US GAAP does not permit firms to revalue the fixed assets on their balance sheets. Assets are reported on the balance sheet after deducting accumulated depreciation and impairment charges.
IFRS allows for revaluation if certain conditions are met or guidelines are followed, but the analyst may face challenges if companies regulated by different standards apply different techniques to revalue assets.
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.