In our previous article, we reviewed the basics of PPE: how we define PPE, what is included in the costs of PPE, how we eventually convert PPE into an expense and how we present PPE in our financial statements.
In this article, we review subsequent measurement of PPE, revaluation, along with what we do with gains and losses upon disposal.
Recognizing PPE (ASPE vs IFRS)
ASPE and IFRS are similar in many aspects of recognition, but differ, most notably, in how PPE can be subsequently recognized. IFRS presents the concept of “revaluation”. The revaluation model allows entities to appraise their PPE at regular intervals and present the new PPE values based on appraisals. For example, if an entity owns office buildings and property prices increase significantly, the value of their office buildings assets will increase. Using the revaluation model will allow these entities to present the estimated present-day value of their properties on their Statement of Financial Position.
Revaluations are tricky because we need to keep track of gains and losses as a result of revaluations. We review this in more detail, and with concrete examples, below.
Subsequent Measurement and Recognition:
Gains and Losses:
Revaluation: IFRS only
Items should be revalued using Fair Market Value (this is usually done by an external appraiser). However, if there is no Fair Value for the item (for example, because it is specialized), the item should be valued using either the income or replacement cost approach.
Fair Market Value: A certified/professional appraisal is done providing the market value of the property. The market value is what an arm’s length buyer would be willing to pay for the PPE if bought at the time of the appraisal.
Income Approach: This approach should only be used if there is not possible to determine the Fair Market Value. The income approach uses the present value of future economic benefits/ future cash flows that are expected from the use of the asset.
Replacement Cost Approach: This approach should only be used if there is not possible to determine the Fair Market Value. The replacement cost approach simply uses the cost if the item were to be purchased/replaced today.
As promised earlier, let’s now go through a detailed example of how we would recognize a Building revaluation, using the Fair Market Value approach.
Purchase Price for Building @ end of year: $100,000
Closing Costs: $10,000
New Windows: $10,000
Total Building Cost $120,000
Excerpt from Statement of Financial Position, End of Year 1:
Revaluation of Building by appraisal at year end shows the building is now worth $150,000, with a gain of $30,000. Let’s assume the building is being depreciated by $20,000/year.
Excerpt from Statement of Financial Position, End of Year 2:
Excerpt from Income Statement:
Revaluation of Building by appraisal at year end shows the building is now worth $110,000, with a loss of $40,000 since year 2.
First, we must reverse our Year 2 revaluation gain in Other Comprehensive Income, by $30,000. Then, we must include a loss of $10,000 in our Income/ Loss Section. This will total the full $40,000 loss.
Excerpt from Statement of Financial Position, End of Year 3:
Excerpt from Income Statement:
Depreciation combined with Revaluation
When assets are revalued (up or down), depreciation is calculated based on the new value, revalued amount.
Revaluation at the beginning of year: Use the newly revalued asset amount as a basis for the depreciation schedule until the next revaluation.
Revaluation at the end of the year: First, we must deduct the depreciation for the year based on the initial cost prior to revaluation, then recognize the revaluation amount.
Revaluation during the year: This uses a hybrid approach. Depreciate based on before-revaluation cost prior to revaluation, and then depreciate based on new amount for the remainder of the year.
As shown in the example above, when we revalue, if the asset increases in value, we should first empty out the Accumulated Depreciation account.
Transfers from Revaluation Surplus to Retained Earnings: Often companies will transfer the difference in depreciation from the Revaluation Surplus into their Retained Earnings at end of year.
Note that Revaluation Surplus is also depreciated, so I need to use the depreciated amounts. When I do a revaluation, I need to consider the unamortized balance on the statement of Other Comprehensive Income.
Gains and Losses on Disposal
Gains and Losses on disposal are shown on the Income Statement. Losses are shown in the Expense section, Gains are shown in the Revenue section.
If Net Book Value of the asset < Selling Price, we record a Gain
If Net Book Value of the asset > Selling Price, we record a Loss
Example Journal entries for Disposal of PPE:
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