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In the cost method, depreciation is charged in the income statement against income as an expense, and the value of the asset after deducting depreciation is carried to the balance sheet. In the revaluation method, any increase in future value of the asset, is recorded in the balance sheet and is recognized directly in equity under the head revaluation surplus. If the future value of an asset decreases then the decrease is recorded in the income statement as an expense item. Accounting for the revaluation method is beneficial if the future value of the assets increase since the inclusion of revaluation surplus will increase revaluation reserve, which will increase the value of equity of a company. But if the future value is on the verge of decrease it is better to consider the cost method instead of the revaluation method for the purpose valuation of assets on a long-term basis. The reason to this can be explained with the help of a small example given below- Question: A building was purchased by a company on 1st January 2009 at a cost of $100million. The company estimates the life-time of the asset to be 50years, and thus the asset is to be depreciated over 50years. The company decides to use the revaluation for determining the value of the buildings at the end of 2015. The value of the building at the end of 31st December 2015 was $80 million, as determined by an efficient valuer. Answer: Using the revaluation method as opted by the company- Value of the building on 1st January 2009= $100million Value of the building on 31st December 2015= $80million Therefore, Accumulated Depreciation= $20million ($100million-$80million). Thus the value at which the asset is to be carried in the balance sheet on 31st December 2015 is $80million. If the company had opted for the cost method of depreciation, then- Value of the building on 1st January 2009= $100million Life of the asset= 50years Therefore, Accumulated depreciation at the end of 6years on 31st December 2015= $100million/50years * 6Years = $12million. Thus the value at which the asset is to be carried in the balance sheet on 31st December 2015 is $88million. Thus, from the above example it can be concluded that due to the use of revaluation method, a revaluation loss of $8million was suffered which is adjusted against the existing revaluation reserve of the company. It also led to the increase in the value of depreciation and decreased the value of the asset in the balance sheet. Increase in depreciation will affect the income adversely, as it will lead to a decrease of net income by $8million which will have a consequent effect on the balance sheet and will also impact the shareholders. Considering the above illustration, it is advisable to use the cost method to record the value of land and building of Rabbit Limited. Though revaluation method is considered to provide a more accurate record in terms of part replacement and depreciation, yet it is criticized on the grounds that the amount of depreciation charged on a particular asset differs year to year though the asset provides the same benefits, which make the accounting system complex and time consuming, and sometimes it is said to have chances of manipulation. So as stated by the director of Rabbit ltd. that the prices of the value of real estate are on the verge of decreasing, so it will be better to use the ...Show more

Summary

Presentation notes Answer a). Revaluation method and cost method are applied to record the value of assets at the end of accounting period. In revaluation method the assets are valued at the end of each period and the difference between the old value and the new value is considered to be the actual depreciation to be charged against the profit and loss account…
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Presentation notes essay example
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