Introduction
US generally accepted accounting principles (US GAAP) carry property, plant and equipment (PP&E) at historical cost, less depreciation and impairment, for as long as a company owns it. International Financial Reporting Standards (IFRS) offer a choice. Under International Accounting Standard (IAS) 16, a company can keep the cost model or adopt the revaluation model, carrying an entire class of assets, such as land and buildings, at fair value and updating it regularly. Deloitte's comparison of PP&E under IFRS and US GAAP lists the option among the differences between the frameworks; US GAAP prohibits upward revaluation altogether.
Most large listed companies keep their PP&E at cost, but the revaluation model is used for land and buildings by a number of property-heavy groups, and it changes their balance sheets, equity and depreciation in ways that matter when they are compared with US peers. The cost-based approach it contrasts with is explained in historical cost vs fair value.
How the Revaluation Model Works
A company that chooses the model must apply it to every asset in the class, not selectively to the assets that have risen in value, and must revalue with enough regularity that carrying amounts do not differ materially from fair value at the reporting date. Volatile assets may need annual valuations; stable ones may need them only every three or five years. Valuations often involve independent appraisers.
- Revaluation surplus
The cumulative net increase in the carrying amount of revalued property, plant and equipment recognized in other comprehensive income and accumulated in a separate component of equity under IAS 16, less any amounts transferred to retained earnings. It is not recycled to profit or loss when the asset is sold.
The gains and losses follow an asymmetric rule:
- Increases are recognized in other comprehensive income and accumulated in the revaluation surplus, except to the extent that they reverse a decrease on the same asset previously recognized in profit or loss, which is reversed through profit or loss.
- Decreases are recognized in profit or loss, except to the extent that they reverse an existing surplus on the same asset, which is reduced through other comprehensive income first.
After a revaluation, depreciation is based on the revalued amount over the remaining useful life, so an upward revaluation raises future depreciation. Companies may transfer the extra depreciation on the revalued amount each year from the revaluation surplus directly to retained earnings, an equity movement that does not pass through profit or loss.
Investment Property Is Different
Property held to earn rent or for capital appreciation, rather than for use in the business, falls under IAS 40 instead. Its fair value model works differently: changes in fair value go straight to profit or loss each period, and the property is not depreciated. A real estate company using it can therefore report large gains or losses in net income when property values move, whereas a company revaluing owner-occupied buildings under IAS 16 sends the gains to other comprehensive income.
A Revaluation in Numbers
Suppose a company owns a building that cost $1,000, with $200 of accumulated depreciation and a remaining life of 40 years, and revalues it to a fair value of $1,200:
| Line item | Before | After |
|---|---|---|
| Building at cost or valuation | 1,000 | 1,200 |
| Accumulated depreciation | (200) | 0 |
| Carrying amount | 800 | 1,200 |
| Revaluation surplus in equity | 0 | 400 |
| Annual depreciation over 40 remaining years | 20 | 30 |
The 400 increase goes to other comprehensive income. One common presentation eliminates accumulated depreciation and restates the asset at its revalued amount. Deferred tax on the surplus is ignored for simplicity.
The carrying amount rises by $400, recorded in other comprehensive income and in the revaluation surplus; net income is unaffected in the year of revaluation. In later years, depreciation rises from $20 to $30, lowering profit by $10 a year, and the company may transfer $10 a year from the revaluation surplus to retained earnings. If the building is later sold, the gain or loss is measured against the revalued amount, and any remaining surplus moves to retained earnings without ever passing through profit or loss.
In practice, a deferred tax liability is usually recognized on the surplus where the tax basis stays at cost, so the net amount added to equity is the surplus less tax.
Comparing With US GAAP Peers
When comparing a revaluation-model company with a US company, bankers usually restate the IFRS company to cost: remove the revaluation surplus from assets and equity, together with the related deferred tax, and replace depreciation on revalued amounts with depreciation on historical cost. The disclosures help: IAS 16 requires companies using the model to disclose the cost-model carrying amount of each revalued class, a requirement the IFRS Interpretations Committee called clear in its 2014 agenda decision on cost-model disclosures. The wider set of adjustments for IFRS reporters is covered in adjusting IFRS reporters for US comparisons.
The revaluation model is a balance sheet choice more than an earnings one. It gives a more current view of what a company's property is worth, at the cost of judgment in the valuations and of comparability with companies that report at cost. For valuation work, neither book value matters much; the cash the assets generate does. For credit work and asset-backed financing, though, a revalued balance sheet can show more collateral value than a cost-based one, and lenders typically look through to independent appraisals either way.
