Introduction: Revaluation Reserve comes into existence when various fixed assets in the financial statements of the enterprise are stated at their replacement cost and not Historical Cost. When the value of fixed assets in written up in the books of account of a company on revaluation, a corresponding credit is given to the Revaluation Reserve. Such reserve represents the difference between the estimated present market values and the book values of the fixed assets.
Points to remember for Revaluation:
1. Methods of revaluing fixed assets: Appraisal by Competent Valuer, Indexation & Reference to current prices which when applied are cross checked periodically by appraisal method.
2. Different bases of valuation are sometimes used in the same financial statements to determine the book value of the separate items within each of the categories of fixed assets or for the different categories of fixed assets. In such cases, it is necessary to disclose the gross book value included on each basis.
3. Selective revaluation of assets can lead to unrepresentative amounts being reported in financial statements. Accordingly, when revaluations do not cover all the assets of a given class, it is appropriate that the selection of assets to be revalued be made on a systematic basis. For example, an enterprise may revalue a whole class of assets within a unit.
4. It is not appropriate for the revaluation of a class of assets to result in the net book value of that class being greater than the recoverable amount of the assets of that class.
5. The revalued amounts of fixed assets are presented in financial statements either by restating both the gross book value and accumulated depreciation so as to give a net book value equal to the net revalued amount or by restating the net book value by adding therein the net increase on account of revaluation.
6. An upward revaluation does not provide a basis for crediting to the profit and loss statement, the accumulated depreciation existing at the date of revaluation.
7. An increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of Revaluation Reserves and is regarded as not available for distribution.
8. A decrease in net book value arising on revaluation of fixed assets is charged to Profit and Loss statement. If such a decrease is considered to be related to a previous increase on revaluation that is included in revaluation reserve, it is charged against that earlier increase and not to the Profit & Loss Statement.
9. It sometimes happens that an increase to be recorded is a reversal of a previous decrease arising on revaluation which has been charged to profit and loss statement. In this case, the increase is credited to profit and loss statement to the extent that it offsets the previously recorded decrease.
10. On disposal of a previously revalued item of fixed asset, the difference between net disposal proceeds and the net book value is normally charged or credited to the profit and loss statement. If such a loss is related to an increase which was previously recorded as a credit to revaluation reserve and which has not been subsequently reversed or utilized, it is charged directly to Revaluation Reserve Account.
11. As per AS 10, the amount standing in revaluation reserve following the retirement or disposal of an asset which relates to that asset may be transferred to General Reserve. A company may transfer the whole of the reserve when the asset is sold or disposed of. Alternatively, it may transfer proportionate amount as the asset is depreciated.
Adjusting Accumulated Losses & Arrears of Depreciation against Revaluation Reserve:
It is argued that Revaluation Reserve is created as a result of a book adjustment only and, therefore, such a reserve is an unrealised reserve which is not available for distribution as dividends.
Section 205 of the Companies Act, 1956 provides that a company can declare or pay dividend only out of its profits. The profits for this purpose are to be arrived at after providing for depreciation.
Analysis: If dividend is to be declared out of the profits of any earlier year or years, it is necessary that such profits should be arrived at after providing for depreciation for the respective years.
When accounts are prepared on the basis of historical cost, measurement of profits can be made by comparing the cost of the assets at the beginning and at the end of the accounting period.
Taking credit for unrealised gains cannot be justified because the increase in market value may be due to various extraneous factors such as fall in the purchasing power of currency or other factors which are not related to the operations of the company.
The difference between the market value and the book value does not represent realised gain and cannot be treated as such in the books of account.
When accumulated losses and depreciation (including arrears of depreciation) are adjusted against Revaluation Reserve, it will amount to setting off actual losses against unrealised gains.
In such a case, if dividend is declared out of the current profits after adjusting accumulated losses or arrears of depreciation against the Revaluation Reserve, it will mean that dividend is declared out of profits which should have been utilised in setting off past losses and arrears of depreciation. By adopting this method, the company will be declaring dividend out of unrealised gains appearing in the accounts in the form of Revaluation Reserve, which are not available for distribution.
Accordingly, accumulated losses or arrears of depreciation should not be set off against Revaluation Reserve.
However, the revaluation reserve can be utilised for adjustment of the additional depreciation on the increased amount due to revaluation from year to year or on the retirement of the relevant fixed assets.
Need for Revaluation Reserve:
The revaluation of fixed assets is normally done in order to bring into books the replacement cost of such assets. This is a healthy trend as it recognizes the importance of retaining sufficient funds through additional depreciation in the business for replacement of fixed assets. As such, it will be prudent not to charge the additional depreciation against revaluation reserve, though this may result in reduction of distributable profits. This practice would also give a more realistic appraisal of the company’s operations in an inflationary situation.
Difference between Capital Reserve and Revaluation Reserve:
Capital Reserves are reserves created out of capital profits and not during the normal course of business. It may be created due to the following:
It can be used in writing off the capital losses from sale of fixed assets, shares & debentures and issue of fully paid up bonus shares to existing shareholders. Capital Reserve is not available for distribution to shareholders.
Revaluation Reserve, on the other hand, is created out of revaluation of fixed assets. It cannot be utilised for the purpose of issue of fully paid up bonus shares or write off of capital losses, unless the revalued fixed assets have been disposed off.
(Author is a CA Final Student and Registered with ICAI)