What is a Revaluation Reserve in Accounting? Definition, Example and Importance
Revaluation Reserve Definition
In accounting, a revaluation reserve is a specific account in a business’s financial records that represent the cumulative changes in the value of assets (usually non-current) over time.
In other words, it shows the total changes in the value of assets since they were first brought onto the balance sheet (ie the “carrying amount”).
These changes result from periodic revaluations, which involve reassessing the fair market value of assets such as property, plant, and equipment (PPE).
Revaluation Reserve Importance
The primary purpose of using a revaluation reserve is to provide a more accurate representation of a business’s financial position.
As the market value of assets go up and down, the historical cost recorded on the balance sheet may become outdated.
Revaluation reserves allow businesses to adjust the carrying amount of their assets to reflect their current market value, providing stakeholders with a more realistic view.
The revaluation process involves engaging professionals, such as independent appraisers, to determine the fair value of the business’s assets.
This fair value is then compared to the carrying amount recorded on the balance sheet.
Any difference between the fair value and the carrying amount is recognised in the revaluation reserve.
Example of a Revaluation Reserve in Action
Let’s use a real-world example to help illustrate this concept.
Imagine a manufacturing company that owns a factory building.
The building was purchased for £2m a few years ago, and the carrying amount on the balance sheet is still £2m.
However, due to an increase in the real estate market, the fair value of the building is now assessed at £2.5m.
The revaluation reserve would reflect an increase of £0.5m, highlighting the appreciation in the value of the building.
Accounting Treatment of a Revaluation Reserve
The accounting treatment for using a revaluation reserve usually involves the following steps:
Initial Revaluation
The business carries out a revaluation of their assets to determine their fair values.
This can be done by using external experts or using other valuation methods such as comparing the asset to similar assets in the market that have been recently sold.
The difference between the fair value and the carrying amount (historical cost) of the asset is calculated.
If the fair value is higher than the carrying amount, the asset is said to have appreciated, and the increase is recorded as a revaluation surplus in the revaluation reserve.
If the fair value is less than the carrying amount, indicating a decrease in value, the decrease is recorded as a revaluation deficit.
Recognition in Financial Statements
Any increases in asset value are credited to the Revaluation Reserve account.
Asset | Debit |
Revaluation Reserve | Credit |
Any decreases in asset value are debited to the Revaluation Reserve account.
Asset | Credit |
Revaluation Reserve | Debit |
Depreciation
Depreciation is calculated on the revalued amount of the asset.
The depreciation expense is then recognised in the income statement.
Disposal of Revalued Assets
If a revalued asset is disposed of, any revaluation surplus (or deficit) related to that asset is moved to retained earnings.
This ensures that the impact of the revaluation on equity is appropriately reflected when the asset is no longer part of the company’s balance sheet.
Impact on Financial Statements
Revaluation reserves have a significant impact on a business’s financial statements.
The updated asset values give a more accurate representation of the business’s equity.
Revaluation reserves can also impact key financial ratios, such as return on assets (RoA) and return on equity (RoE), providing a more realistic measure of the financial performance of the business.