by A revaluation of fixed assets is an action that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation, where the recorded decline in value of an asset is tied to its age.
A company can account for changes in the market value of its various fixed assets by conducting a revaluation of the fixed assets. Revaluation of a fixed asset is the accounting process of increasing or decreasing the carrying value of a company’s fixed asset or group of fixed assets to account for any major changes in their fair market value.
Fixed assets are held by an enterprise for the purpose of producing goods or rendering services, as opposed to being held for resale for the normal course of business. An example, machines, buildings, patents or licenses can be fixed assets of a business.
The purpose of a revaluation is to bring into the books the fair market value of fixed assets. This may be helpful in order to decide whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.
Reasons for revaluation
It is common to see companies revaluing their fixed assets. It is important to make a distinction between a ‘private‘ revaluation and a ‘public‘ revaluation which is carried out in the financial reports. The purposes are varied:
- To show the true rate of return on capital employed.
- To conserve adequate funds in the business for replacement of fixed assets at the end of their useful lives. Provision for depreciation based on historic cost will show inflated profits and lead to payment of excessive dividends.
- To show the fair market value of assets which have considerably appreciated since their purchase such as land and buildings.
- To negotiate fair price for the assets of the company before merger with or acquisition by another company.
- To enable proper internal reconstruction, and external reconstruction.
- To issue shares to existing shareholders (rights issue or follow-on offering).
- To get fair market value of assets, in case of sale and leaseback transaction.
- When the company intends to take a loan from banks/financial institutions by mortgaging its fixed assets. Proper revaluation of assets would enable the company to get a higher amount of loan.
- Sale of an individual asset or group of assets.
- In financial firms revaluation reserves are required for regulatory reasons. They are included when calculating a firm’s funds to give a fairer view of resources. Only a portion of the firm’s total funds (usually about 20%) can be loaned or in the hands of any one counterparty at any one time (large exposures restrictions).
- To decrease the leverage ratio (the ratio of debt to equity).
Methods
Appraisal Method
In this method, the technical valuer does a detailed assessment of the assets to find out the market value. A complete assessment is required when the Co. is taking out an insurance policy for fixed assets. In this method, we should ensure that the fixed assets not over/undervalued.
- Date of purchase of fixed assets for calculating the age of fixed assets.
- Usage of Assets such as 8 hours, 16 hours, and 24 hours (Generally 1 Shift = 8 Hours).
- Type of assets such as Land & Building, Plant & Machinery.
- Repairs & Maintenance policy of the enterprise for fixed assets;
- Availability of Spare Parts in the future.
Current Market Price Method
As per the prevailing market price of assets.
Plant and Machinery: Forgetting the fair market value of plant and machinery, we can take the help of the supplier.
Revaluation of the Land & Building: For getting the fair market value of the building, we can take the help of real estate values/ property dealers available in the market.
Indexation Method
In this method, the index does apply to the cost of assets to know the current cost. Index list issued by the statistical department.
Advantages
- To negotiate a fair price for the assets of the entity before the merger with or takeover by another company.
- If assets revalued on the upward side, this will increase the cash profit (Net Profit plus Depreciation) of the Entity.
- The credit balance of revaluation reserve can be used for the replacement of fixed assets at the end of their useful lives.
- Tax Benefit: It results in an increase in the value of assets; hence the amount of depreciation will increase and thereby resulting in income tax deductions.
- To decrease the leverage ratio (Secured Loan to Capital).
Disadvantages
- The total depreciation charged on fixed assets revaluation does not show a regular pattern.
- The company could not revalue its fixed assets every year, or the cost of the fixed asset may not decline. In such a situation, depreciation could not be charged by the company.
- The company does spend much amount on revaluation of fixed assets as this work takes assistance from technical experts, and an increase in expenses results in less profit.
