What is revaluation?
Revaluation is the revaluation of the value of a long-lived asset or foreign currency on the financial state. Revaluation is often used by businesses that operate in multiple currencies.
Key points to remember
- Revaluation is the process of restoring the value of an item or asset to provide a more accurate financial record of its value.
- Companies use revaluation to report assets that are valued in a different currency in their financial statements.
- Revaluation is also used in cases of impairment of long-lived assets, such as a fixed or intangible asset.
- COVID-19 has led to complications related to goodwill impairment testing and valuation for revaluation.
Revaluation is the process of restoring the value of an item or asset to provide a more accurate financial record of its value. Companies use revaluation when Translating the value of a foreigner’s income and assets subsidiary company which is denominated in another currency. Revaluation is also important because it can help companies reassess fixed assets (physical, long term assets) as well as intangible assets, such as Good will.
Types of revaluation
Revaluation due to foreign currency translation
Revaluation is common for companies doing business in another country, where the local currency may be different from that of the company. reporting currency. Any gain or loss is recognized in the company’s income statement.
Remeasurement can also be used when there is hyperinflation or large and frequent fluctuations in the exchange rate. Hyperinflation occurs when a country experiences rapid and excessive increases in the prices of goods. Revaluation, in this context, is also known as temporal methodwhich uses historical exchange rates based on the date of acquisition of the assets.
Foreign currency revaluation could come into play for a UK-based company doing business in the European Union. Although the company may retain certain bank accounts and other assets denominated in euros, they should be revalued to the functional currency for the parent company’s financial statements.
Remeasurement vs translation
Revaluation converts financial results into a company’s reporting currency, providing information about how future cash flows might change due to changes in exchange rates. The translation expresses the financial results of a separate entity, whose functional currency is different from that of the parent company. Revaluation results are presented in net income, while translation results are presented in equity.
Revaluation gains or losses are generally recorded in net income, while foreign currency translation is recorded in “other comprehensive income”. Accumulated other comprehensive income includes unrealized gains and losses from various sources that do not affect net income income statement directly. These gains and losses are instead reported separately, below retained earningsin the equity section of the balance sheet.
Revaluation due to impairment
Revaluation is used in a situation where the value of a long-lived physical asset, such as land, has declined significantly and cannot be recovered. A company holds the value of the land it owns on the balance sheet at historical cost—the price initially paid to acquire the land. Generally Accepted Accounting Principles (GAAP) require the use of historical cost when reporting the value of fixed assets, as the amount is easily verifiable and generally conservative, as the property tends to increase in value over time. Consequently, a capital gain cannot be revalued at a higher value on the balance sheet.
However, if the value of the land decreases significantly and permanently, re-measurement may be appropriate. Asset revaluation allows the company to more accurately record the value of impaired asset and may allow a deductible loss to be taken. In order to determine whether there is impairment, a company must determine whether the market value of an asset has fallen below its book value.
An impairment should only be recognized if future forecasts cash flow are irrecoverable. Therefore, in the event of a depreciation of land, a company should generally anticipate a sale in the near future in order to record a revaluation at the lower value. If its sale is not imminent, it is reasonable to expect that the value of the land will recover over time. When the carrying amount of an impaired asset is written down to its market value, the loss is recognized in the company’s income statement at the same accounting period.
Example of revaluation
As a result of the COVID-19 outbreak, the US economy has suffered major disruptions and some accounting issues have resulted. One of these questions arose around the identification and evaluation of impairment of goodwill. Goodwill is generally analyzed and tested for impairment on an annual basis. However, if a “trigger event” occurs, such as the drastic downturn in the economy following the COVID-19 outbreak, companies are advised to test their goodwill for impairment outside of the annual basis. An additional and immediate examination may be necessary in order to accurately reassess the value of the goodwill.
When testing goodwill for impairment, a company can choose between one of two methods. The income approach uses discounted future cash flows to identify the value of goodwill. The market approach uses fair market valuations to determine the value of goodwill based on similar transactions within the same sector or industry. Both of these remeasurement methods are made more difficult as a result of the COVID-19 pandemic.
The earnings-based approach to re-evaluating goodwill is complicated by the difficulties surrounding projecting future cash flows. With an uncertain future, as well as growing government involvement in helping businesses, it is more difficult for businesses to accurately project their cash flow. Additionally, there are more immediate issues affecting a company’s ability to project future cash flows due to business closures, reduced operations, uncertain employee sick leave and reduced productivity due to work-from-home agreements. The market approach is also confusing because a precise analysis of the market and comparable transaction selection is also problematic.
Correction–Nov. 27, 2021. This article has been updated to clarify the distinction between remeasurement and translation.
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