Revaluation Model of PPE under Indian Accounting Standard 16 “Property, Plant and Equipment”
Roadmap for Implementation of Ind AS in India
Indian Accounting Standards (Ind ASs) were introduced in India with effect from 01st April 2016 on a mandatory basis to converge with high quality Global Financial Reporting Standards, i.e. IFRS Standards. These Ind ASs have been implemented by the class of companies as per the roadmap issued by the Ministry of Corporate Affairs (MCA). MCA has issued the Companies (Indian Accounting Standards) Rules, 2015 vide Notification dated February 16, 2015 including the roadmap of implementation of Ind ASs for companies other than Banking companies, Insurance companies and Non-banking financial corporations (NBFCs).
As per the said Notification, Ind ASs converged with IFRS may be implemented on voluntary basis from 1st April, 2015 and shall mandatorily be applicable from 1st April, 2016. Further, the MCA on March 30, 2016, had also notified the Roadmap for implementation of Ind ASs for Scheduled Commercial banks, Insurance companies and NBFCs from 1st April, 2018 onwards. NBFCs had started phase-wise implementation of Ind AS beginning, April 1, 2018 but banks and Insurance companies are yet to implement Ind AS.
Introduction: Cost Model vs. Revaluation Model
An entity has an option to either choose ‘revaluation model’ or the ‘cost model’ as its accounting policy in terms of Ind AS 16. If an entity chooses to adopt the revaluation model, an item of property, plant and equipment 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.
Ind AS 113 “Fair Value Measurement” shall be used for arriving at the fair value of PPE. Fair value as defined in Paragraph 9 of Ind AS 113 is:
“The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
The frequency of revaluation would largely depend on the changes in fair value of items of PPE being revalued. Paragraph 31 of Ind AS 16 states:
“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.”
| Cost Model | Revaluation Model |
|---|---|
| Cost: XXXXX | Fair Value on Revaluation: XXXXX |
| Less : Depreciation: XXXXX | Less : Depreciation: XXXXX |
| Less : Impairment: XXXXX | Less : Impairment: XXXXX |
| Carrying Amount: XXXXX | Carrying Amount: XXXXX |
Revaluation of Entire Class of PPE (Paragraphs 29, 36 & 37)
As mentioned earlier, in terms of Paragraph 29, 36 and 37 of Ind AS 16, when an item of PPE is revalued, the entire class of PPE to which that asset belongs needs to be revalued. This is done 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.
Some examples of separate classes are as follows:
The aforementioned is a broad illustration of the classes of assets and it is possible that there may be other classes of assets as well based on their similar nature and use. It is a matter of judgement in the context of the specific operations of an individual entity. However, the entity needs to provide the disclosures as required by paragraph 73 of Ind AS 16 for each class of property, plant and equipment.
Accounting Treatment of Revaluation (Ind AS 16, Paras 39 & 40)
Upward Revaluation (Paragraph 39):
In terms of paragraph 39 of Ind AS 16, if an asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income (OCI) and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss.
Downward Revaluation (Paragraph 40):
In terms of paragraph 40 of Ind AS 16, if an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income (OCI) to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus.
First Time Revaluation Matrix
| Movement | Accounting Recognition |
|---|---|
| ⬆️ Revaluation Profit | Revaluation Profit to be recognised in Other Comprehensive Income (OCI) |
| ⬇️ Revaluation Loss | Revaluation Loss to be recognised in the Statement of Profit or Loss |
Subsequent Revaluation Matrix
| Initial Position | Current Year Position | Accounting Treatment |
|---|---|---|
| Initially there was revaluation profit (⬆️) | Current year also there is a revaluation Profit (⬆️) | Revaluation Profit to be recognised in OCI |
| Initially there was revaluation profit (⬆️) | Current year there is a revaluation Loss (⬇️) | First the earlier profit recognised in OCI shall be reversed, and then excess if any shall be charged to Profit and Loss |
| Initially there was revaluation loss (⬇️) | Current year also there is a revaluation Loss (⬇️) | Revaluation Loss shall be charged to Profit & Loss |
| Initially there was revaluation loss (⬇️) | Current year there is a revaluation profit (⬆️) | First the earlier loss recognised in P&L shall be reversed, and then excess if any shall be accounted for through OCI |
Methods of Revaluation: Restatement vs. Elimination (Paragraph 35)
In terms of paragraph 35 of Ind AS 16, when an item of property, plant and equipment is revalued, the carrying amount of that asset is adjusted to the revalued amount. At the date of the revaluation, the asset is treated in one of the following two ways:
Option (a): Proportionate Restatement
The gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. For example, the gross carrying amount may be restated by reference to observable market data or it may be restated proportionately to the change in the carrying amount. The accumulated depreciation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses.
Option (b): Elimination of Accumulated Depreciation
The accumulated depreciation is eliminated against the gross carrying amount of the asset. The net carrying amount is then restated to the revalued amount (fair value) of the asset.
Practical Comprehensive Example: SA Private Limited
Let us understand the concept and accounting of revaluation model of PPE through the following example:
Case Profile: SA Private Limited decided to revalue its plant and machinery at 31st March 2020. The useful life of machinery is 10 years and the company uses straight line method (SLM) of depreciation. The revaluation was performed at the end of 4 years.
| Particulars | Amount in ‘000 (₹) |
|---|---|
| Gross Carrying Amount | 5,000 |
| Accumulated Depreciation (SLM) [4 years @ 10% p.a.] | 2,000 |
| Net Carrying Amount (Carrying Amount before Revaluation) | 3,000 |
| Fair Value (Determined as on 31.03.2020) | 4,500 |
Treatment Under Option (a): Adjusting the Gross Value (Proportionate Restatement)
If the company opts for the treatment as per option (a) above i.e. adjusting the gross value, the calculation of the revised carrying amount of the machinery is:
| Particulars | Computation Formula | Amount in ‘000 (₹) |
|---|---|---|
| Revised Gross Carrying Amount | (Gross Carrying Amount / Net Carrying Amount) * Fair Value = 5,000 / 3,000 * 4,500 | 7,500 |
| Accumulated Depreciation | Revised Gross Amount – Fair Value = 7,500 – 4,500 | 3,000 |
| Net Carrying Amount (Revalued Amount) | Revised Gross Carrying Amount – Accumulated Depreciation | 4,500 |
Journal Entries in the year of revaluation (FY 2019-20) under Option (a):
To Accumulated Depreciation a/c Cr ₹ 10,00,000
To Revaluation Reserve a/c Cr ₹ 15,00,000
(Being plant and machinery gross block and accumulated depreciation restated proportionately to reflect fair value of ₹ 45,00,000, surplus credited to revaluation reserve)
Treatment Under Option (b): Eliminating Accumulated Depreciation
If the company opts for the treatment as per option (b) above i.e. eliminating accumulated depreciation against the gross carrying amount, the revised carrying amount of the machinery is recorded through the following journal entries:
Journal Entries in the year of revaluation (FY 2019-20) under Option (b):
To Fixed Assets (Gross Block) a/c Cr ₹ 20,00,000
(Being accumulated depreciation eliminated against the gross carrying amount)
2. Fixed Assets (Gross Block) a/c Dr ₹ 15,00,000
To Revaluation Reserve a/c Cr ₹ 15,00,000
(Being the net carrying amount restated to fair value of ₹ 45,00,000 by crediting revaluation reserve)
Depreciation after Revaluation & Transfer of Revaluation Surplus
Subsequent Years’ Depreciation Charge:
In subsequent years, depreciation charged to the Statement of Profit & Loss over the remaining useful life of 6 years shall be:
Transfer of Revaluation Surplus to Retained Earnings (Paragraph 41):
In terms of paragraph 41 of Ind AS 16, the amount of surplus transferred is the difference between depreciation based on the revalued carrying amount and depreciation based on the asset’s original cost. Hence, for each of the remaining 6 years under usual circumstances:
Annual Surplus Transfer = (₹ 15,00,000* / 6) = ₹ 2,50,000 per annum
*₹ 15,00,000 being the difference between Fair Value (₹ 45,00,000) and Net Carrying Amount (₹ 30,00,000).
₹ 2,50,000 shall be transferred from revaluation reserve to retained earnings in order to avoid the revaluation reserve being maintained indefinitely even after the asset ceases to exist. However, this transfer is not mandatory. The company may choose to make the entire transfer at the end of the useful life or when the asset is sold.
Depreciation Rules & Derecognition / Sale of Revalued PPE:
- Depreciation on Revalued Amount: On revaluation of assets, depreciation has to be charged on the revalued amount as per Ind AS 16. Additional depreciation arising due to revaluation shall not be retrieved from the revaluation reserve.
- Gain or Loss on Disposal: On sale of revalued PPE, profit or loss on sale is calculated as the difference between net sale consideration and the revalued carrying amount.
- No Recycling to P&L: On sale of PPE, the revaluation surplus originally recognised in OCI cannot be transferred / recycled to Profit & Loss. It may only be transferred directly to retained earnings.
Statutory Disclosure Requirements (Ind AS 16, Paragraph 77 & Ind AS 113)
In terms of paragraph 77 of Ind AS 16, following are the mandatory disclosure requirements in Financial Statements in addition to the disclosures required by Ind AS 113 “Fair Value Measurement”:
- Effective Date: The effective date of the revaluation;
- Involvement of Independent Valuer: Whether an independent valuer was involved;
- Historical Cost Benchmark: For each revalued class of property, plant and equipment, the carrying amount that would have been recognised had the assets been carried under the cost model; and
- Revaluation Surplus Movements & Restrictions: The revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders.