An accounting-related term used when a business makes a line item in its balance sheet for the maintenance of a reserve account tied to a particular asset.
How Revaluation Reserve Works
In most cases, the use of revaluation reserves happens when there's a large fluctuation in an asset’s market or when the market is volatile as a result of shifts in currency. Businesses use the revaluation reserve line on a balance sheet to determine the value of fluctuation in long-term assets. Depending on the revaluation's change, an offsetting expense can be either credited or debited to the reserve.
Companies can put line items on the balance sheet for reserves whenever they need to, to make their accounting practices clearer. And they can use reserves for various reasons, like the revaluation of assets. like most of the other line items for reserve, the total balance sheet value is either decreased or increased by the amount of the revaluation reserve.
In common cases, companies don’t use revaluation reserves. But they can do it when they believe there will value fluctuation of certain assets beyond the established schedules. To identify the assets’ carrying value on the balance sheet, there's a standard procedure that includes marking the assets down over time on a planned timetable.
Example of Revaluation Reserve
Flexx Inc., a sportswear company, does a revalue for its fixed assets. During the process, it's clear that their building's new carrying value is $5,000 instead of $3,500. It means that the revaluation surplus is $1,500. As a result, the Flexx Inc. company will record a debit of $1,500 for the building and then credit that same amount as the revaluation surplus.
Since the building is an asset, it will increase when debited. On the other hand, the revaluation reserve will get credited since it is a liability. The balance sheet remains balanced since the assets (building) increased by $1,500 and the liability (revaluation reserve) increased by $1,500.
Retained Earnings Vs Revaluation Reserve
Retained earnings are the profits the company gets after it has paid dividends. They show the balance sheet strength and that of the company. Companies with a high return on capital redeploy it at similar rates to reduce debt, expand their business and reward the shareholders in dividend form. Because of this, it's important to know the strength of the business by looking at its retained earnings trend.
But, there are revaluation reserves that are not frequent, and due to business operations, they don’t arise. In case the company undertakes the revaluation process, there will be no event of loss, actual profit, or even cash flows that will happen. So a shareholder's funds boost that comes as a result of a revaluation exercise won't portray the earnings quality of the company. Not to mention the fact that it won't be sustainable.
Significance of Revaluation Reserves
Generally, the carrying value can either decrease or increase based on the revaluation reserve's fair value estimates. When a company thinks that an asset carrying value needs assessment or close monitoring as a result of certain market situations, it establishes a revaluation reserve.
These market situations might include increased real estate market value or fluctuating foreign assets. Companies don't need to wait for either the monthly or the quarterly adjustments schedule to subtract or add to the revaluation reserve.