In general, value of assets decrease over time but it may increase in certain circumstances especially in inflationary economies. Accounting standards allows two models for accounting of fixed assets.
Cost model (as discussed above)
Under revaluation model, management can revalue its assets to their current market value. If there is an increase in value of asset, the difference between asset’s market value and current book value is recorded as revaluation surplus.
A company purchased an asset two year ago at the cost of $ 100,000. Depreciation rate was 20% at straight line method so now accumulated depreciation for 2 years would be $ 40,000 and carrying value of asset is $ 60,000. Assume that company revalues its assets and finds that asset is worth $ 85,000. Under the revaluation model management needs to record a surplus of $ 25,000.
Carrying value of asset at the end of year 2 would be as follows:
Depreciation expense during next year (year 3) would be based on the new carrying value i.e. 85,000 and remaining useful life of 3 years. Depreciation for 3rd year would be = 85,000/ 3 = 28,333.
Alternatively, while recoding the entry for depreciation, incremental depreciation due to the revaluation (i.e. $ 8,333) can be charged to the revaluation surplus account.
Carrying value of asset at the end of year 3 would be as follows:
Now let’s assume that at the start of year 4, company identifies that value of asset has decreased to $ 40,000. In that case there is a revaluation loss of $ 16,667 (i.e. $ 56,667 – $ 40,000) and company needs to pass adjusting entry as follows:
Carrying value of asset after the above adjustment would be:
It is to be noted that in case of decrease in value, maximum amount that can be charged to the revaluation surplus account is limited to the remaining balance in surplus account. If the decrease in asset’s value in more than the balance of surplus account, the additional amount is booked as impairment loss.