Financial Accounting and Reporting: Depreciation, Impairment, and Revaluation

This article explains the concepts of depreciation, impairment, and revaluation of fixed assets in financial accounting and reporting. It discusses the impact of these charges on profitability and the necessary disclosures for changes. The article also provides expert advice from Montana and Associates on how to report on performance without upsetting managers.

Running head: Financial accounting and Reporting
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Financial accounting and Reporting
9/7/2018

Financial accounting and Reporting 1
Montana and Associates
696 George Street, Brisbane, QLD 4000
4th September 2018,
Managing Director
Pepper Limited Level 5, 49 William Street,
Brisbane QLD 4000
Dear Sir,
Thank you so much, for consulting with us. As issues rose by your operations manager on
accounting concepts regarding charging of depreciation are notable. We provide you all
relevant information regarding depreciation. You will be able to answer all the questions that
would be raise by your operations manager. The accounting concept used by your new
management accountant made your operations manager confused, you will solve with clear
explanation.
I will ensure you providing the best knowledge on depreciation, impairments, revaluation
losses and many more with relevant reference.
Please go through the enclosures regarding explanation and calculation of depreciation and,
for advantages/ disadvantages of charging high and low percentage of depreciation on
machines.
Regards
Montana and Associates
696 George Street, Brisbane, QLD 4000

Financial accounting and Reporting 2
ENCLOSURES
Difference between depreciation, impairment, and revaluation losses:
Depreciation: Depreciation is the apportionment of cost of fixed asset over its beneficial
life or accounting periods. Depreciation on assets is imposing according to the IRS rules.
Businesses depreciate their long-term assets like, machine, truck and many more, for tax and
accounting purpose (Mao, & Wu, 2018).
Example: Calculation of depreciation of machine having cost $ 100000, life 10 years and
having scrap value $ 10000.
Answers: Using these variables depreciation will be calculated, financial analyst
calculates depreciation as the difference of cost, and scrap value fixed asset i.e. machine.
1. $100000-$10000 = $90000
2. $90000/10 years
Amount of depreciation = $9000
There are two methods of charging of depreciation
1. Straight line method = at the same rate on initial value of the asset
2. Written down method= at the same rate on value, remaining after deduction of 1st year
depreciation and so on.
Impairments: It is an accounting principle, which describes the reduction in value of
asset on permanent basis (Tan & Trotman, 2018). Impairment is calculated as the change of
book price of the asset and its cash inflow. If the book price of the asset exceeds the money
movement of the asset, then the change will be written off as expense permanently. In
addition, value of the asset will decline accordingly (Schwarzbichler, Steiner & Turnheim,
2018).
Example: Book value of the asset is $100000 and cash inflow from asset is $90000,
difference of $10000 will be written off as expense.
Revaluation losses: Revaluation account is prepared to find out the upsurge or reduction
in the carrying value of an asset in comparison to its fair market value. This technique is used

Financial accounting and Reporting 3
to control the just market price of the fixed asset. Revaluation of asset gives either decrease
or upsurge in the price of the immovable asset.
Example: Balance sheet value of the machinery is $ 1000000, just market price of machinery
is $1100000; prepare revaluation account for the machinery.
Revaluation A/c
Impact of these charges on profitability of the business:
Depreciation is an expense charged on fixed asset, as deduction from their market
value. Charging depreciation with higher rate has its own benefits to the organization. If the
organization expecting higher income bracket in later years, then it would be good to charge
higher depreciation on machines for saving the deductions in later years. Depreciation saves
the taxes of the organization, by showing as expenditure in the profit and loss account.
Depreciation affects profitability of an organization, as depreciation on assets gives
more income to the company. Income from depreciation shown in P/L A/c and increase in
value of asset will be shown in B/S of the company.
Example: The machinery has a cost $10000, that was purchased in the year 2015.
Depreciation charged on machinery was $1000 i.e. 10%, $4000 is the net income and this
will increase the asset value in balance sheet. When stakeholders look at financial statements
of the company, they would appreciate the increased net income and increased value of fixed
asset i.e. machinery.
Particulars $ Particulars $
To profit transferred to
old partners’ capital
A/c 100000
By increase in
machinery 100000
Total 100000 Total 100000

Financial accounting and Reporting 4
Why changes are required for depreciation, impairment, and revaluation?
Changes are required for depreciation, impairment, and revaluation of fixed assets.
Depreciation is charged as expense and reflects its value in P & L account of the company as
deduction from gross profit of the company.
There are mainly two methods of depreciation, one is straight-line method, and other
is written down method. Both the methods have their own significance from view of trade
and business.
Changes in depreciation, impairment, and revaluation are directly depending on
method of calculation, depreciation rate at which the depreciation is charged and asset life.
These changes are used to manipulate the earnings of the business. Above quoted
three factors, manipulates the depreciation. Following are the techniques used for
manipulation of depreciation:
Less depreciation on assets: Charging less depreciation on machines would result in
higher profit substantially. In some situation, company wants to show high earnings in their
accounts, and then they go for less depreciation for their fixed assets. There are some ways,
where companies lower their rate of depreciation within the framework of law, and they need
not have to explain the reason of changing the rate of depreciation (Pilcher, 2018).
On the other hand, when company wants to show the less profit in their accounts, then they
increase the rate of depreciation (Barker & Teixeira, 2018).
Life span of the asset: If the machine is used for, more than its estimated or useful
life, then written down method of depreciation is used to calculate the amount of depreciation
(Brett, 2018). On the other hand, when machine is fully used in its useful life, then the
company calculates depreciation using straight-line method of depreciation (Rogge, van der
Hurk, Larsen, & Sauer, 2018).
Example: Machine costs $ 10000, having life of 5 years, and rate of depreciation is
10%.
Calculate the depreciation on machinery of the company. Assuming two situations where,
1. When the machine has useful life of five years and will be destroyed after 5 years.

Financial accounting and Reporting 5
2. When the machine has estimated life of five years but will be taken in use for more
than 5 years.
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Straight line
method for 5
years
(machine is
fully utilized
within its
useful life)
$1000 $1000 $1000 $1000 $1000
Written down
method for 7
years
(machine is
being used for
more than its
useful life)
$1000 $900 $810 $729 $656.1 $590.49 $531.441
Revaluating assets: Taking an example of a particular machine, there is a sudden
soaring in the demand of a particular machine, this leads to the increase in value of that
particular machine (Nijam, 2018). That is why revaluation of asset is necessary for judging
the real price of the asset or just price of the asset in the market. In the balance sheet, the
revalued value of asset will be recorded (Azmi, 2018).
What disclosures are necessary for the changes of depreciation, impairment, and
revaluation?
International accounting standards (IAS) 16 Property, Plant, and Equipment outlines
the treatment of fixed assets like diverse types of property, plant and, equipment. These assets

Financial accounting and Reporting 6
are primarily measure at its cost; subsequently they are measured by revaluation method.
Depreciated amount is allocated over the valuable life of asset (IAS plus, 2018).
Recognition: Property, plant, and equipment are known as assets when it is likely that: [IAS
16.7]
 It is feasible that future financial assistances are related with the asset which will
flow to the business and
 The price of the asset can be dignified consistently.
 The principle of recognition is practical to all property, plant, and equipment.
Disclosures:
Information about each class of property, plant and equipment
 Basis on which carrying amount is measured
 Method on which depreciation is calculated
 Life of the asset
 Accumulated depreciation and impairment losses
 Reconciling amount at the beginning and end of the period (Rauf, & Matroud, 2018).
 Additions
 Disposals
 Purchase
 Revision
 Damage
 Depreciation
 Foreign exchange (IAS plus, 2018).
 Additional disclosures
 Restrictions on pledged as security for liabilities
 Expenditures on construction during the period
 Contractual commitment
 Compensation received from third party
Disclosure for impairment of assets: IAS 36 ensures that the properties are not carried
amount more than its recoverable amount. IAS 36 was issued in the year 2004 and applies to
the goodwill and intangible assets of the trade (Gunn, Khurana, & Stein, 2018).

Financial accounting and Reporting 7
Disclosure [IAS 36.126]
 Damage losses recognized in profit and losses
 Impairment losses upturned in profit and loss
 Impairment losses on reappraised asset (Cao, & Donnelly, 2018).
How we could otherwise report on performance without upsetting the managers?
The issue raised by the operations manager of company regarding charge of higher
rate of depreciation is notable. Operations manager has the issue that, why management
accountant charged higher rate of depreciation on plant & machinery. Reporting of this
information will be done within the hierarchy of the flow of information of the company (IAS
plus, 2018).
Firstly, managing director of company report to the top officials of company, after
discussion on this issue, information will float to the managerial positions of the company.
The benefits of charging higher rate of depreciation will be clearly explain to the managers,
who manage the plant and machinery of the company. Relevant clarification and right
explanation on depreciation will result in convincing the operations manager. Charging
higher rate of depreciation on plant and machinery is done to manipulate the accounts when
company wants to show less profit (IAS plus, 2018).

Financial accounting and Reporting 8
REFERENCES
Azmi, A. F. (2018). Revaluation of Fixed Assets and Future Firm Performance: Determining
the Effectiveness of Temporary Tax Cut Policy for Fixed Assets Revaluation in
Indonesia.
Barker, R., & Teixeira, A. (2018). Gaps in the IFRS conceptual framework. Accounting in
Europe, 15(2), 153-166.
Brett, T. (2018). Determining the Useful Life of Infrastructure Assets.
Cao, T., Shaari, H., & Donnelly, R. (2018). Impairment reversals: unbiased reporting or
earnings management. International Journal of Accounting & Information
Management, 26(2), 245-271.
Gunn, J. L., Khurana, I. K., & Stein, S. E. (2018). Determinants and consequences of timely
asset impairments during the financial crisis. Journal of Business Finance &
Accounting, 45(1-2), 3-39.
IAS plus. (2018). IAS 16- Property, Plant and Equipment. Retrieved from:
https://www.iasplus.com/en/standards/ias/ias16
Magnan, M., & Parbonetti, A. (2018). Fair value accounting: a standard-setting perspective.
In The Routledge Companion to Fair Value in Accounting (pp. 59-73). Routledge.
Mao, C. W., & Wu, W. C. (2018). Does the government-mandated adoption of international
financial reporting standards reduce income tax revenue? International Tax and
Public Finance, 1-22.
MoneyWorks4me. (2018). Depreciation calculation. Retrieved from:
https://www.moneyworks4me.com/investmentshastra/
Nijam, H. M. (2018). Motives for Reporting Fixed Assets at Revalued Amount: Evidence
from a Developing Economy. Global Business Review, 19(3), 604-622.
Pilcher, R. (2018). Depreciation in local government—still the problems continue. In Public
Sector Accounting, Accountability and Governance (pp. 30-42). Routledge.
Rauf, N. A., & Matroud, S. J. (2018). The effect of depreciation the methods of extinction on
the identification of the tax base applied research for a sample of the listed companies
listed in the Iraqi Stock Exchange. International Journal of Research, 5(01), 560-585.

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Rogge, M., van der Hurk, E., Larsen, A., & Sauer, D. U. (2018). Electric bus fleet size and
mix problem with optimization of charging infrastructure. Applied Energy, 211, 282-
295.
Schwarzbichler, M., Steiner, C., & Turnheim, D. (2018). Impairment of Assets (Fixed Assets
and Goodwill). In Financial Steering (pp. 343-370). Springer, Cham.
Schwarzbichler, M., Steiner, C., & Turnheim, D. (2018). Impairment of Assets (Fixed Assets
and Goodwill). In Financial Steering (pp. 343-370). Springer, Cham.
Tan, H. C., & Trotman, K. T. (2018). Information Processing Biases in Impairment
Decisions: Effect of Reversibility of Impairment Losses and Disclosure
Transparency. Behavioral Research in Accounting.