Explanation of Depreciation, Impairment and Revaluation in Financial Accounting and Reporting

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Financial Accounting and Reporting

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8th September, 2018
Peter Pepper
Managing Director, Pepper Limited
Level 5, 49 William Street,
Brisbane QLD 4000
Dear Peter,
With respect to your email in connection with accounting issues for year end June, 2018,
please find below the explanation regarding various issues. In the following explanation we
have discussed various concepts of related assets such as depreciation, impairment and
revaluation.
Difference between Depreciation, Impairment and Revaluation
Deprecation is charge to the profit and loss towards the usage of an asset. When an asset is
used, its value is declined. Depreciation is the charge on the asst in order to account for its
usage, obsolesce and degradation in value due to efflux of time.
An asset is said to be impaired when the recoverable amount of the asset in an open market
falls below its carrying amount. Impairment is the decline in the value of the asset in the
market due to various factors. Once impairment is charges over an asset, it is not likely that
the recoverable amount of the asset will go up. For example, we have an asset with a carrying
amount of $40000, the recoverable amount of such asset is estimated to be $35000, the asset
is said to be impaired by $5000.
Revaluation of asset refers to change in fair value or value in use of the asset. The revaluation
is asset results in matching of the carrying amount of the asset with its fair value. Revaluation
may be done upwards or downwards, that is, the fair value may be increased or decreased.
(Australian Accounting Standards Board)
Impact of these on the profitability of the company
As discussed earlier depreciation is charge to the profit and loss. The amount of depreciation
charged is sent to the profit and loss statement, that is, depreciation reduces the profit of the

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8th September, 2018
Mr. Peter Pepper
current year. Though there is no actual cash flow, the profit of the company declines due to
depreciation.
Impairment loss any should be immediate recognised in the profit and loss stamen. The
difference between the carrying amount and recoverable amount of an asset, should be
transferred to the profit and loss statement as impairment loss towards asset, this will decline
the profits of the company. Such losses are to be shown as a separate line item in profit and
loss.
As discussed, revaluation may lead to increase or decrease in the carrying amount of the
asset. When the value of the asset increases, then a revaluation reserve of the same amount is
created this is shown as a part of the equity in balance sheet. Balance in such reserve is
transferred to surplus profits directly on sale on such assets. If the value of the asset declines
due to revaluation, then such losses is charges to profit and loss, except in cases when there
exists previously created revaluation reserve in connection with such assets. In such cases,
the revaluation loss is first written off with revalued loss and remaining amount is then
charged to the profit and loss statement. For example, say there is a machine which was
earlier revalued from $25000 to $35000, creating a revaluation surplus of $10000. Now the
same machine has been revalued downwards by $12000. In this case the revaluation loss will
first be written off form the surplus, and remaining amount $2000 will be charged to the
profit and loss statement.
All the above create a charge on the profit of the company. Depreciation, impairment and
revaluation losses are all written off in the profit and loss statement, decreasing the profit of
the year.
Need for changes required for depreciation, impairment and revaluation
There are various methods to charge depreciation. The method which is most suitable to the
industry type of the company should be opted for. (Australian Accounting Standards
Board)Depreciation is tool which is used by many managers in order to manipulate profits;
therefore it is important to implement the most suitable for of depreciation so that correct
profits of the company can be arrived at. It is impairment to bring changes in the depreciation