Revaluation Reserve

What is a Revaluation Reserve? 

A revaluation reserve is an accounting term for the increase in the value of a company’s asset. This increase is recorded in the company’s financial statements and shows the difference between the asset’s current market value and its original purchase price. 

Understanding Revaluation Reserve 

When a company buys an asset, it records the purchase price of it. With time asset’s market value can be fluctuate. When the value increased the company adjusts its assets’ value to show the current market value. This adjustment is known as revaluation. Increase in the value is added to revaluation reserve. 

Importance of Revaluation Reserve 

Revaluation reserves are important for several reasons: 

• Accurate Financial Statements 

Revaluations provides the clarity for company’s financial health by ensuring that the company’s financial statements provide real value of its assets. 

• Better Borrowing Capacity 

Lenders or investors prefers to provide loans to firms who have valuable assets and as a result higher asset value help companies to borrow more money. 

• Informed Investment Decisions 

By knowing true value of company’s assets investors decision making becomes better. 

Example  

Imagine a company in India that owns a piece of land bought 10 years ago for ₹10 lakh. Due to development around the area, the market value of the land has increased to ₹50 lakh. The company decides to update its books to reflect the new value. The ₹40 lakh increase is added to the revaluation reserve. 

Accounting for Revaluation Reserve 

When an asset is revalued, the increase in value is not recorded as income. Instead, it is added to the revaluation reserve in the equity section of the balance sheet. This way, the revaluation doesn’t directly affect the company’s profit and loss statement. 

Journal Entry for Revaluation 

When a company revalues an asset, it records this change with the following entry: 

Debit: Asset Account (with the amount of increase) 

Credit: Revaluation Reserve Account (with the amount of increase) 

Impact on Depreciation 

After revaluation, the depreciation (the decrease in value over time) of the asset is based on the new value. For example, if the revalued land is used for building a structure, the depreciation expense will be higher because of the land’s increased value. 

Regulatory Framework in India 

In our country the Institute of Chartered Accountants of India (ICAI) govern assets revaluation by making required rules. The relevant rule is Accounting Standard 10 (AS 10), which covers Property, Plant, and Equipment.AS 10 provides guidelines for revaluing of assets as well as managing the revaluation reserve. 

Uses of Revaluation Reserve 

A revaluation reserve can be used in specific ways: 

• Offsetting Losses 

Revaluation reserve is used to cover the loss when the assets value decline in future. 

• Issuing Bonus Shares 

Sometimes, Shareholders can get bonus shares by companies from the revaluation reserve. 

Limitations and Considerations 

While revaluation reserves have benefits, there are also drawbacks: 

• Subjectivity 

Valuation is subjective; different valuers might give different values for the same asset. 

• Costs 

Revaluation can be expensive as it might require hiring professional valuers. 

• Regulations 

There may be rules about how often assets can be revalued. 

Questions to test your understanding 

Ques1: What is a revaluation reserve? 

1. An increase in the company’s debt
2. A decrease in the value of a company’s asset
3. An increase in the value of a company’s asset
4. The original purchase price of an asset

Ques2: Why are revaluation reserves important? 

1. They decrease the company’s borrowing capacity
2. They provide accurate financial statements
3. They reduce the company’s profits
4. They are recorded as income

Ques3: What happens to the increase in value when an asset is revalued? 

1. It is recorded as income
2. It is added to the revaluation reserve
3. It is subtracted from the original purchase price
4. It is ignored

Ques4: How does revaluation of an asset affect depreciation? 

1. Depreciation decreases because of the higher asset value
2. Depreciation increases because of the higher asset value
3. Depreciation remains the same regardless of asset value
4. Depreciation is not affected by revaluation

Ques5: Which organization governs asset revaluation rules in India? 

1. Securities and Exchange Board of India (SEBI)
2. Institute of Chartered Accountants of India (ICAI)
3. Reserve Bank of India (RBI)
4. Ministry of Finance

Conclusion 

A revaluation reserve is important for a company’s financial management. It helps show the true value of assets and provides more accurate financial statements. Companies in India follow ICAI guidelines for proper revaluation practices. While revaluation is beneficial, companies must consider the costs and limitations. By doing so, they can make better decisions about managing their assets and finances.