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i would be very grateful to anyone who can explain this!
i can’t understand the logic in the transfer to retained earnings of the difference in depreciation arising from a revaluation.
What I don’t understand is if you had an asset X that was worth $150 and depreciated over 3 years straight line to $0 and at the end of year 1 you revalued to £300, you would have:
SOFP
non current asset
X $300equity
revaluation
$200Then in year 2 and 3 you would charge $150 depreciation each year, the difference is $100 per year on what you would have charged pre-revaluation.
So you end up with $200 in retained earnings at the end of the end of year 3 – even though the asset has now been derecognised as its at the end of its life and has been used up.
Surely that can’t be right – that $200 does not exist – how can it be in retained earnings?Revaluation is always computed using the NBV of the non-current asset.
here NBV of the asset = 150 – 50 (acc. dep) = 100In your case, these are the entries
compare revaluation with the NBV: 300 – 100 = 200
Dr X – 200
Cr Revaluation Surplus – 200
To record the revaluationAccording to IAS 16, the excess depreciation on revaluation will be realized from revaluation surplus and goes to retained earnings, so:
Depreciation should be: 150/3 = 50/year
Depreciation because of revaluation: 300/2(remaining life) = 150/yearso, increase in depreciation = 150 – 50 = 100
Dr Revaluation Surplus – 100
Cr Retained Earnings – 100ALTERNATIVE
if in case depreciation amount is not given, divide revaluation amount by remaining life, so: 200/2 = 100/year.
NB: upon revaluation, accumulated depreciation becomes nil.
HOPE THIS WOULD SATISFY YOU.
You should read the contribution by Kingnasha to a similar question – he / she explains it perfectly
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The revaluation reserve (for unrealised gain) is a capital reserve so that the transfer signals a movement from capital reserve to revenue reserve (becomes realised), which would be distributable to shareholders.
The real question is how we transfer it, through ‘profit or loss’ or not. Of course, the mandatory treatment under IAS16 is not through profit or loss.
Hi nav1980,
After the upward revaluation at end of Year 1, you have added $200 to Asset X and $200 to Revaluation Surplus.
In Year 2 and Year 3, you are moving the excess depreciation from Revaluation Surplus on the Balance Sheet to Retained Earnings on the Balance Sheet, $100 per year, so at the end of year 3, you can the $200 in Retained Earnings and $0 in Revaluation Surplus.
In addition to the above the reason why this process is carried out is to avoid “punishing” an organisation for carrying out revaluations by restating their earnings to what they would have been if no revaluation had occurred.This helps give a more faithful representation of the financial position and aids comparability.
The logic of the process of a transfer between the reserves(revaluation reserve and the retained earnings reserve) is to deal with the fact that retained earnings would otherwise be lower than they would have been had the revaluation not taken place- clearly a nonsensical situation.In this way the revaluation reserve is also lowered to zero over the remaining life of the asset.The part relating to the asset in question of course.No “phantom” earnings are created as a result of this process.
I am sorry but do not understand logic behind transfering an revaluation reserve to retained earnings account . I would highly appreciate if someone could please explain it in more detail.
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Thank you!
for making the logic clear.so is it alright to say that, just to realize the never ending Revaluation Surplus we transfer it Annually to Retained Earnings.??
Equity reserves are discretionary accounts.The standard does not require you to maintain reserves other than retained earnings. Let me see if I can briefly explain based on the initial question posed.
On revaluation, the company has at its discretion created a revaluation reserve for the 200 (dr asset 200, cr reserve 200). All further depreciation will be charged to the retained earnings. At the end there would be a debit for 200 in the retained earnings which represents the excess depreciation. This would be offset by the revaluation reserve credit of 200.
This would be similar to the scenario where a company does not maintain a revaluation reserve and instead all revaluation is passed to the retained earnings on recognition. The resulting excess depreciation would be passed to the retained earnings over time to ultimately offset this revaluation.
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