Revaluation of Assets and liabilities in partnership accounts

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Introduction

In this article we will learn about "Revaluation " in Partnership accounts. In this article we will understand the basic concepts of revaluation. In the subsequent article we will discuss specific examples on revaluation of assets and liabilities.

Meaning of Revaluation

Revaluation is made of two words.

Re and valuation.

Re means to do something again.

Valuation means finding the value of something.

Hence revaluation means finding the value of assets and liabilities once again. Under this topic we will be learning the accounting treatment and impact in books of accounts due to revaluation of assets and liabilities. Before understanding revaluation further or why revaluation is done, first we have to understand the meaning of historical cost principle.

Historical Cost principle

In accounting there is historical cost principle which is a fundamental concept in accounting. Historical cost principle states that Assets and Liabilities should be recorded in books of accounts at their original cost, rather than their current market value. Original cost of asset means the purchase price. The amount you paid at the time of purchasing the asset. Original cost for a liability can be either the actual amount borrowed or the value of goods received on credit on the date of purchase.

Due to historical cost principle, Every year assets and liabilities are shown at their original cost in the balance sheet. Only depreciation is adjusted from the value of assets. Book Value remains the original cost less depreciation, even if the current market value of assets or liability is higher or lower than its book value.

However, Historical cost principle allows revaluation of assets and liabilities in certain cases like reconstitution of partnership firm. Reconstitution of partnership firm means either admission, retirement or death of a partner or the change in profit sharing ratio among the partners.

Why revaluation is done

Now that we have understood the historical cost principle, lets shift our focus on why revaluation is done. Why do we value the assets and liabilities again? Let's understand this with an example.

Suppose a partnership firm has two equal partners, A and B. The partnership firm purchased a land for Rs 10 Lakhs. Land is an asset for the partnership firm. For this transaction we will pass the journal entry in books of accounts at the purchase price. The entry passed will be

Land A/c Dr.. Rs 10 Lakhs
- To Bank account Rs 10 Lakhs.
- Now, Book value of land is Rs 10 lakhs. Book Value means the value in books of accounts.

Due to historical cost principle, the value of land in books of accounts remains at Rs 10 Lakhs, even if in later years the market value of land changes.

Suppose the market value of land after 4 years becomes Rs 11 lakhs. Still the land in the balance sheet of the partnership firm will be shown at Rs 10 Lakhs only. This is due to the historical cost principle. Or suppose the market value of land after 10 years becomes Rs 15 lakhs. Still the land in the balance sheet of the partnership firm will be shown at Rs 10 Lakhs only due to historical cost principle. This variation between book value and market value can continue and become larger in later years.

Let's understand what happens in books of accounts after 10 years. After 10 years the partnership firm has a profit of Rs 5 Lakhs (Rs 15 Lakhs - Rs 10 Lakhs) on land. But this profit is not yet accounted in books of accounts. Secondly even though the present market value of land is Rs 15 Lakhs, but the firm is still showing the land in balance sheet at Rs 10 Lakhs.

Now suppose after ten years, a new partner, C is admitted to the firm. From the date of admission, C will also become a partner in assets and profits of the firm. It means that C will also become a partner in the profit of Rs 5 Lakhs from the rise in value of land.

Think about it. Is it correct to give share in Rs 5 Lakh profits to C ? The answer is no. Actually the gain of Rs 5 lakhs was generated before the admission of C. So he should not get any share from this gain.

What is the solution? The solution is doing the revaluation of all the assets and Liabilities before admission of C. And then distribute any resultant profit or loss among the old partners in old ratio.

Revaluation of all assets and liabilities

The profit or loss on land as per the above example which happened before admission of C, can be present in other assets and liabilities as well. So all the assets and liabilities are revalued.

Secondly, such profit or loss can arise, at the time of all kinds of reconstitution of partnership firm. Like admission, retirement, death of a partner or change in profit sharing ratio. So all the assets and liabilities are revalued, at the time of all kinds of reconstitution of partnership firm. For this purpose revaluation account is made. The resultant gain or loss due to revaluation of all the assets and liabilities is distributed among the old partners in the old profit sharing ratio.

It is important to understand that under revaluation we are revaluing all the assets and liabilities from their book value as per balance sheet to their present market value.

Impact of doing revaluation

On account of revaluation, the value of assets and liabilities can either increase, decrease or there will be no change. Increase means that the New Market value is higher than the book value. Decrease means that the New market value is lower than the book value. If question is silent on new value for few assets and liabilities, then it means there is no change.

flowchart TD A[Revaluation of Assets and Liabilities] --> B[Value Increases] A --> C[Value Decreases] A --> D[No Change in Value] B --> E[New Market Value > Book Value] C --> F[New Market Value < Book Value] D --> G[Question Silent on New Value] G --> H[Assume No Change in Value]

How is revaluation done

Let's now discuss the process of doing the revaluation.

Language of question

Let's now understand the few points about the language of question.

Instead of writing "increase", the question can use other similar words, like appreciated, rise, brought up. All these words have same meaning and indicate the increase in value of assets or liabilities.

Instead of "decrease" the question can use other words like depreciated, fall, brought down, reduce to indicate the decrease in value of assets or liabilities.

Increase	Decrease
Appreciated	Depreciated
Rise	Fall
Brought Up	Brought Down
	Reduce

The accounting treatment will be same irrespective of the word used in the language of the question for indicating either increase or decrease.

Amount to be calculated in revaluation questions

Let's understand the amounts we have to calculate in each revaluation adjustment.

A revaluation question will give two things

Book Value of asset or liability. The book value can be given either in the Balance sheet or just written in a paragraph.
Change percentage or change amount. This is given either as a change percentage or change amount from book value

flowchart TD A[Revaluation Question] --> B[Book Value of Asset or Liability] A --> C[Change Percentage or Change Amount] B --> D[Book Value in Balance Sheet] B --> E[Book Value in Paragraph] C --> F[Change Percentage] C --> G[Change Amount]

From the information given in the question we have to calculate two things.
- First. Revaluation gain or loss. This is the profit or loss due to revaluation for each asset and liability.
- Second. New Balance Sheet Value. This is the new value of each asset and liability which will be shown in the new balance sheet.

flowchart TD A[From Information Given in Question calculate] --> B[Revaluation Gain or Loss] A --> C[New Balance Sheet Value] B --> D[Profit or Loss due to Revaluation for Each Asset and Liability] C --> E[New Value of Each Asset and Liability for the New Balance Sheet]

Next, we will discuss an example to understand this more clearly.

Example question on revaluation

Book Value of building as per balance sheet is Rs 1 Lakh. The value of buildings to be increased by Rs 25000.

Here the book value as per question is Rs 1 Lakh. The change amount as per question is Rs 25000. Now we have to calculate two numbers. First, Revaluation gain in this example will be Rs 25000. Second, new Balance sheet value calculated as follows. Book Value Rs 1 Lakh add gain on revaluation Rs 25000 . This gives Rs 125000 as the new value of building to be shown in new balance sheet.

Usage of similar sounding words in revaluation questions

Another important concept in revaluation questions is the usage of few similar sounding words. Revaluation questions usually can use three different words. "By". "To" or "At" in the language of the question.

If the language of the question gives, "By", it means question has given the revaluation gain or loss. It has not given the new value of asset or liability. In such questions we will find the new value of asset by the formula - (Book Value Add revaluation profit or subtract revaluation loss)

If the language of the question gives, either "To" or "At", it means question has given the new value of the asset or liability. In such questions we will find the revaluation gain or loss by the formula (Book Value - New Value). The accounting treatment in "To" and "At" questions is same.

flowchart TD A[Three types of question] --> B[By] A --> C[To] A --> D[At] B --> E[Gives] B --> F[Find] E --> G[Revaluation Gain or Loss] F --> H[New Balance Sheet Value] C --> I[Gives] C --> J[Find] I --> K[New Balance Sheet Value] J --> L[Revaluation Gain or Loss] D --> M[Same as To question]

Examples of various languages in question

S No	Asset	Book Value	Adjustment	Type	Given	Find
1	Machinery	100000	Machinery value increased by Rs 5000	By	Rev Gain of Rs 5000	New Balance Sheet Value = 100000 + 5000 = 105000
2	Machinery	100000	Machinery value increased to Rs 150000	To	New Value Rs 150000	Revaluation Gain = 150000 - 100000 = 50000
3	Machinery	100000	Machinery revalued at Rs 180000	At	New Value Rs 180000	Revaluation Gain = 180000 - 100000 = 80000

Example 1. Questions gives the book value of machinery as Rs 1 Lakh. The additional information in the question states that "Machinery value increased by Rs 5000". This is a "by" question. Here the question gives the revaluation gain or loss. In this example there is revaluation gain of Rs 5000. We have to find the revised balance sheet value of machinery as Rs 1 Lakhs Add revaluation gain Rs 5000 equals Rs 105000.

Example 2. Question gives the book value of machinery as Rs 1 Lakh. The additional information in the question states that "Machinery value increased to Rs 150000".This is a "to" question. Here the question gives the revised value of machinery as Rs 150000. We have to find the revaluation gain as Rs 150000 Less Rs 100000 equals Rs 50000.

Example 3. Question gives the book value of machinery as Rs 1 Lakh. The additional information in the question states that "Machinery revalued at Rs 180000". This is an "At" question. Here the question gives the revised value of machinery as Rs 180000. We have to find the revaluation gain as Rs 180000 Less Rs 100000 equals Rs 80000.

Profit or Loss on revaluation

flowchart TD A[Asset] --> B[Increase] A --> C[Decrease] B --> D[Profit on Revaluation] C --> E[Loss on Revaluation] F[Liability] --> G[Increase] F --> H[Decrease] G --> I[Loss on Revaluation] H --> J[Profit on Revaluation]

Now we move to understanding whether there is profit or loss on revaluation. For each asset and liability as per question check whether the value is increasing or decreasing.

If the value of asset increases, then there will be profit on revaluation
If the value of asset decreases, then there will be loss on revaluation
If the value of liability increase then there will be loss on revaluation
If the value of liability decrease then there will be profit on revaluation

Why there is profit when value of asset increase

Now we discuss why there is profit when value of assets increase or there is loss when value of assets decreases.

Suppose you have a land of Rs 1 Lakh. Land is an asset. Its market value increases to Rs 1.25 Lakhs. Since the value of something you own is rising so there will be profit. So in case of increase in value of assets there is a profit. Alternately, suppose the value of land falls to Rs 80000 . The value of something you own is falling so there will be a loss. In this case of decrease in value of assets there is a loss.

Why there is loss when value of liability increase

Now we discuss why there is profit when value of liability decreases, or there is a loss when value of liability increases.

Suppose you have to pay Rs 50000 to someone. Later it is found that actually you had to pay Rs 60000. Now you have to pay Rs 10000 more. This is a loss. So in case of increase in liabilities there is a loss. Alternately, suppose you later found that you have to pay Rs 45000 only. It means now you have to pay less. This is a profit. So in case of decrease in liabilities there is a profit.

What if value of few assets or liabilities does not change

This happens if the question is silent on the revised value of few assets or liabilities. We will ignore such assets and liabilities and we will not do anything. In such cases we assume that there is no change in value of such assets and liabilities. There will be no revaluation gain or loss on such assets. The same old book values will come in the new balance sheet also.

Revaluation Account debit credit rules

If due to revaluation, there is a profit then revaluation account gets credited. If due to revaluation, there is a loss then revaluation account gets debited.

Now we combine the rules learned in earlier slides, and get the following final rules for debit and credit of revaluation account.

When value of asset increases or the value of liability decreases then there is a profit. So revaluation account gets credited in such cases.

When value of asset decreases, or the value of liability increases then there is a loss. So revaluation account gets debited in such cases.

flowchart TD A[Revaluation Scenarios] --> B[Profit Cases] A --> C[Loss Cases] B --> D[Asset Value Increases] B --> E[Liability Value Decreases] D --> F[Revaluation Account is Credited] E --> F C --> G[Asset Value Decreases] C --> H[Liability Value Increases] G --> I[Revaluation Account is Debited] H --> I

Revaluation Account format

Finally, we come to the format of revaluation account. The format of revaluation account is same as any other account. The nature of revaluation account is nominal account so debit and credit rules of nominal accounts will apply. All the gains or profits on revaluation will be shown on credit side. All the losses due to revaluation will be shown on the debit side.

REVALUATION A/C

Particulars	Amount	Particulars	Amount
All Losses on revaluation		All Profits on revaluation

Conclusion

Please note that whatever we have learned in this video applies to admission, retirement, death of a partner or change in profit sharing ratio questions. You need not understand the revaluation adjustments separately for these chapters.

This article is a must read for understanding the concept of revaluation account. Please read this article two to three times for full clarity. In the next article the specific questions on revaluation of assets and revaluation of liabilities are discussed.