Use of Revaluation Model for Valuation of PPE under IFRS

A.C.A Sajal Maheshwari

Index Measurement at Initial Recognition Measurement after Initial Recognition Frequency of Revaluation Accounting Treatment for Revaluation of PPE Revaluation of Class of Assets Treatment of Surplus or Deficit arising on the Revaluation of the assets Utilisation of the Revaluation Reserves Dividend declaration out of Revaluation Reserve Accounting Treatment for Deferred Tax Consolidation in Group IAS 8 Implication

Measurement at Initial Recognition – Cost Basis

Cash Price equivalent at recognition date

Exchange of assets @ Fair Value

If Fair Value cannot be determined, then at Carrying Vale of Asset given up

Self Constructed Assets

1

Measurement after Initial Recognition i.e. at Reporting Date Option 1: Cost Model

• After recognition as an asset, an item of PPE shall be carried at its cost less any accumulated depreciation and an accumulated impairment losses. [Para 30]

Option 2: Revaluation Model

• After recognition as an asset, an item of PPE whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. [Para 31]

2

Frequency of Revaluation Revaluations shall be made with sufficient regularity to ensure that

the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. [Para 31]

IAS 16 therefore does not requires annual revaluation adjustments. The frequency of the revaluations will depend upon fluctuations in the fair values of the items of the PPE under consideration.

3

Accounting Treatment for Revaluation of PPE

Option 1: Gross Carrying amount (CA) is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. Gross CA is restated to

observable market data Gross CA restated

proportionately to the change in the carrying amount

Option 2: The Accumulated depreciation is eliminated against the Gross Carrying amount of the Asset.

(Refer Example 1 for detailed accounting treatment)

4

Example 1

Date Original Cost of the Asset

Accumulated Depreciation

Net Carrying Amount

Other Details

31-Dec-05 100,000

37,000

63,000

Gross CA assessed at 150,000 and the Fair Value of the Asset as on date assessed at 84,000

5

Solution to Example 1:Entry to be posted as on 31st December 2005 Option 1:

(DR) Fixed Assets (BS) 50,000 (CR) Revaluation Surplus (OCI) 21,000 (CR) Provision for Depreciation (BS) 29,000

OR

(DR) Fixed Assets (BS) 33,333 [100,000*84/63-100,000] (CR) Revaluation Surplus (OCI) 21,000 (CR) Provision for Depreciation (BS) 12,333 [37000*84/63-37,000]

*BS represents “Balance Sheet”*OCI represents “Other Comprehensive Income”

6

Solution to Example 1:Entry to be posted as on 31st December 2005 (cont.) Option 2:

(DR) Provision for Depreciation 37,000 (CR) Fixed Assets 16,000 (CR) Revaluation Surplus 21,000

7

Revaluation of Class of Assets

Selective Revaluation of Asset(s)

r

Revaluation of Entire Class of Assets

a

8

Is it possible to revalue the assets or a class of assets of a specific division of the Company? NO.

Class of assets of a company may be revalued but not a class of assets or all assets belonging to specific division of a company as that will result in selective revaluation of the assets.[Interpretation drawn from Para 36-38 of IAS 16]

9

Treatment of Surplus or Deficit arising on the Revaluation of the assets

FV: 8,000 FV: 12,000

FV: 5,000 FV: 11,000 FV: 9,000 FV: 15,000

Carrying Amount 10,000

2,000 OCI

(2,000) SOPL

(3,000) SOPL

2,000 SOPL 1,000 OCI

(2,000) OCI(1,000) SOPL

3,000 OCI

FIRST TIME REVALUATION

SECOND TIME

REVALUATION

10

Utilisation of the Revaluation Reserves

(Transfer between the revaluation reserve and the retained earnings which should be made on a net of tax basis)

Systematic Allocation: Amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset’s original cost. [Para 41]

Complete Transfer: Transferred directly to retained earnings when theasset is derecognised in respect of that asset.

No Transfer:

This would result in PERMANENT RETENTION OF THE REVALUATION RESERVE as Deficits adjustments are allowed on an asset to asset basis under Para 40.

11

Dividend declaration out of Revaluation Reserve

Question: Whether Dividend can be declared out of the Revaluation Reserve?

In line with Section 379 and 380 of CAMA, 2004, Dividend cannot be declared out of the Revaluation Reserves of the Company.

12

Dividend declaration out of Revaluation ReserveQuestion: Whether Dividend can be declared out of the Amount transferred to the Retained Earnings from the Revaluation Reserves either under the systematic allocation or on a totality basis when the Asset is derecognized?

Accordingly, Dividend declared out of the amount transferred from the Revaluation Reserves to the Retained Earnings will be effectively subjected to a Tax of 30% under the CITA.

13

Accounting Treatment for Deferred Tax

International Financial Reporting Standards require or permit particular item to be recognized in other comprehensive income. Examples of such items are:o (a) a change in carrying amount arising from the revaluation of property, plant and

equipment (see IAS 16);[Extract of Para 62](Refer Example 2 in the next slide)

14

Example 2 A non-current asset costing 2,000 was acquired at the start of year 1. It is being

depreciated straight line over four years, resulting in annual depreciation charges of 500. Thus a total of 2,000 of depreciation is being charged. Tax Rate is 25%. The capital allowances (depreciation under the Income Tax) granted on this asset are:

The asset is revalued to 2,500 at the end of year 2.

Year Capital Allowance

Carrying Value Under the Tax Books at the end

of the yearDepreciation in the

Financial BooksAsset Value on the

Books

1 800 1200 500 15002 600 600 500 1000

15

Example 2 (Cont.)Solution: The carrying value at the end of the Year 2 will be 2,500 while the tax base remains at 600. There is, therefore, a temporary difference of 1,900, of which 1,500 relates to the revaluation surplus. This gives rise to a deferred tax liability of 25% x 1,900 = 475 at the year-end to report in the Statement of Financial Position. However 75 has already been provided for in the first year as DTL. Accordingly the DTL Liability is to be created for an amount of 400. The Entries to be posted are as follows;

(DR) PPE (Fixed Assets) 1500(CR) Revaluation Surplus (OCI) 1500

(DR) Tax expense (in SOPL) 25 (DR) Tax Expense (OCI) 375 (CR) Deferred tax liability 400

Revaluation Surplus in the OCI will be shown net of tax element, i.e. at 1,125*OCI represents “Other Comprehensive Income”*SOPL represents “Statement of Profit and Loss”

16

Amount transferred from Revaluation Surplus to Retained Earnings to be net of Deferred Tax

a

Refer Example 2.1 for detailed explanation

*SOCE represents Statement of Changes in Equity

Revaluation Surplus (SOCE) Retained Earnings (SOCE)

Systematic Allocation

Complete Transfer

Net of Deferred Tax Transfer

17

Example 2.1 Assume that the Carrying Amount of the PPE at the end of Year 3 becomes 1,250 while the Carrying

amount as per the Tax Books (i.e. the tax base) of the asset is 240.

Now the deferred tax liability in the books should be (1250-240)*25%=252.5Accordingly, the entry to be posted at the End of Year 3 will be;(DR) Deferred tax liability 222.5 [475-252.5]

(CR) Tax Expense (in SOPL) 222.5

(DR) Revaluation Surplus 562.5, (CR) Retained Earnings 562.5

Year Capital Allowance

Carrying Value Under the Tax Books at the end

of the yearDepreciation in the

Financial BooksAsset Value on the

Books

1 800 1200 500 15002 600 600 500 10003 360 240 1250 1250

Asset has been

revalued at 2,500 at

the end of year 2,

useful life remains the same i.e. 4

Years

1. [1250(Revised Depreciation)-500 (Original Depreciation)= 750]

2. [750*25% (Tax rate) =187.5],

3. [750-187.5=562.5]

18

Consolidation in Group

[Para IFRS 10:19]

Prepare

Uniform Accounting Policies

for like transactions

Parent Consolidated Financial Statements

19

Consolidation in Group

Different Accounting Policies

for like transactions from

the Group

Member of the Group

Make appropriate adjustments to Group’s FS in

preparation of the Consolidated FS

To Ensure conformity with the Groups Accounting Policies

[Para IFRS 10:B87]

“FS” represents Financial Statements

20

Initial Adoption of Revaluation Basis – Implication under IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors. The initial application of a policy to revalue assets in accordance with IAS

16 PPE or IAS 38 Intangible Assets is a change in an accounting policy to be dealt with as a revaluation in accordance with IAS 16 or IAS 38, rather than in accordance with IAS 8. [Para 8:17]

Consequently the valuation uplift or write down occurring on the initial adoption of the revaluation basis is dealt with in Other Comprehensive Income (and accumulated in the revaluation surplus) or P/L, in line with IAS 16.

Prior Period Amounts are not restated

21

END OF PRESENTATION

25Accounting Standard Relevant Text:

An item of PPE that qualifies for recognition as an asset shall be measured at its cost. [Para 15]

If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belong shall be revalued.[Para 36]

The items within a class of property, plant and equipment are revalued simultaneously to avoid selective revaluation of assets and the reporting of amounts in the financial statements that are a mixture of costs and values as at different dates. However, a class of assets may be revalued on a rolling basis provided revaluation of the class of assets is completed within a short period and provided the revaluations are kept up to date. [Para 38]

26Treatment of Surplus or Deficit arising on the Revaluation of the assets

First Time Revaluation or Revaluation on the Same side as the previous movement

o SURPLUS - If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus.[Para 39]

o DEFICIT - If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognized in profit or loss. [Para 40]

Revaluation NOT on the Same side as the previous movemento SURPLUS - The increase shall be recognized in

profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss. [Para 39] (*)

*The amount of Revaluation Surplus that is credited to the Profit and Loss should be reduced by the cumulative reduction in depreciation as a result of recognizing the previous revaluation deficit

o DEFICIT - The decrease shall be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognized in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus. [Para 40]

27 Utilisation of the Revaluation Reserves

Complete Transfer: The revaluation surplus included in equity in respect of an item of property, plant and equipment may be transferred directly to retained earnings when theasset is derecognised. [Para 41]

Systematic Allocation: Some of the surplus may be transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset’s original cost. [Para 41]

(Transfers from revaluation surplus to retained earnings, regardless of the method of movement are not made through profit or loss. Any transfer between the revaluation reserve and the retained earnings which should be made on a net of tax basis will reduce the amount that is available for offset against future revaluation deficits in respect of individual assets)

No Transfer: The reserve transfers referred to in Para 41 are implied to be at the option of the reporting entity rather than being mandated by the Standard. There would therefore appear to be another alternative to make no transfer. HOWEVER THIS WOULD RESULT IN PERMANENT RETENTION OF THE REVALUATION RESERVE as Deficits adjustments are allowed on an asset to asset basis under Para 40.

28Question: Whether Dividend can be declared out of the Revaluation Reserve?

Relevant Sections of the CAMA, 2004 Section 379(5) - Subject to the provisions of this Act, dividends shall be

payable to the shareholders only out of the distributable profits of the company.  

Section 380 - Subject to the company being able to pay its debts as they fall due, the company may pay dividends out of the following profits‐   o (a) profits arising from the use of the company's property although it is a

wasting asset;   o (b) revenue reserves;   o (c) realized profit on a fixed asset sold, but where more than one asset is

sold, the net realized profit on the assets sold.   Accordingly, Dividend cannot be declared out of the Revaluation

Reserves of the Company under the CAMA, 2004

29Question: Whether Dividend can be declared out of the Amount transferred to the Retained Earnings from the Revaluation Reserves either under the systematic allocation or on a totality basis when the Asset is derecognized?Relevant Sections of the CITASection 19 - Payment of dividend by a Nigerian companyWhere a dividend is paid out as profit on which no tax is payable due to‐                (a)   no total profits; or   (b)   total profits which are less than the amount of dividend which is paid, whether or not the recipient of the dividend is a Nigerian company, is paid by a Nigerian company, the company paying the dividend shall be charged to tax at the rate prescribed in subsection (1) of section 40 of this Act (30%) as if the dividend is the total profits of the company for the year of assessment to which the accounts, out of which the dividend is declared, relates. Accordingly, Dividend declared out of the amount transferred from the Revaluation Reserves to the Retained Earnings will be effectively subjected to a Tax of 30% under the CITA.

30Question: Whether Dividend can be declared out of the Amount transferred to the Retained Earnings from the Revaluation Reserves either under the systematic allocation or on a totality basis when the Asset is derecognized?Accordingly, Dividend declared out of the amount transferred from the Revaluation Reserves to the Retained Earnings will be effectively subjected to a Tax of 30% under the CITA.

31Amount transferred from Revaluation Surplus to Retained Earnings to be net of Deferred Tax

IAS 16 does not specify whether an entity should transfer each year from revaluation surplus to retained earnings an amount equal to the difference between the depreciation or amortization on a revalued asset and the depreciation or amortization based on the cost of that asset. If an entity makes such a transfer, the amount transferred is net of any related deferred tax. Similar considerations apply to transfers made on disposal of an item of property, plant or equipment. [Para 64]

Refer Example 2.1 for detailed explanation