Under revaluation model long-lived assets can be reported at their fair values. A few important points about revaluation model are discussed below:
- If a company chooses to use revaluation model, it must use it for all similar assets and not apply it selectively to specific assets.
- To be able to use the revaluation, a firm must have a reliable way to estimate the fair value such as existence of active markets.
- Revaluation can result in increase or a decrease in fair value.
- When the company moves from historical cost to revaluation model, if fair value is less than historical cost, a loss is reported in income statement.
- If fair value is more than historical cost (regardless of prior revaluation), no gain is reported in income statement. Instead the amount is reported as a part of shareholder’s equity in an account called revaluation surplus.
- In the subsequent years, if revaluation results in a loss, the loss is first deducted from the revaluation surplus and once the surplus is exhausted, a loss is reported in income statement.
A financial analyst may need to revalue a company’s reported asset base in order to perform proper due-diligence when analyzing the firm for debt and/or equity valuation purposes.
If the analyst revises a company’s balance sheet asset values in an upward manner, then the analyst’s near term financial forecast for the company should show a decline in profit and asset turnover, as the firm is believed to be publicly reporting an insufficient depreciation expense. The higher asset base will drive a lower ROA.
