What is Revaluation Reserve?
Revaluation reserve is a non-cash reserve created to reflect the true value of the asset when the market value of the certain category of asset is more or less than the value of such asset at which it is recorded in the books of account. Any increase in value will be credited (increase the reserve a/c) to this account and any decrease in value will be debited (decrease the reserve a/c) to the account.
This reserve’s purpose is to reflect and account for in the books, the real and fair value of an asset. It is expressly excluded from free reserves, and hence this reserve is not available for distribution of dividends to shareholders.
- A revaluation reserve account is credited when the asset’s market value is more than it’s recorded value in the books and vice versa.
- Revaluation of assets differs depending on the accounting policy followed, namely US GAAP and IFRS. The method of revaluation followed under these two policies differs in the following manner.
- US GAAP follows Cost Model for valuing fixed assets where it is generally carried at historical cost less accumulated depreciation. Any downward adjustment due to impairment loss is only accounted for, and upward adjustments are ignored. There is no revaluation reserve account, and the downward adjustment, which is impairment of asset, directly reduces the value of an asset. The loss is recognized in the income statement.
- IFRS follows the Revaluation model, where both upward and downward adjustments to the value of the asset reflect under these accounts. In case of disposal of an asset being revalued, if sold at a profit, the amount standing in the asset’s revaluation reserve is transferred to the General Reserve account. Once the same is transferred to the General Reserve account, it is available for the distribution of dividends to shareholders.
- If the asset is sold at a loss, any amount in reserve is reduced to the extent of the damage. Balance, if any, in the revaluation reserve is transferred to the General Reserve account.
Difference Between Revaluation Reserve and Capital Reserve
- The primary difference is that the revaluation reserve is created to account for an increase/decrease in the value of certain assets. The capital reserve is created to finance future projects for business expansion or meet unforeseen business exigencies. And, Capital reserves are created out of non-operational activities like profit arising out of the sale of fixed assets, sale of investments, issue of shares at a premium, etc.
- Certain profits are mandatorily required to be disclosed under capital reserve like share premium (shares issued at a premium). In contrast, certain profits may transfer to Capital reserve at the discretion of the management like profit on the sale of fixed assets or investment. In contrast, revaluation reserve is created out of an increase in the value of the assets compared to its recorded value in the books.
- Capital reserves are carried in the Balance Sheet until the future projects are financed or to finance the unforeseen business exigencies. In contrast, revaluation reserves are carried in the Balance Sheet until the asset is discarded.
- Understanding the similarities between the two will also throw some light on the characteristics of the two reserves. One of the similarities between the two reserves is that both the reserves are not created out of profits from normal business operations. Hence, both these reserves cannot reflect the operational efficiency of the company.
How is it Created?
Revaluation reserve is created out of changes in the value of specific categories of assets. Any increase in the value of an asset from the value recorded in books will increase the reserve and vice versa. There are different methods of valuing the asset on the revaluation date, depending on the accounting policy followed. Indexation and Current Market Price method are the two most commonly used methods. The frequency of revaluation depends on the changes in the fair value of the asset. If the fair value of the asset changes materially from the carried value, then the revaluation of the asset is appropriate, and it is done using the proper method depending on the asset class.
Difference Between Revaluation Reserve and Revaluation Surplus
- Revaluation surplus is the amount remaining after adjusting for loss on discarding of the revalued asset. Hence, the revaluation surplus arises only after the discarding of an asset. Revaluation surplus is transferred to the General Reserve account, which is then available for distribution to shareholders as a dividend.
- Revaluation reserve is the upward and downward adjustment of the value of an asset, done depending on the material changes in the value of the asset. This reserve is not available for the distribution of dividends to shareholders.
The essence of the revaluation reserve account, as it can be appreciated from the above discussion is reflecting the right and fair value of the asset even in case of upward adjustments to the value of an asset. Since accounting of upward adjustment in the value of an asset is not an average gain, the same cannot be recognized as income but is shown under the Revaluation Reserve account, and any subsequent downward adjustment will reduce this account accordingly.
Hence, this account ensures that the income statement is undisturbed by changes in the asset value during the lifetime of the asset. The loss on the sale of the asset will be recognized in the income statement only after adjusting it against the revaluation reserve; profit, if any, is recognized in the income statement.
This article has been a guide to what is Revaluation Reserve and its meaning. Here we discuss accounting treatment and how revaluation reverse is created along with its difference with revaluation surplus. You may learn more about financing from the following articles –