As you are aware that Revaluation Reserve is a Non-Cash reserve prepared by business entities to give effect in case market value of some assets is more or less than the value on which it is written in books or Book Value.
Revaluation generally used to give effect of difference in market value of assets and book value of assets at given point of time.
The nature of Revaluation Reserve is of Capital Nature, the depreciation on revalued amount of assets will be debited in this reserve and normal depreciation will debited into Profit and Loss Account.
Revaluation fund is the accounting term utilized when a business establishes a line item on the balance sheet for the purpose of maintaining a contingency account connected to other assets. A line item will be used when a re-evaluation appraisal shows that the carrying value of the asset has changed.
If the asset falls in value, the revaluation fund is credited to the balance sheet to reduce the carrying value of the asset, and the cost is debited to maximise the overall revaluation cost. If the value of the asset increases, the offsetting reserve expense would be reduced by credit, and the balance-sheet revaluation reserve would be increased by debit.
WIKIPEDIA
In finance, a revaluation of fixed assets is an action that may be required to accurately describe the true value of the capital goods a business owns. This should be distinguished from planned depreciation, where the recorded decline in value of an asset is tied to its age.
Fixed assets are held by an enterprise for the purpose of producing goods or rendering services, as opposed to being held for resale for the normal course of business. An example, machines, buildings, patents, or licenses can be fixed assets of a business.
The purpose of a revaluation is to bring into the books the fair market value of fixed assets. This may be helpful in order to decide whether to invest in another business. If a company wants to sell one of its assets, it is revalued in preparation for sales negotiations.
INVESTOPEDIA
Revaluation reserve is an accounting term used when a company creates a line item on its balance sheet for the purpose of maintaining a reserve account tied to certain assets. This line item can be used when a revaluation assessment finds that the carrying value of the asset has changed.
- Companies use revaluation reserve lines on the balance sheet to account for value fluctuations in long-term assets.
- Revaluation reserves are most often used when an asset’s market value greatly fluctuates or is volatile due to currency relationships.
- Revaluation reserves have an offsetting expense that is debited (increased) or credited (decreased) depending on the change from revaluation.
LINE ITEM ACCOUNTING
It is an accounting practice that segments each category of income and expenses into separate areas, or lines, on a balance sheet. Each line item represents a distinct type of revenue, expense, asset, liability or equity that may affect the account's value.
Some examples of line items
i) Plural line items- An item appearing on a single line in any schedule of information.
ii) Accounting- An item of revenue or expenditure in a budget or other financial statement or report.
iii) Government- A budget appropriation.
iv) Logistics- One item on an order, regardless of quantity.
PLEASE NOTE:
1. From above definitions and discussions it is clear that “ Revaluation” is a process through which we give effect of difference in Market Value of assets and the Book Value of Assets at given point of time by creating Revolution Reserve in the financial statement of an entity.
2. It is a Non-Cash Reserve. The Revaluation Reserves are carried in the Balance Sheet until asset asset is discarded.
3. There is no inflow or outflow of cash to the company.
4. There is no profit recorded in Profit & Loss Account in case there is revaluation surplus , the difference is credited in Revaluation Reserve.
5. It is not a Free -Reserve and available for payment of dividend and profit sharing or issue of Bonus Shares.
6. It is of Capital Nature.
7. Since it is a Non-Cash Reserve and does not involve in cash inflow or outflow. It does not affect Cash Flow Statement of the entity.
8. A Revaluation Reserve does not have negative balance, separate Revaluation Reserve will be prepared for each asset.
REVALUATION RESERVES IN INSURANCE COMPANIES
The Preparation of accounts of Insurance Companies are governed by IRDAI( Preparation of Financial Statements & Auditor’s Report of Insurance Companies) Regulations, 2000.
Regulation 7- Procedure to determine the value of investments.-An insurer shall determine the values of investments in the following manner:-
a) Real Estate – Investment Property-- The value of investment property shall be determined at historical cost, subject to revaluation at least once in every three years. The change in the carrying amount of the investment property shall be taken to Revaluation Reserve.
The insurer shall assess at-each balance sheet date whether any impairment of the investment property has occurred.
Gains/ losses arising due to changes in the carrying amount of real estate shall be taken to equity under ‘Revaluation Reserve’.
The ‘Profit on sale of investments’ or ‘Loss on sale of investments’, as the case may be, shall include accumulated changes in the carrying amount previously recognised in equity under the heading ‘Revaluation Reserve’ in respect of a particular property and being recycled to the relevant Revenue Account or Profit and Loss Account on sale of that property.
The bases for revaluation shall be disclosed in the notes to accounts. The Authority may issue directions specifying the amount to be released from the revaluation reserve for declaring bonus to the policyholders.
For the removal of doubt, it is clarified that except for the amount that is released to policyholders as per the Authority’s direction, no other amount shall be distributed to shareholders out of Revaluation Reserve Account.
An impairment loss shall be recognised as an expense in the Revenue/Profit and Loss Account immediately, unless the asset is carried at revalued amount.
Any impairment loss of a revalued asset shall be treated as a revaluation decrease of that asset and if the impairment loss exceeds the corresponding revaluation reserve, such excess shall be recognised as an expense in the Revenue/Profit and Loss Account.
PLEASE NOTE THAT:
1. From above discussion and according to Regulation 7 of IRDAI( Preparation of Financial Statements & Auditor’s Report of Insurance Companies) Regulations, 2000, it is clear that The value of investment property shall be determined at historical cost, subject to revaluation at least once in every three years. The change in the carrying amount of the investment property shall be taken to Revaluation Reserve.
2. Gains/ losses arising due to changes in the carrying amount of real estate shall be taken to equity under ‘Revaluation Reserve’. The ‘Profit on sale of investments’ or ‘Loss on sale of investments’, as the case may be, shall include accumulated changes in the carrying amount previously recognised in equity under the heading ‘Revaluation Reserve’ in respect of a particular property and being recycled to the relevant Revenue Account or Profit and Loss Account on sale of that property.
3. An impairment loss shall be recognised as an expense in the Revenue/Profit and Loss Account immediately, unless the asset is carried at revalued amount. Any impairment loss of a revalued asset shall be treated as a revaluation decrease of that asset and if the impairment loss exceeds the corresponding revaluation reserve, such excess shall be recognised as an expense in the Revenue/Profit and Loss Account.
4. The IRDAI (the Authority) can issue direction to the insurer to pay Bonus to the policyholders out of Revaluation Reserve. It means that for Insurance Companies , Revaluation Reserves are Cash Reserves and will affect Cash Flow Statement.
5. No dividend will be paid out of Revaluation Reserve.
6. The assets are generally recorded in the books of accounts of insurance company on Historical Cost less impairment loss.
7. Impairment loss shall be recognised as an expense in the Revenue/Profit or Loss Account immediately.
8. Any gain in revaluation of Capital Investments n real estate will be recited in Revaluation Reserve.
9. The insurance company is required to disclose in Notes to the Accounts, the basis of revaluation of capital investment.
PLEASE NOTE THAT:
Revaluation reserves are assets that insurance companies set aside per state law to mitigate the risk of declines in the value of investments they hold. They function as a hedge to an investment portfolio and ensure that an insurance company remains solvent.
Because policies such as life insurance, health insurance, and various annuities may be in effect for extended periods of time, valuation reserves protect the insurance company from losses from investments that may not perform as expected. This helps ensure that the policyholders are paid for claims and that annuity holders receive income even if an insurance company’s assets lose value.
KEY TAKEAWAYS
- A Revaluation reserve is money set aside by an insurance company to hedge against a decrease in the value of its assets.
- Revaluation reserves are mandatory under state law to protect against the natural fluctuations in the value of investments.
- Revaluation reserves are calculated using an asset valuation reserve and an interest maintenance reserve to separate valuations in equity versus interest gains and losses.
- Regulators are increasingly looking at risk-based capital requirements, such as valuation reserves, as a more prudent way to ensure solvency.
- To make sure that an insurance company remains solvent so that it can pay insurance claims and annuities, it must maintain a certain amount of valuation reserves.
CONCLUSION
From the above, we conclude that the Revaluation Reserves is treated differently in insurance company and other companies. A Revaluation Reserve in insurance company is a Cash Reserve and on the direction of IRDAI, insurance company will distribute bonus to the policyholders and not any dividend. On the other hand Revaluation Reserves in other entities are Non-Cash Reserves and cannot be utilised for distribution of profit and cannot be treated as Free Reserve.
DISCLAIMER: The article produced here is only for sharing information with the readers. The views expressed here are personal views of the author . In case of necessity do consult with professionals.
CAclubindia
