in one of our earlier videos we
introduced the notions of fair value accounting and accounting at cost I’m
sure you know the difference if there are any doubts please feel free to
rewind the videos and clear your doubts to keep things simple we did not mention
one important detail and I kind of feel bad about that so I’m going to share it
here US GAAP does not allow fair value accounting there have been considerable
talks about the need of convergence between IFRS and US GAAP however there
are still notable differences and this is one of them so the US GAAP does not
allow fair value accounting but the IFRS does companies can choose to opt for
fair value accounting for their fixed assets when there is a clear market for
these assets and a valuation exercise can be carried out if companies choose
to use fair value accounting they have to apply the revaluation model which
consists in appraising the asset periodically most often on an annual
basis very similarly to what we said for impairment tests a specialized appraiser
will value the asset and will determine its current market value of course we
can have two possible situations option number one the asset is more expensive
than its current carrying amount the amount at which it is registered on the
balance sheet in this case we will adjust the assets value on the balance
sheet but we will not report a game in the firm’s P&L the gain will be
registered directly in equity which is the account tied to net income the
rationale behind this is that we don’t want to inflate the firm’s
earnings through an asset that’s not even sold yet okay instead we’ll account
we have higher ownership claims given that the asset has appreciated in value
and we will have option number two when the appraiser values the asset at an
amount which is lower than its carrying value in this case we will have to
report a loss in the income statement and decrease the balance sheet value of
the asset later on if the value of the asset continues to decrease we will have
to follow the same procedure if however it starts to increase we will be able to
reverse the P&L loss and we’ll be able to report an income in the P&L for the
amount we’ve already reported has a loss earlier we can only report as income up
until the amount for which we have reported a loss previously afterwards
potential gains will go directly in equity without reporting a gain in the
income statement this is how the revaluation principle functions okay
let’s consider a practical example to make things clearer company X owns a
real estate building for simplicity we’ll assume a zero depreciation rate
the building’s carrying amount on company X’s balance sheet is 15 million
dollars however in 2017 the building is valued at 17 million dollars okay what
happens the company will update the fair value of 17 million dollars on its
balance sheet right will it recognize a profit of 2 million dollars it won’t it
will directly report an increase of 2 million dollars in other comprehensive
income in equity okay perfect let’s assume that the next year 2018 the
market for real estate goes down and the revaluation test indicates the building
is worth 13 million dollars what happens we have to record the new value of the
building on our balance sheet right it becomes 13 million dollars and in
addition to that we’ll report a loss of 4 million dollars in the P&L so the
company’s net income for 2018 will be four million dollars lower okay and
finally let’s say that in 2019 the real-estate market recovers slightly and
the building is valued at fourteen million dollars what happens then
remember that we said that the revaluation method allows us to reverse
previous losses and recognize them as profit in the P&L okay
the one million dollars of revaluation surplus will be recognized as profit in
the P&L for 2019 and the value of the building becomes fourteen million
dollars on our balance sheet I hope this example helped you understand how the
revaluation model functions this will do for now thanks for watching