Revaluations and Impairment Testing of Non-Current Assets

Chapter 6
Revaluations and
impairment testing of
non-current assets
.
Copyright 2010 McGraw-Hill Australia Pty Ltd

PPTs to accompany Deegan, Australian Financial Accounting 6e
6-1
Objectives of this lecture

Understand how and when to revalue an item of
property, plant and equipment in accordance with
AASB 116
Understand how and when to revalue an
intangible asset in accordance with AASB 138
Understand the difference in accounting
treatments for upward revaluations to fair value,
as opposed to write-downs to recoverable
amount
Understand what an impairment loss is and
know how to account for one
.

6-2
Objectives (cont.)
Understand how to account for revaluations that
act to reverse previous revaluation increments
and decrements
Understand how to account for accumulated
depreciation when a non-current depreciable
asset is revalued
Understand that, subsequent to revaluation, new
depreciation charges will be based on the
revalued amount of the non-current asset
Know how the profit is determined on disposal of
a revalued non-current asset
.

6-3
Objectives (cont.)
Understand how asset revaluations can affect an
organisations profits owing to changes in
depreciation expenses and in final profits or
losses on the sale of the revalued asset
Be able to explain possible motivations driving
an organisation to elect to revalue, or not to
revalue, its non-current assets to fair value
Know the disclosure requirements pertaining to
asset revaluations

6-4
Relevant accounting standards

There are three standards of particular relevance
1. AASB 116 Property, Plant and Equipment
Requirements for revaluations, depreciation and
determining acquisition cost of property, plant and
equipment
2. AASB 138 Intangible Assets
Revaluation of intangible assets and other issues
3. AASB 136 Impairment of Assets
When to recognise an impairment loss

6-5
Introduction to revaluations
Historical cost has been criticised for bearing no
relation to current asset values
In Australia, entities may revalue many noncurrent assets
However, AASB 138 specifically excludes the
revaluation of some intangible assets
Asset revaluationswhat are they?

Recognising a reassessment of the carrying amount of
a non-current asset to fair value as at a particular
date
Excludes recoverable amount write-downs (i.e.
impairment losses)

6-6
Introduction to impairment losses

If a non-current assets carrying amount
exceeds its recoverable amount it must be
written down to its recoverable amount (AASB
136)
The write-down is called an impairment loss
(again, not to be confused with a revaluation)
Carrying amount: cost of asset (or revalued
amount) less accumulated depreciation and
impairment losses thereon
Recoverable amount: higher of an assets fair
value less costs to sell, and value in use
.

6-7
Introduction to impairment losses

(cont.)
Fair value, less costs to sell (or net selling
price): amount obtained from the sale of an asset
in an arms length transaction between
knowledgeable, willing parties less the costs of
disposal
Value in use: present value of the future cash
flows expected to be derived from an asset

6-8
Impairment losses
Impairment losses can be reversed in subsequent
periods (unless a particular accounting standard
prohibits itas is the case with intangible assets)
Worked Example 6.1 (p. 199) provides an example of a
reversal of an impairment loss
Impairment losses will at times be determined by
reference to a cash-generating unit rather than to a
specific asset.
AASB 136 defines a cash-generating unit as the
smallest identifiable group of assets that generates
cash inflows that are largely independent of the cash
inflows from other assets or groups of assets
See Worked Example 6.4 (p. 202)Accounting for an
impairment loss by reference to a cash-generating unit

6-9
Worked Example 6.4Accounting for an impairment

loss by reference to a cash-generating unit
Ulladulla Ltd has a printing process comprising four separate but highly
interdependent assets. The printing machinery has a combined carrying
value of $1 000 000, made up as follows:
Asset 1
$100 000
Asset 2
$200 000
Asset 3
$300 000
Asset 4
$400 000
$1 000 000
It was determined that the value in use of the cash-generating unit,
which is calculated at its present value, amounted to $800 000
The current fair value less costs to sell of the entire unit is $750 000
The total impairment loss will therefore be equal to $1 000 000 less the
greater of the value in use and fair value less costs to sell
This gives us a total impairment loss of $200 000. The impairment loss
would be apportioned across the four assets by using their respective
carrying values as the basis for the allocation. For example, the allocation
of the impairment loss to Asset 4 would be 400 000 divided by 1 000 000
multiplied by 200 000. This would equal $80 000

6-10
Worked Example 6.4Accounting for an impairment

loss by reference to a cash-generating unit (cont.)
Hence the accounting entry to record the impairment

loss on the cash-generating unit would be:
Dr
Cr
Cr
Cr
Cr
Impairment loss
200 000
Accum. impairment lossesAsset 1

20 000
40 000
60 000
80 000
6-11
Measuring property, plant and equipment at

cost or fair valuethe choice
AASB 116 requires each class of property, plant and
equipment to be measured at either cost or fair value
Examples of classes are land and buildings, machinery and
motor vehicles
Some classes might be measured at cost and others at

fair value
With a mix of measurement methods, is the total balance
of non-current assets meaningful?
Entities may switch from fair value to cost for justifiable
reasons and provided adequate disclosures are made
(AASB 116)

6-12
Measuring property, plant and equipment at

cost or fair value (cont.)
Where an entity changes from cost (that is, they have
been using the cost model) to fair value (that is, they
have decided to use the revaluation model) for a class of
non-current assets and there was a previous impairment
loss (AASB 116):
any increase in an assets carrying amount is first
recognised as income; and
any excess above the amount if no impairment loss
was recognised is transferred to a revaluation surplus
account (it should be noted that recently the AASB and
IASB have been using the terminology revaluation
surplus previously they had referred to a
revaluation reservebut they are just different names
for the same thing)

6-13
Measuring property, plant and

equipment at cost or fair value (cont.)
If a class of non-current assets is measured at cost,
AASB 136 is to be applied:
if an assets carrying amount is greater than its
recoverable amount, an impairment loss must be
recognised
this would not constitute a revaluation

6-14
The use of fair values

Any revaluation of non-current assets must be to
fair value (AASB 116)
Fair value is the amount for which an asset could
be exchanged between knowledgeable, willing
parties in an arms length transaction
Fair value is determined on the assumption that
the entity is a going concern
Market price is to be used where an active and
liquid market exists for the asset

6-15
The use of fair values (cont.)

The required disclosures regarding asset
revaluations (AASB 116) are:
effective date of revaluation

whether an independent valuer was involved
methods and assumptions applied
extent to which fair values were determined, with reference to
observable prices in active markets or recent market
transactions
for each revalued class, the carrying amount if the cost model
was used
the revaluation surplus, indicating the change for the period
and any restrictions on distribution of the balance to
shareholders

6-16
The use of fair values (cont.)

Revaluations must be made with sufficient
regularity so the carrying amount of each asset
in the class does not differ materially from its fair
value (AASB 116)
If values change regularly and changes are
material, revaluations might be necessary each
reporting period
Otherwise every three to five years is sufficient

6-17
Revaluation increments
General procedure (AASB 116)

Debit
Credit
Asset
Revaluation surplus
The revaluation surplus is part of shareholders

funds (owners equity)
Directors may approve cash distributions to
shareholders from the revaluation surplus but
they must exercise extreme caution
6-18
Treatment of balances of accumulated

depreciation upon revaluation
If a revalued asset is a depreciable asset, any balance of
accumulated depreciation is credited to the asset account prior
to revaluation (AASB 116)
Journal entry (net-amount method)
Dr
Cr
Accumulated depreciation
Asset
Dr
Asset
Cr
Revaluation surplus
Refer to Worked Example 6.5 (p. 205)Revaluation of a
depreciable asset using the net-amount method
Subsequent depreciation is to be based on the revalued
amount of the asset

6-19
Worked Example 6.5Revaluation of a depreciable

asset using the net-amount method
As at 1 July 2011, Farrelly Ltd has an item of machinery that
originally cost $40 000 and has accumulated depreciation of $15
000. Its remaining life is assessed to be five years, after which
time it will have no residual value. Farrelly decided on 1 July 2011
that the item should be revalued to its current fair value, which was
assessed as $45 000.
The total revaluation increment will represent the difference
between the carrying amount and the fair value. In this case it
would be:
$45 000 ($40 000 $15 000) = $20 000
The journal entries on 1 July 2011 would be:
Dr Accumulated depreciationmachinery 15 000
Cr Machinery
15 000
Dr
Machinery
20 000
Cr Revaluation surplus
20 000

6-20
IllustrationRevaluation increment
A building with a cost of $400 000 and accumulated
depreciation of $190 000 is revalued to its fair value of
$350 000
What are the journal entries?
Dr Accumulated depreciation
Cr Building
190 000
Dr Building
Cr Revaluation surplus
140 000

190 000
140 000
6-21
Treatment of balances of accumulated

depreciation upon revaluation (cont.)
Alternative method (AASB 116)
Accumulated depreciation may be restated
proportionately with the change in gross carrying
amount of the asset, so the carrying amount after
revaluation equals the revalued amount
This is referred to as the gross method
Journal entry
Debit Asset
Credit
Credit
Revaluation surplus
Refer to Worked Example 6.6 (p. 205)Revaluation of a
depreciable assetthe use of the gross method

6-22
Revaluation decrements
In line with the concept of conservatism, revaluation
decrements are recognised as an expense in the
statement of comprehensive income
Journal entry (AASB 116)
Dr
Cr
Dr
Cr
Asset
Loss on revaluation of asset
Asset
Refer to Worked Example 6.7 (p. 206)A revaluation

decrement

6-23
IllustrationRevaluation decrement
Refer to the previous example, except this time the fair
value of the building (acquired for $400 000 and having
accumulated depreciation of $190 000) is $150 000 rather
than $350 000
What are the journal entries?
Dr
Cr
Building
190 000
Dr
Cr
Loss on reval. of building

Building
60 000

190 000
60 000
6-24
Reversal of revaluation decrements and

increments
For an asset class, reversals of previous revaluations
should be recorded by the reverse of the initial revaluation
entries
If a revaluation decrement reverses a previous increment
for the same asset, then the entries are:
Dr
Cr
Asset
Dr
Dr
Cr
Revaluation surplus
Loss on revaluation (the excess, if any)
Asset

6-25
Example of a reversal of a previous revaluation

increment (Worked Example 6.8, p. 207)
PK Ltd acquires a block of land on 1 January 2010 for $200 000 in cash
Due to increased housing demand in the area, the land has a market
value of $290 000 on 1 January 2011
However, the market value falls to $140 000 on 30 June 2013
1 January 2010
Dr
Land
Cr
Cash
200 000
200 000
1 January 2011
Dr
Land
Cr
Revaluation surplus
90 000
30 June 2013
Dr
Revaluation surplus
Dr
Loss on revaluation of land
Cr
Land
90 000
60 000
90 000

150 000
6-26
Reversal of revaluation decrements and

increments (cont.)
If a revaluation increment reverses a previous
decrement for the same asset:
Dr Asset
Cr Gain on revaluation
Cr
Revaluation surplus (the excess if
any)

6-27
Example of a reversal of a previous

revaluation decrement
Land was acquired for $200 000 on 1 July 2009. On 30 June 2010 it has
a fair value of $150 000. On 30 June 2012, due to increased population,
the land is considered to have a fair value of $270 000
1 July 2009
Dr
Land
Cr
Cash
30 June 2010
Dr
Loss on revaluation of land
Cr
Land
200 000
200 000
50 000
30 June 2012
Dr
Land
120 000
Cr
Gain on revaluation of land 50 000
Cr
Revaluation surplus

50 000
70 000
6-28
Accounting for the gain or loss on

disposal of a revalued non-current asset
Gain or loss from derecognition of an item of
property, plant and equipment is to be calculated
as the difference between (AASB 116):
net disposal proceeds (if any), and
the assets carrying amount
Derecognition is:
the point in time when an asset is removed from the
statement of financial position (balance sheet)
when an asset is sold, or
when no future economic benefits are expected from
an assets use or disposal

6-29
Accounting for profit on disposal of a

revalued non-current asset
When an asset is sold, any resulting balance in
the revaluation surplus (AASB 116):
may be transferred directly to retained earnings
cannot be transferred to the profit or loss
If a non-current asset is revalued upwards, any

gain on sale will be less than the gain if the asset
had not previously been revalued
Refer to Worked Examples 6.9, 6.10 and 6.11on
pages 208211

6-30
Consideration of present values

Recoverable amount is the higher of an assets net
selling price and its value in use (AASB 136)
Value in use (AASB 136) is:
the present value of the future cash flows expected from an
asset
Estimating value in use (AASB 136) involves:

estimating future cash inflows and outflows from the
continued use and subsequent disposal of the asset; and
applying the appropriate discount rate to future cash flows
Discounting future cash flows will decrease the calculated

recoverable amount

6-31
Can we offset revaluation increments and

decrements within a class of assets?
Increments and decrements may be offset only
to the extent that they relate to a particular asset
(AASB 116)
- Therefore, if say one item of land increased in
fair value by $10 million and another item of land
decreased in fair value by $1 million (and
assuming no prior revaluations), then a loss of
$1 million would be recognised in profit or loss
for the period (and the $10 million would be
shown as part of other comprehensive income)
Do we think this is sensible?
.

6-32
Economic consequences of asset

revaluations
If contracts in place are tied to reported profits
(debt or management compensation),
management might have an incentive not to
revalue
However, if assets are increased a revaluation
might loosen constraints such as debt-to-assets
restrictions
Firms subject to political scrutiny might be more
likely to undertake upwards revaluation resulting
in a reduction in profits
As the perceived competence of independent
valuers increases, audit time might be reduced
.

6-33
Disclosure requirements
AASB 116 includes various disclosure
requirements relating to the revaluation of noncurrent assets
These were previously discussed under the
heading The use of fair values

6-34
Summary
This lecture considered the revaluation of noncurrent assets, with the emphasis on property,
plant and equipment
If the recoverable amount is below the carrying
amount, an impairment loss should be recorded
For upwards revaluations:
assets are to be revalued to fair value
any increase is to be transferred to a revaluation
surplus, unless it is a reversal
For downwards revaluations:

any decrease is to be treated as an expense, unless it
is a reversal

6-35
Summary (cont.)
When a revaluation is undertaken:
any existing accumulated depreciation should be
credited against the non-current asset (if the net
method is used which is the common approach), and
the non-current asset should be increased by the
amount of the revaluation
Where a revalued asset is sold, the gain or loss

is the difference between the carrying amount
and the net disposal proceeds of the asset
The lecture also discusses how revaluations can
loosen certain accounting-based debt covenants

6-36

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Chapter 6

Copyright 2010 McGraw-Hill Australia Pty Ltd

Objectives of this lecture

Copyright 2010 McGraw-Hill Australia Pty Ltd

Copyright 2010 McGraw-Hill Australia Pty Ltd

Copyright 2010 McGraw-Hill Australia Pty Ltd

Relevant accounting standards

Copyright 2010 McGraw-Hill Australia Pty Ltd

Asset revaluationswhat are they?

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to impairment losses

Copyright 2010 McGraw-Hill Australia Pty Ltd

Introduction to impairment losses

Copyright 2010 McGraw-Hill Australia Pty Ltd

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 6.4Accounting for an impairment

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 6.4Accounting for an impairment

Hence the accounting entry to record the impairment

Copyright 2010 McGraw-Hill Australia Pty Ltd

Measuring property, plant and equipment at

Some classes might be measured at cost and others at

Copyright 2010 McGraw-Hill Australia Pty Ltd

Measuring property, plant and equipment at

Copyright 2010 McGraw-Hill Australia Pty Ltd

Measuring property, plant and

Copyright 2010 McGraw-Hill Australia Pty Ltd

The use of fair values

Copyright 2010 McGraw-Hill Australia Pty Ltd

The use of fair values (cont.)

effective date of revaluation

Copyright 2010 McGraw-Hill Australia Pty Ltd

The use of fair values (cont.)

Copyright 2010 McGraw-Hill Australia Pty Ltd

General procedure (AASB 116)

The revaluation surplus is part of shareholders

Treatment of balances of accumulated

Copyright 2010 McGraw-Hill Australia Pty Ltd

Worked Example 6.5Revaluation of a depreciable

Copyright 2010 McGraw-Hill Australia Pty Ltd

Copyright 2010 McGraw-Hill Australia Pty Ltd

Treatment of balances of accumulated

Copyright 2010 McGraw-Hill Australia Pty Ltd

Refer to Worked Example 6.7 (p. 206)A revaluation

Copyright 2010 McGraw-Hill Australia Pty Ltd

Loss on reval. of building

Copyright 2010 McGraw-Hill Australia Pty Ltd

Reversal of revaluation decrements and

Copyright 2010 McGraw-Hill Australia Pty Ltd

Example of a reversal of a previous revaluation

Copyright 2010 McGraw-Hill Australia Pty Ltd

Reversal of revaluation decrements and

Copyright 2010 McGraw-Hill Australia Pty Ltd

Example of a reversal of a previous

Copyright 2010 McGraw-Hill Australia Pty Ltd

Accounting for the gain or loss on

Copyright 2010 McGraw-Hill Australia Pty Ltd

Accounting for profit on disposal of a