Question

On March 1, 2012, the company purchased a building for $1,200,000 which is expected to last 40 years. When purchased, the building was not in a desirable area, but a new stadium is being built nearby, so the value of the building on December 31, 2015 is $2,000,000.

Assuming the company only adjusts depreciation at year-end, the adjusting journal entry on December 31, 2015 is:

Answer 1

Introduction for this problem

Revaluation of Fixed Assets

Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of major changes in fair market value of the fixed asset. Internation Financial Reporting Standards (IFRS) require fixed assets to be initially recorded at cost but they allow two models for subsequent accounting for fixed assets, namely the cost model and the revaluation model.

Cost Model

In cost model the fixed assets are carried at their historical cost less accumulated depreciation and accumulated impairment losses. There is no upward adjustment to value due to changing circumstances

The building has a useful life of 40 years and the company uses straight line depreciation (Assumed). Yearly depreciation is hence $1,200,000/40 or $30,000.

So , Adjusting Journal entry is not required other than depreciation entry on December 31, 2015 is

Depreciation Expense -Building (Dr) $ 30,000

Accumulated Depreciation -Building (Cr) $ 30,000

Under Revaluation Model:

In revaluation model an asset is initially recorded at cost but subsequently its carrying amount is increased to account for any appreciation in value. The difference between cost model and revaluation model is that revaluation model allows both downward and upward adjustment in value of an asset while cost model allows only downward adjustment due to impairment loss.

Assume on December 31, 2015 the company intends to switch to revaluation model and carries out a revaluation exercise which estimates the fair value of the building to be $2,000,000 as at December 31, 2015. The carrying amount at the date is $1,085,000 (1,200,000 -(30,000 X 3 years + 30,000 /12 X10)) and revalued amount is $2,000,000 so an upward adjustment of $915,000 is required to building account. It is recorded through the following journal entry:

Building (Dr)	915,000
Revaluation Surplus (Cr)		915,000

Revaluation Surplus

Upward revaluation is not considered a normal gain and is not recorded in income statement rather it is directly credited to an equity account called revaluation surplus. Revaluation surplus holds all the upward revaluations of a company's assets until those assets are disposed of.

Depreciation After Revaluation

The depreciation in periods after revaluation is based on the revalued amount