Revaluation Model Value of Asset

Question: Describe about the Revaluation Model for Value of Asset. Answer: Journal Entries In Revaluation Model Journal Entries in case if revaluation results in increase in value of asset In $ 000' Sr. No. Date Particular Dr. Amount Cr. Amount 1 30.06.2016 Non- Current Asset A/c 6875000 To Revaluation Surplus A/c 6875000 [Being revaluation reserve created with the increase in carrying amount of asset.] Conditions for raising debt are as follows: Debt ratio should be less than 0.6, and The time's interest earned ratio should be more than 3 Debt ratio Total Liabilities/Total Assets Cost Model Revaluation Model Debt $20,000,000.00 Debt $20,000,000.00 Assets $35,500,000.00 Assets $49,250,000.00 Ratio 0.563380282 Ratio 0.406091371 Times interest earned ratio Profit before tax + interest expense/interest expense Profit before tax $450,000.00 Profit before tax $7325000 Interest exp. $900,000.00 Interest exp. $900,000.00 Ratio 1.5 Ratio 9.138888889 Working note Balance sheet under cost model Liabilities Amount Assets Amount Equity (Bal Fig) $15,300,000 Property plant and equipment $27,500,000 Net profit $200,000 current assets $8,000,000 Long term liability $17,500,000 short term liabilities $2,500,000 $35,500,000 $35,500,000 Balance sheet under revaluation model Liabilities Amount Assets Amount Equity (Bal Fig) $29,050,000 Property plant and equipment $41,250,000 Net profit $200,000 current assets $8,000,000 Long term liability $17,500,000 short term liabilities $2,500,000 $49,250,000 $49,250,000 Analysis On the basis of the given case study and the calculations above many interpretations can be drawn. The total assets of Sha Maru Ltd. amount to $35,500,000. These assets include $27,500,000 worth of property, plant and equipment, while the remaining is current assets. From the companys financial data, it can be stated that a large proportion of the assets is consumed by property, plant and equipment. Therefore, the carrying amount of asset must be greater than the actual value because it is mentioned that the fair amount of assets is 25% greater than their current value. This will lead to higher depreciation and the increase in asset value is likely to minimise the companys liabilities. Sha Marus long-term liabilities are worth $17,500,000, while the short-term obligations amount to $2,500,000. Net profit for the period is $2,000,000; the interest expense is $900,000 and the tax expense cumulate to $250,000. The rise in carrying the amount of the asset is going to have a direct favourable impact on the companys debt-equity ratio. As the company will require making various changes in the depreciation adjustments because cost methodology was being followed earlier and now the company is adopting the revaluation method. Sha Maru will now have to abide by the statutory and cost changes as per the changes in the accounting standard. It is critical to properly present the difference between the assets revalued amount and the carrying amount while reporting in the books of account. Applying the revaluation model is more advantageous in the context of managing the debt percentage. Moreover, it will also enable the organisation to make sufficient payments in terms of dividend. Ratios under the revaluation model are more favourable and this will be helpful in taking a loan because all conditions are getting satisfied in this model. Moreover, the debt-asset ratio was more during the cost model and lower during the revaluation model. Higher debt-asset ratio implied that more than nearly 56% of the companys assets were being financed by debt, while in the revaluation method 48% of the assets were being financed through debt. Under the cost method, Sha Maru had a comparatively higher degree of leverage and hence a lower level of financial flexibility. This is due to the fact that debt servicing payments ought to be made under any condition or else Sha Maru would violate the debt covenants and become vulnerable to bankruptcy. The Times Interest Earned ratio was only 1.5 during the application of cost method. This implied that Sha Marus ability to meet its debt payments was very weak. On the other hand, under the revaluation method, it increased to 9.13 which is a substantial increase in Sha Marus ability to honour its debt obligations. Definitely, the creditors would prefer Sha Maru more now as it has a much greater times interest ratio which demonstrates the organisation can afford to pay the interest amounts when they become due. Moreover, a higher ratio is less risky, whereas a ratio below 3 indicates credit risk. Impact on books of account when applying revaluation model The fair value of the asset can be calculated with the help of a qualified valuator. If the nature of an asset is such that it is not feasible to use market value method, then an alternate method can be used to determine its fair value. If an assets revaluation leads to a rise in the carrying amount then such increase will be considered as a rise in other comprehensive income and will be recorded as revaluation surplus in the equity. Hence, if in future, the asset value again decreases then the pertinent profit will be considered as revaluation gain and the loss to the degree the balance is available in the revaluation account will be implemented by decreasing the revaluation reserve. If after revaluation it is concluded that there is a fall in the assets value, then in such cases, the fall in the amount will be recorded as a loss in the PL account. If a revaluation reserve is present in the books of account then the loss amount is going to be adjusted against the revaluation reserve account to the available balance and the rest of the amount will be charged to the PL account.