Since the arrival of FRS 102, there have been a number of questions as to the application of Section 17 (property, plant and equipment). Steve Collings clears up some of the confusion.
Property, plant and equipment are dealt with in Section 17 Property, Plant and Equipment in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. Section 17 allows a reporting entity to measure property, plant and equipment (PPE) under the cost model or the revaluation model, as was the case under previous UK GAAP.
Since the arrival of FRS 102, there have been a number of questions asked by practitioners as to the application of Section 17 as well as the impacts of applying the transitional exemption in paragraph 35.10(d) of FRS 102 Revaluation as deemed cost.
This article will hopefully clear up some of the confusion for preparers of financial statements under FRS 102. It must be noted at the outset that micro-entities applying FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime cannot use fair value or revaluation amounts, therefore no revaluation reserve should be presented in a micro-entity’s balance sheet.
The revaluation model
Where an entity applies the revaluation model, it will be applying the alternative accounting rules in the Companies Act 2006, hence additional disclosures will be necessary (see paragraph 17.32A of FRS 102). It should also be noted that deferred tax must also be considered where an item of property, plant and equipment is revalued due to the timing difference plus approach in Section 29 Income Tax (non-monetary assets subject to revaluation are now within the scope of deferred tax).
The revaluation model in Section 17 works in much the same way as the revaluation model in the previous FRS 15 Tangible fixed assets, although there are differences in respect of the timing of revaluations, which are covered later. The asset is revalued to fair value at the date of revaluation less any subsequent accumulated depreciation and subsequent impairment losses.
In practice, the most common type of fixed asset to be revalued is a property (although other types of fixed assets can also be revalued provided all assets in the same class are subject to revaluation at the same time). FRS 15 at paragraph 45 said that where properties are revalued, an up-to-date revaluation should be obtained at least every five years with an interim valuation in year three. Interim valuations should also be obtained in years one, two and four where there had been a material change in value.
FRS 102 is not as specific as previous FRS 15, and this is where professional judgment will need to be carefully exercised. Paragraph 17.15B of FRS 102 (September 2015) says that revaluations should be made with sufficient regularity to ensure that the carrying amount of the revalued fixed asset does not differ materially from that which would be determined using fair value at the balance sheet date. Paragraph 17.15B of FRS 102 was not subject to any amendments during the recent triennial review.
The frequency of the revaluation exercise will all depend upon fluctuations in the fair value of the asset. Some assets may experience significant and volatile movements in fair value, and therefore it may be the case that annual revaluations are necessary, whereas other types of assets may experience insignificant and less volatile movements in fair values which would mean the revaluation exercise is carried out less frequently.
FRS 102 is inherently simpler than previous FRS 15 because all revalued assets are measured at fair value, whereas previous FRS 15 required a variety of valuation bases for different kinds of properties. For example, non-specialised properties were based on existing use value. The existing use basis assumed that the property could only be used for the foreseeable future for its existing use, whereas the focus of FRS 102 is on fair value which does not reflect such an assumption as can be seen in the following example:
A building that was used as a ‘do-it-yourself’ retailer is going to be converted into apartments following a successful planning application.
Under FRS 15, the building would have been valued as a retail outlet, whereas under FRS 102 the valuation will reflect the alternative use. As a consequence, the valuation under FRS 102 may be higher than what would have been achieved under previous FRS 15 and hence a higher depreciation charge would be reflected in the financial statements.
When an item of property, plant and equipment is revalued, the revaluation gain or loss is taken directly to a revaluation reserve within the equity section of the balance sheet and is reported as other comprehensive income. Gains should only be recognised in profit and loss to the extent that they reverse a revaluation decrease of the same asset that was previously recognised in profit or loss.
Conversely, losses on revaluation should only be recognised in the revaluation reserve to the extent of a credit balance on the revaluation reserve. Any remaining loss is taken to the profit and loss account. Should the asset appreciate in value at the next revaluation, the gain is recognised in profit or loss to the extent of the loss recognised, with any further gain being recognised in the revaluation reserve.
This is notably different than under previous FRS 15. Under FRS 15, it was possible to recognise a fall in value below historical cost in the statement of recognised gains and losses (STRGL) and revaluation reserve in certain circumstances. Any fall in value below depreciated historic cost was recognised in the profit and loss account unless it could be demonstrated that the recoverable amount of the asset was greater than its revalued amount, in which case the loss was taken to the STRGL to the extent that the recoverable amount of the asset was greater than its revalued amount.
On 1 January 2017, a company acquired some land for £75,000 and at the year-end 31 December 2017 the land was revalued to £60,000. On 31 December 2018, the land had increased in value to £85,000.
The revaluation loss on 31 December 2017 is £15,000 and this is recognised in the profit and loss account.
The land appreciates in value as at 31 December 2018 to £85,000 which is a £25,000 increase in its carrying value. The revaluation gain is accounted for as follows:
There has been some confusion concerning the accounting treatment for revaluations under Section 17 due, in large part, to the revised accounting treatment for investment properties accounted for under Section 16 Investment Property of FRS 102.
Under Section 16, fair value gains and losses in respect of investment property are taken directly to profit or loss; they are not taken to a revaluation reserve because the fair value accounting rules are being applied in respect of investment property.
Under Section 17, the alternative accounting rules are being applied, which require gains and losses to be taken to the revaluation reserve (losses to the extent of a credit balance on the revaluation reserve).
It is important to understand the correct accounting treatments for investment property accounted for under Section 16 and revalued property, plant and equipment accounted for under Section 17.
Revaluations and depreciation
FRS 102 is silent on how accumulated depreciation on an asset that has been revalued should be treated. Paragraph 35 of IAS 16 Property, Plant and Equipment allows a choice of one of two treatments:
Method 1: adjust the gross carrying amount in a manner which is consistent with the revaluation of the carrying amount of the asset. The accumulated depreciation at the date of the revaluation is adjusted so that it is equal to the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses; or
Method 2: the accumulated depreciation is eliminated against the gross carrying amount of the asset.
|A property has a carrying value of £188,000 made up of cost of £200,000 and accumulated depreciation of £12,000. The property is revalued to fair value of £225,600.|
|Method 1||Method 2|
|Prior to revaluation||200,000||200,000|
|Prior to revaluation||12,000||12,000|
|*Property fair value increased by 20% (£225,600 - £188,000/£188,000 x 100) hence uplift of 20% on cost and 20% on depreciation.|
Transfer between revaluation reserve and retained earnings
The accounting regulations say that an amount may be transferred from the revaluation reserve to retained earnings (profit and loss reserves) if the amount was previously charged to that account or represents realised profit. There is no specific requirement to make this transfer but if it is not done, the balance on retained earnings will understate the profits which are available for distribution.
There are two types of transfer which can be undertaken:
- Each year, a transfer from the revaluation reserve to the profit and loss reserves equivalent to the excess depreciation that has been charged in respect of the revalued asset (ie the depreciation charged under the revaluation model less the depreciation that would have been charged under the cost model).
- When the entity disposes of the asset, the balance remaining on the revaluation reserve is transferred to the profit and loss reserves.
A company has an item of property, plant or equipment which is carried under the revaluation model. The annual depreciation under the revaluation model is £20,000 but under the cost model would have been £15,000.
The difference of £5,000 should be transferred from the revaluation reserve to the profit and loss reserves each year so the value of the revaluation reserve, which becomes realised by the depreciation charge, is correctly reflected in the equity section of the entity’s balance sheet. Only the depreciation charge calculated under the historical cost accounting rules should impact on the balance of profit and loss reserves available for distribution.
Previous revaluations as deemed cost
As companies complete their transition to FRS 102, this issue will largely fade away this year but there are some important considerations that should be borne in mind when a company applies paragraph 35.10(d) Revaluation as deemed cost on transition to FRS 102.
Under previous FRS 15, a company could measure its tangible fixed assets using the revaluation model. This would have represented a change in accounting policy from the historic cost model. A company changes an accounting policy voluntarily when the revised policy results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the financial position, financial performance or cash flows.
It was virtually impossible to revert back to the historic cost model when an entity revalued an asset because the entity would not be able to justify how a switch back to historic cost provides reliable and more relevant information than the revaluation model. Therefore, once a company was on the revaluation model, it was essentially stuck with it.
This transitional exemption may be particularly useful where a company has previously revalued an asset, but no longer wishes to obtain periodic revaluations. Where this transitional exemption is applied, the valuation used must be at, or before, the date of transition but not after.
For example, a small company with a 31 December 2016 year-end is mandatorily required to transition to FRS 102 and its date of transition will be 1 January 2015. A valuation carried out on 31 December 2015 cannot be used as deemed cost as it would be inappropriate to apply this valuation to a balance sheet which is made up a year earlier.
A company applying paragraph 35.10(d) and using a previous GAAP revaluation as deemed cost will be applying the alternative accounting rules in the Companies Act 2006. Notwithstanding the fact that the company is using a revaluation as deemed ‘cost’, the company is still using a revalued amount because the asset(s) concerned is not stated at its purchase price or production cost.
As a consequence, the reporting entity must present a revaluation reserve within the equity section of its balance sheet and make the disclosures required by paragraph 34(3) of Schedule 1 to the accounting regulations. Paragraph 34(3) of Schedule 1 to the accounting regulations was amended by SI 2015/980 and says:
‘In the case of each balance sheet item affected, the comparable amounts determined according to the historical cost accounting rules must be shown in a note to the accounts.’
This means that the entity must disclose the historical cost equivalent amounts (cost and depreciation) that would have been reported had the revalued asset(s) not been revalued.
Paragraph 34(4) states that ‘comparable amounts’ relate to:
- the aggregate amount that would have been shown in respect of the revalued asset if the asset’s carrying value had been determined by the historical cost accounting rules; and
- the aggregate amount of accumulated depreciation or diminution in value which would be permitted or required in determining the amounts under the historical cost accounting rules.
In addition, deferred tax should also be brought into account on the revaluation surplus regardless of the fact that the asset is stated at a ‘deemed cost’.
The term ‘deemed cost’ is defined in the Glossary to FRS 102 as:
‘An amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortisation assumes that the entity had initially recognised the asset or liability at the given date and that its cost was equal to the deemed cost.’
If an entity chooses to apply a previous UK GAAP revaluation as deemed cost as a transitional exemption, but then subsequently revalues the asset in a subsequent accounting period, it will need to continue using the revaluation model and obtain revaluations with sufficient regularity to ensure the carrying amount of the asset is not materially different than its fair value. It cannot just revalue and then go back to the historic cost model for the same reasons why an entity could not revert back to the cost model under previous UK GAAP.
There has been an element of confusion where property, plant and equipment and revaluations are concerned (particularly where the use of a previous revaluation as deemed cost has been applied). For micro-entities reporting under FRS 105, please keep in mind that previous revaluations must not be used as revaluation and fair value amounts are prohibited; such assets must be restated to their values under the historical cost accounting rules on transition and going forward to comply with the micro-entities’ legislation.
For more on FRS 105 and choices faced by practitioners click here to download the FRS 105 handbook for accountants and their clients.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.