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Hallo,
May I ask, when we have the case of revaluation of non-current asset and the corresponding double entries, one of the entries is to Dr Accumulated depreciation and to credit it to Revaluation rezerve a/c. Isn’t the accumulated depreciation an expense, and if yes, why do we have to add it to the revaluation rezerve, if revaliation rezerve is a type of capital income for us?
Thank you!
You should not think of entries like this on their own, but look at the overall purpose and effect.
The whole purpose it to change the existing carrying value (cost less accumulated depreciation) to the new revalued amount. So we change the ‘cost’ to the new revalued amount, and remove the existing accumulated depreciation.
It is the final figure in the revaluation account that matters – this is the profit on revaluation and should be shown on the Statement of financial position as a Revaluation Reserve as part of the total capital (a ‘profit’ owing to shareholders but kept separate from the ordinary Income statement profit.
(You also need to look at the chapter on Limited Companies to make full sense of the presentation on the Statement of financial position (and the reason for it).)
Hallo,
Sorry, do you mean any specific source in this case where to have a look at this chapter?
Thank you!
It is Chapter 13 – section 6 (where different reserves are discussed ) – and the lecture that goes with it.
Question: At Dec 20×3 Q, a limited liability company owned a building that had cost $800, 000 on the 1 Jan 20W4.
It was being depreciated at 2% per year.
On 31 Dec 20X3 a revaluation to $1,000,000 was recognised. At this date the building had a remaining useful life of 40 years.
What is the balance on the revaluation surplus at 31 Dec 20X3 and the depreciation charge in the income statement for year ended 31 Dec 20X4?
I was able to work out the dep’n charge as 1,000,000/40=25,000 but the second part is/a bit challenging.
Thanks for ur prompt reply.
Hallo,
I had I think almost or the same example and I also didn’t understand what’s going on, thx for asking, maybe Mr. Moffat will clarify it.
Otherwise, I think Cost – Depr = NBV, then NBV is compared to your revaluation, and this is your revaluation surplus, if I’m right.
And after that, there are some workings for depreciation, which I have no clue why they happen so.
Certainly, the revaluation surplus is the difference between the revalued amount and the net book value (carrying value).
After revaluing we calculate the depreciation on the revalued amount, so it is 1,000,000/40 = 25,000 a year, and put through the entry as usual (dr depn expense; cr accum depn).
However, it does make the expense in the income statement much higher than it would have been if it had not been revalued. Also, part of the reason for having such high depn is because of the revaluation and the revaluation reserve is not payable out as dividend.
So….to deal with this, we make one more entry. We transfer from the revaluation reserve to the retained earnings, the difference between the new depreciation and what it would have been if we had not revalued. The entry is DR revaluation reserve; CR retained earnings.
The new depn is 25,000 a year; if we had not revalued it would have been 2% x 800,000 = 16,000. So the transfer is the difference of 9,000.
Hi Mr Moffat,
The above explanation is clear, but the answer in the revision kit for the revaluation surplus is $360,000. Not sure how they arrived at that conclusion.
The answer: Revaluation surplus- (1,000,000-(800, 000-(800, 000*2%*10))= $360,000
Dep’n Charge- (1,000,000/40) = $25,000Don’t quite understand the calculation for the revaluation surplus work out.
Okay Mr Moffat i think i’ve got it.
They calculated 10 years of accumulated dep’n as $16,000 (800,000*2%)*10=$160,000
So the carrying amount is $800,000-$160,000=$640,000
And the revaluation surplus is $1,000, 000-$640,000=$360,000
Correct me if i’m wrong with the above workings and Question, how are we to know that 10 years of old dep’n was used up prior to the revaluation? I always thought the dates would give light to that…
That is correct:-)
The reason we know that it was 50 years is because the depreciation was 2% straight line. (100%/2% = 50)
Good! :-)….thank u!!
One more question regarding this “awesome” topic…..are we always to assume that when a question ask for the balance on the revaluation a/c that we must minus the excess dep’n?
A question i did stated that “Banjo Co has a policy of transferring the excess dep’n on the revaluation from the revaluation surplus to retained earnings” so the excess dep’n was deducted form the revaluation reserve figure to get the revaluation surplus…
….but another question i did didn’t point that out but, we had to deduct it to get the balance on the revaluation a/c. (little confused with that 1).
The excess depreciation should always be deducted from the balance on the revaluation account.
Hallo,
Concerning depreciation, ok I see the calculations, I understand how it is done, but I would like to know why it is necessary to do all this.
Why is it necessary to transfer the excess dep’n on the revaluation from the revaluation surplus to retained earnings, or why is it necessary to transfer the difference between the new depreciation and what it would have been if we had not revalued?
Is it only to have less expense in the income statement, but as revaluation is not yes inflow of money but more like goodwill, if it’s right to say so, or is it to have more finance to pay out as dividend, but this contradicts the fact the revaluation is not real inflow of money? So, what is the real reason for doing it?
Thank you!
I explained it about four posts earlier.
The reason for keeping the revaluation reserve separate is because it is not a ‘real’ profit and therefore not distributable as dividend.
As we depreciate, the value on the Statement of financial position gets lower. In a sense depreciating is revaluing downwards. The excess of the value on the Statement over the original cost gets lower and so there is less to make non-ditributable.
The reason for doing it is partly this, and also partly to make the Income Statement more realistic and comparable with previous years (and to comply with International Accounting Standards).
Hallo,
coming back to my first question, at the start of the topic, and your answer:
“So we change the ‘cost’ to the new revalued amount, and remove the existing accumulated depreciation.”
– what tells me that we remove the existing accumulated depreciation, is it the Dr Acc depr, Cr Reval rezeve, or when we find the carrying value, where we subtract the acc. depr, or something else is meant here?
Thank you!
To remove the existing depreciation you DR Accumulated depreciation and CR revaluation reserve.
Halo,
ok, if we remove the accumulated depreciation, and transfer it to revaluation rezerve a/c, the acc. depr. is suddenly an unrealized profit for us, what is the connection between the accumulated depreciation and this unrealized profit, why something which depreciates an asset, and is basically it’s cost is transformed to a profit now?
Thank you!
The entry in accumulated depreciation is exactly the same as when we sell an asset, except when we sell an asset the entry goes to disposal account (and we end up with a profit/loss that appears in the SOPOL). When it is a revaluation we end up with an unrealised profit which is why it appears instead in the revaluation reserve.
Hallo,
May I ask about the effect of the retained earnings, meaning the transfer of the excess depr. from rev.rezerve to retained earnings. Can I explain it like this:
1. Reval. rezerve is decreased by the excess depr., our profit in the SOPOL is also decreased by the new depreciation after the revaluation, not only the excess, for the respective period.
2. The transferring of excess depr. to retained earnings, has the effect of increasing our profit.3. So, in SOPOL we decreased the profit with the new depr., but we increased our retained earnings, this has the effect as if we haven’t revalued at all, and it is like this, because the revaluation is unrealized profit, and we can’t have an unrealized profit in the I/S, so we have unrealized capital in the retained earnings, but strangely the retained earnings is a distributable profit, but anyway the net effect is 0.
4. If 3 is true, and if in this moment we decide to pay a dividend, the retained earnings will decrease, so, even though we had an unrealized profit, by transferring it to retained earnings, we do actually use as if this was real cash, e.g. for paying dividend, or sth. else. How is this possible or actually allowed, to use unrealizable profit, as realized profit, when it hasn’t been realized yet?
Thank you!
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