Difference Between Cost Model and Revaluation Model

Key Difference – Cost Model vs Revaluation Model
 

Cost model and revaluation model are specified in IAS 16- property, plant and equipment and are referred to as two options that businesses can utilize to re-measure noncurrent assets. The key difference between cost model and revaluation model is that value of noncurrent assets are valued at the price spent to acquire the assets under cost model while assets are shown at fair value (an estimate of the market value) under revaluation model.

CONTENTS
1. Overview and Key Difference
2. Treatment of Noncurrent Assets
3. What is Cost Model
4. What is Revaluation Model
5. Side by Side Comparison – Cost Model vs Revaluation Model
6. Summary

Treatment of Noncurrent Assets

Irrespective of the measure used to re-measure, all noncurrent assets should be initially recognized at cost. This is inclusive of all the expenses incurred to bring the asset into working condition to meet the intended use of the asset and includes,

• Cost of site preparation
• Cost of delivery and handling
• Cost of installation
• Professional fees for architects and engineers
• Cost of removing the asset and restoring the site

What is Cost Model

Under the cost model, the asset is recognized at the net book value (cost less accumulated depreciation). Depreciation is the charge to record the reduction in economic useful life of the asset. These depreciation charges are collected to a separate account named ‘accumulated depreciation account’ and is used to identify the net book value of an asset at any given point of time.

E.g. ABC Ltd. purchased a vehicle to deliver goods for $50,000 and accumulated depreciation on 31.12.2016 is $4,500.  Thus, the net book value as at that date is $45,500.

The main advantage of using cost model is that there will be no biases in valuation as the cost of a non-current asset is readily available; thus, this is a fairly straightforward calculation. However, this does not provide an accurate worth of a non-current asset since the prices of assets are likely to change with time. This is particularly correct with non-current assets such as property where the prices are constantly increasing.

E.g. Property prices in Aylesbury, UK has increased to 21.5% within 2016

What is Revaluation Model

This model is also known as ‘mark-to-market’ approach or ‘fair value’ method of asset valuation in accordance with Generally Accepted Accounting Practices (GAAP). According to this method, the non-current asset is carried at a revalued amount less depreciation. To practice this method, the fair value should be measured reliably. If the company cannot derive at a reasonable fair value, the asset should be valued using the cost model in IAS 16, assuming that the resale value of the property is zero as stated in IAS 16.

If a revaluation results in an increase in value, it should be credited to other comprehensive income and recorded in equity under the separate reserve named ‘revaluation surplus’. A decrease arising as a result of a revaluation should be recognized as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus. At the time of asset disposal, any revaluation surplus should be transferred directly to retained earnings, or it may be left in revaluation surplus. Noncurrent assets under both models are subjected to depreciation to allow for the reduction in useful life.

According to IAS 16, if one asset is revalued, all assets in that particular asset class should be revalued. For example, if the company has three buildings and wish to practice this model, all three buildings has to be revalued.

The principal reason for companies to adopt this approach is to ensure that noncurrent assets are shown at their market value in financial statements, thus this provides a more accurate picture than the cost model. However, this is a costly exercise since revaluation should be carried out at regular intervals. Furthermore, the management may sometimes be biased and assign a higher revalued amount to assets that are above the reasonable market value, thus lead to overestimation.

What is the difference between Cost Model and Revaluation Model?

Summary – Cost Model vs Revaluation Model

Although there is a difference between cost model and revaluation model, the decision as to which method should be used can be done at the discretion of the management since accounting standards accept both methods. To practice the revaluation model the main criteria should be the availability of a reliable market estimate. This can be done by inspecting the market prices of similar nature noncurrent assets to arrive at a reliable value. If the company prefers a less complicated model, it can use the cost model, which is fairly straightforward.

Reference:
1. “Advantages or Disadvantages of Fair Value Accounting.” Chron.com. N.p., n.d. Web. 12 Feb. 2017.
2. “IAS Plus.” IAS 16 – Property, Plant and Equipment. N.p., n.d. Web. 12 Feb. 2017.
3. “ACCA – Think Ahead.” Accounting for property, plant and equipment | ACCA Global. N.p., n.d. Web. 12 Feb. 2017.

Image Courtesy:
1. “UK house prices adjusted for inflation” By Goose – Own work (Public Domain) via Commons Wikimedia