Why do companies re-value non-current assets? And its impact of an upward revalutaion.

[George Philip]

Hi all, I was goin through the practice questions in Chapter 11 and was unsatisfied by the answer given for Q11.5

Q.11.5
State why a company may revalue its non-current assets and describe the impact of an upwards
revaluation on the company’s financial statements.

The answer that was provided only talks about the changes that are reflected in the statement of financial position and the statement of comprehensive income. But the second part of the question, specifically the impact of upward revaluation is not provide. Could some share what that impact would be for the company and the directors?
Thanks in advance.

 

[Lynn Birchall]

Hi George

I think you might be using an older version of the materials? The 2022 version of that question is worded as : 'Describe the impact of an upwards revaluation on a company's financial statements'. The answer talks about the changes in the statement of financial poistion and the statement of comprehensive income as you say and there is no second part to the question.

In general though, if an upwards revaluation results in a more realistic assessment of the company's assets appearing in the financial statements, this may be seen as increasing the usefulness of this information to the users of the statements, eg shareholders and lenders. In particular, the company may look to be in a stronger position and more able to loan finance.

Hope this helps
Lynn

 

[George Philip]

Thanks Lynn for your reply.

The thing I would like to point out is that in the 2021 September Q 20. part (iii) , the examiners report has given a different answer to how a revaluation would impact a company. It mainly talked about the downside.
The answer is stated as below:
"The revaluation will increase the book value of the buildings, which will increase the amount that has to be written off over their useful lives .
The annual depreciation charge is likely to increase, thereby reducing profit.
The only way to avoid that would be to review the estimated useful lives of the buildings with a view to extending the life and so offsetting some of the increase in depreciation by dividing a larger book value by a larger life.
The performance will also be impacted by the fact that the revaluation will increase the revaluation reserve balance.
That means that capital employed is larger and so return on capital employed will be reduced.
Thus, the profit figure is likely to be smaller in absolute terms and will almost certainly be smaller in relation to the resources that have been invested."

In the answer above, the revaluation is seen as hassle to the company as it will now face larger depreciation costs.

In the event that this question comes up again, do we provide both upside and downside to revaluation of assets?

 

[Lynn Birchall]

Hi George

Good question! Exactly what's needed in the answer would depend on the detail of how a particular question was phrased ...

... but in general if we're describing the impact of revaluation on financial statements, my main advice would be to systematically mention each affected item from the statements (and how it is affected) in turn.

I'd say that the Sept 2021 question and the question in Chapter 11 differ slightly in that the Sept 2021 question is about the impact on 'reported performance', and so the examiners' answer is more focussed in the impact on profits and return on capital employed, and the Chapter 11 question is about the impact on the 'financial statements' and so includes more about the statement of financial position.

(For anyone tryring to find the exam question referred to here, it's September 2021 Q19(iii).)

If a question was worded along the lines 'Discuss the impact to a company of a revaluation of a property ...' then I think we would be looking to provide both the upside and the downside impacts.

Lynn