this revaluation is illustrated in another article (Revaluation of PPE – Part 3 of 4: Presentation and disclosure relating to a revaluation of PPE) in this series, and a revaluation deficit will also be illustrated in the next article
(Revaluation of PPE – Part 2 of 4: Revaluation deficit).