Revaluation Method and Cost Method - Essay Example

? Presentation s Answer a). Revaluation method and cost method are applied to record the value of assets at the end of accounting period. In revaluation method the assets are valued at the end of each period and the difference between the old value and the new value is considered to be the actual depreciation to be charged against the profit and loss account. In cost method the asset is valued at the end of the period by deducting a percentage of depreciation as accumulated depreciation and the impairment loss if any from the old value. Following the IFRS a company can make a choice in selection of any one of the methods, but both the methods have their impact on the financial statements. In the cost method, depreciation is charged in the income statement against income as an expense, and the value of the asset after deducting depreciation is carried to the balance sheet. In the revaluation method, any increase in future value of the asset, is recorded in the balance sheet and is recognized directly in equity under the head revaluation surplus. If the future value of an asset decreases then the decrease is recorded in the income statement as an expense item. Accounting for the revaluation method is beneficial if the future value of the assets increase since the inclusion of revaluation surplus will increase revaluation reserve, which will increase the value of equity of a company. But if the future value is on the verge of decrease it is better to consider the cost method instead of the revaluation method for the purpose valuation of assets on a long-term basis. The reason to this can be explained with the help of a small example given below- Question: A building was purchased by a company on 1st January 2009 at a cost of $100million. The company estimates the life-time of the asset to be 50years, and thus the asset is to be depreciated over 50years. The company decides to use the revaluation for determining the value of the buildings at the end of 2015. The value of the building at the end of 31st December 2015 was $80 million, as determined by an efficient valuer. Answer: Using the revaluation method as opted by the company- Value of the building on 1st January 2009= $100million Value of the building on 31st December 2015= $80million Therefore, Accumulated Depreciation= $20million ($100million-$80million). Thus the value at which the asset is to be carried in the balance sheet on 31st December 2015 is $80million. If the company had opted for the cost method of depreciation, then- Value of the building on 1st January 2009= $100million Life of the asset= 50years Therefore, Accumulated depreciation at the end of 6years on 31st December 2015= $100million/50years * 6Years = $12million. Thus the value at which the asset is to be carried in the balance sheet on 31st December 2015 is $88million. Thus, from the above example it can be concluded that due to the use of revaluation method, a revaluation loss of $8million was suffered which is adjusted against the existing revaluation reserve of the company. It also led to the increase in the value of depreciation and decreased the value of the asset in the balance sheet. Increase in depreciation will affect the income adversely, as it will lead to a decrease of net income by $8million which will have a consequent effect on the balance sheet and will also impact the shareholders. Considering the above illustration, it is advisable to use the cost method to record the value of land and building of Rabbit Limited. Though revaluation method is considered to provide a more accurate record in terms of part replacement and depreciation, yet it is criticized on the grounds that the amount of depreciation charged on a particular asset differs year to year though the asset provides the same benefits, which make the accounting system complex and time consuming, and sometimes it is said to have chances of manipulation. So as stated by the director of Rabbit ltd. that the prices of the value of real estate are on the verge of decreasing, so it will be better to use the cost method since it being simple will also help to reduce the impact of the decrease in the fair value of the assets on the financial statements and profit or loss of the company. As per the requirements of Australian Accounting Standards and the principles of IFRS, changes in accounting policies can only be made if changes results in financial statements that would provide a more reliable and relevant accounting information about the financial position of the business and the effect of transactions on the financial performance of the business. Thus the company, Rabbit Ltd, can consider the change in its accounting method since the change would provide better information about the financial performance of the business, and will improve the position of the financial statements by reducing the problems associated with the revaluation method. Answer b). In the financial year ending 30th June 2016, the company bought a piece of land for $1,000,000, i.e. the cost of the land to the company at the time of purchase is $1,000,000. According to the principles of International Accounting Standard 16 (IAS 16), an asset is recorded in the accounts at the initial stage or at the time of purchase at the cost of purchase of the asset, including the construction cost and other cost required to bring the assets into the position of operations. Therefore, since the purchase cost of the land to Rabbit Ltd. is $1,000,000 and the company has incurred no other cost on the land at the initial stages, so in the accounts the value of the land is to be recorded at the purchase price. Thus, the transaction was correctly recorded. The market value of the land will affect the value recorded in the accounts when the value of land will be revalued at any point of time. The effect will be determined by the method used by the company to record the value of land at the time of valuation. If the company decides to use the cost method of accounting, then market value of the land will not affect the recorded value of land. The value of the land in this method will be determined by reducing the amount of depreciation calculated over the life from the purchase value of the land. But if the company decides to follow the depreciation method, the market value of the land will be considered to determine the value of the land on the date of revaluation. Works Cited Duff & Phelps. 2010. PP&E Impacts of First Time Adoption of IFRS in Canada. Pdf. August 14, 2013. . Deloitte. 2009. International Financial Reporting Standards: Property, Plant and Equipment Accounting Considerations for Power & Utility Companies. Pdf. August 14, 2013. . Read More