finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...

, a revaluation of fixed assets is an action that may be required to accurately describe the true value of the

capital good The economic concept of a capital good (also called complex product systems (CoPS),H. Rush, "Managing innovation in complex product systems (CoPS)," IEE Colloquium on EPSRC Technology Management Initiative (Engineering & Physical Sciences Researc ...

s a business owns. This should be distinguished from planned

depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...

, where the recorded decline in the value of an asset is tied to its age. 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,

machine A machine is a physical system using power to apply forces and control movement to perform an action. The term is commonly applied to artificial devices, such as those employing engines or motors, but also to natural biological macromolecul ...

building A building, or edifice, is an enclosed structure with a roof and walls standing more or less permanently in one place, such as a house or factory (although there's also portable buildings). Buildings come in a variety of sizes, shapes, and func ...

patent A patent is a type of intellectual property that gives its owner the legal right to exclude others from making, using, or selling an invention for a limited period of time in exchange for publishing an enabling disclosure of the invention."A ...

s, or

license A license (or licence) is an official permission or permit to do, use, or own something (as well as the document of that permission or permit). A license is granted by a party (licensor) to another party (licensee) as an element of an agreeme ...

s can be

fixed asset A fixed asset, also known as long-lived assets or property, plant and equipment (PP&E), is a term used in accounting for assets and property that may not easily be converted into cash. Fixed assets are different from current assets, such as cash ...

s of a business. The purpose of a revaluation is to bring into the books the

fair market value The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by sever ...

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 Return on capital employed is an accounting ratio used in finance, valuation, and accounting. It is a useful measure for comparing the relative profitability of companies after taking into account the amount of capital used.Fernandes, Nuno. Finance ...

. * To conserve adequate funds in the business for replacement of fixed assets at the end of their useful lives. Provision for

based on

historical cost In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' v ...

will show inflated profits and lead to payment of excessive

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...

s. * 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 Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspec ...

with or acquisition by another company. * To enable proper internal reconstruction and external reconstruction. * To issue shares to existing

shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal o ...

s (

rights issue A rights issue or rights offer is a dividend of subscription rights to buy additional securities in a company made to the company's existing security holders. When the rights are for equity securities, such as shares, in a public company, it can b ...

follow-on offering A follow-on offering, also known as a follow-on public offering (FPO), is a type of public offering of stock that occurs subsequent to the company's initial public offering (IPO). A follow-on offering can be categorised as dilutive or non-dilu ...

). * To get fair market value of assets, in case of sale-and-

leaseback Leaseback, short for "sale-and-leaseback", is a financial transaction in which one sells an asset and leases it back for the long term; therefore, one continues to be able to use the asset but no longer owns it. The transaction is generally done ...

transaction. * When the company intends to take a

loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...

from

bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

s or

financial institution Financial institutions, sometimes called banking institutions, are business entities that provide services as intermediaries for different types of financial monetary transactions. Broadly speaking, there are three major types of financial inst ...

s 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 A counterparty (sometimes contraparty) is a legal entity, unincorporated entity, or collection of entities to which an exposure of financial risk may exist. The word became widely used in the 1980s, particularly at the time of the Basel I deliberat ...

at any one time ( large exposures restrictions). * To decrease the debt-to-equity ratio ("leverage ratio").

Methods of revaluation of fixed assets

The common methods used in revaluing assets are:

Indexation

Under this method, indices are applied to the cost value of the assets, to arrive at the current cost of the assets. The Indices by the country's departments of Statistical Bureau or Economic Surveys may be used for the revaluation of assets.

Current Market Price (CMP)

*Land values can be estimated by using recent prices for similar plots of land sold in the area. However, certain adjustments will have to be made for the plus and minus points of the land possessed by the company. This may be done with the assistance of brokers and agencies dealing in land, or by a licensed

appraiser An appraiser (from Latin ''appretiare'', "to value"), is a person that develops an opinion of the market value or other value of a product, most notably real estate. The current definition of "appraiser" according to the Uniform Standards of Prof ...

. *Buildings values can be estimated by a

real estate agent A real estate agent or real estate broker is a person who represents sellers or buyers of real estate or real property. While a broker may work independently, an agent usually works under a licensed broker to represent clients. Brokers and ag ...

(or broker or dealer) or

Chartered Surveyor Chartered Surveyor is the description (protected by law in many countries) of Professional ''Members'' and ''Fellows'' of the Royal Institution of Chartered Surveyors (RICS) entitled to use the designation (and a number of variations such as "Chart ...

(in the UK) in a similar manner to land. *Plant and Machinery: The CMP can be obtained from suppliers of the assets concerned. This may not be possible if brands are unavailable in the market due to the closure of companies manufacturing them. Similarly, a direct CMP may not be available for a model that has been discontinued or changed by the manufacturer. Comparison of assets to most similar types available for sale, new or used, can provide an estimate of value. CMP of an existing asset = CMP of comparable new asset × remaining useful life of asset ÷ original useful life of asset.

Appraisal method

Under this method, technical experts are called in to carry out a detailed examination of the assets with a view to determining their fair market value. A proper appraisal is necessary when the company is taking out an

insurance policy In insurance, the insurance policy is a contract (generally a standard form contract) between the insurer and the policyholder, which determines the claims which the insurer is legally required to pay. In exchange for an initial payment, known a ...

for the protection of its fixed assets. It ensures that the fixed assets are neither over-insured nor under-insured. The factors which are considered in determining the value of an asset, are as follows: * Date of purchase. * Extent of use i.e. single shift, double shift, triple shift. * Type of asset. Whether the asset is a general purpose or special purpose asset? * Repairs and Maintenance policy of the enterprise. * Availability of spares in the future, mainly in the case of imported machines. * Future demand for the product manufactured by an asset. * If the asset is part of a bigger fixed asset, the life of the latter is crucial.

Selective revaluation

Selective revaluation can be defined as the revaluation of specific assets within a class or all assets within a specific location. A manufacturing company may have its manufacturing facilities spread over different locations. Suppose it decides to undertake a revaluation of its plant and machinery. Selective revaluation will mean revaluing specific assets (such as the boiler, heater, central air-conditioning system) at all locations, or revaluing all items of Plant and Machinery at a particular location only. Such revaluation will lead to unrepresentative amounts being shown in the

fixed asset register A fixed asset register (FAR) is nothing more than a list of fixed assets that belong to an entity. Traditionally the fixed asset register was maintained in written form by a bookkeeper using a book that was set aside specifically for that purpose ...

(FAR). In case of revaluation of specific assets of a class, while some assets will be shown at a revalued amount others will be shown at historical cost. The same will happen in case of revaluation of all assets of plant and machinery at a particular location only. It is not consistent to value and depreciate fixed assets using different bases. Therefore, selective revaluation is generally not considered best practice.

Preliminary considerations

Revaluation will typically require liaison between the company's Production Department, Accounts Department, Technical Department, and external appraisers. To commission the project they should set out their conclusions to the following questions: * Why is the revaluation necessary? * What is the most suitable method, taking into account the type of fixed assets, statutory requirements, availability of required information? Should the values arrived at by one method be crosschecked with the values derived from another method? * What assets are to be revalued? * What is the period within which the revaluation has to be completed? * What guidelines should be laid down for the revaluation? * What modifications will be required in the FAR to show revalued figures in place of historical figures? Similarly, depreciation will be computed twice. One takes into account the historical cost, and the other as per revalued figures.

Upward revaluation

The

FASB The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Sec ...

in the U.S. does not allow upward revaluation of fixed assets to reflect fair market values although it is compulsory to account for impairment costs in fixed assets (downward revaluation of fixed assets) as per FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In other countries, upward revaluation is mainly done for fixed assets such as land, and real estate whose value keeps rising from year to year. It seems the concept of upward revaluation of fixed assets such as real estate has not been widely welcomed by a majority of companies in USA on account of fear of paying higher property and capital gains taxes. Further, the provision against upward restatement ensures conservative valuation. The

United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the continental mainland. It comprises England, Scotland, Wales and ...

Australia Australia, officially the Commonwealth of Australia, is a sovereign country comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands. With an area of , Australia is the largest country by ...

, and

India India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area, the List of countries and dependencies by population, second-most populous ...

allow upward revaluation in the values of fixed assets to bring them in consonance with fair market values. However, the law requires disclosure of the basis of revaluation, amount of revaluation made to each class of assets (for a specified period after the financial year in which revaluation is made), and other information. Similarly, the law prohibits payment of dividend out of any reserve created as a result of the upward revaluation of fixed assets. The law in Australia has been amended recently to allow for the payment of dividends from the increase in the value of non-current assets in certain instances where a company meets other liquidity tests (see section 254T of the

Corporations Act 2001 The ''Corporations Act 2001'' (Cth) is an Act of the Parliament of Australia, which sets out the laws dealing with business entities in the Commonwealth of Australia. The company is the Act's primary focus, but other entities, such as partner ...

(Cth)).

Important points

* Increase in the value of fixed assets because of revaluation of fixed assets is credited to "Revaluation

Reserve Reserve or reserves may refer to: Places * Reserve, Kansas, a US city * Reserve, Louisiana, a census-designated place in St. John the Baptist Parish * Reserve, Montana, a census-designated place in Sheridan County * Reserve, New Mexico, a US ...

", and is not available for distribution as dividend. Revaluation Reserve is treated as a Capital Reserve. * The increase in depreciation arising out of revaluation of fixed assets is debited to revaluation reserve and the normal depreciation to Profit and Loss account. * Selection of the most suitable method of revaluation is extremely important. The most used method is the appraisal method. Methods such as indexation and reference to current market prices are also used. However, when these methods are used they are crosschecked with the values arrived at by using the appraisal method. * When an asset is sold that has previously been revalued, the revaluation within the carrying value is debited to the Revaluation Reserve. * When assets are revalued, every

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

shall show for a specified period of years, the amount of increase or decrease made in respect of each class of assets. Similarly, the increased/decreased value shall be shown in place of the original cost. * In case of land and buildings, revaluation is desirable as their value generally increases over time, and is carried out every 3 to 5 years. In case of plant and machinery, revaluation is carried out only if there is a strong case for it. In case of depreciable assets such as vehicles, furniture and fittings or office equipment, revaluation is not carried out. * Revaluation should not result in the net book value of an asset exceeding its recoverable value.

Downward revaluation

Revaluation does not mean only an upward revision in the book values of the asset. It can also mean a downward revision (also called impairment) in the book values of the assets. However, any downward revision in the book values of the assets is immediately written off to the Profit and Loss account. Under IFRS, an asset is considered to be impaired (and is thus written down) if its carrying amount is greater than its recoverable amount. The recoverable amount is the greater of the asset's value in use (present value of future values) or net realizable value.

Successive revaluations

An upward revaluation of a fixed asset which has been previously subject to downward revaluation, an amount of the upward revaluation equal to the amount previously expensed is credited back to the Profit and Loss Account. :Example: :Machinery 'A' is purchased on 01-04-1999 for $100,000. It is depreciated using the Straight Line Method at the rate of 10% p.a.