Assets are originally recorded at its original price, but when certain events occurred, such as 1) a new partner is admitted, 2) or a partner leaving the firm and 3) if the partners change their profit or loss sharing ratios, the assets will have to be revalued.
There are two rationales in doing such exercise, first, the true value of asset is being reflected correctly on the books and second, this is to ensure that new partner do not share the profit and loss on revaluation. The first point is pretty much updating the value of your assets from original price into a more recent price (or even market price).
Revaluation is pretty simple. You only need to follow three to five steps to do revaluation. For those with a weaker double entry skill, doing the first two steps are important, otherwise, you can skip to the third step.
The steps are:
- Open the relevant T-accounts.
- Identify the relevant entries to the increase or decrease in the T-account.
- Post the double entry of item 2 in Revaluation account.
- Compute the profit or loss in the Revaluation account.
- Apportion the profit or loss of revaluation according to the partners’ profit and loss sharing ratio.
The first step is to open up a T-account for every item identified to be revalued. Most of the items that will be revalued are all fixed and current assets. As for the second step, you will need to know whether it increases or decreases the account. See below for a sample T-Account and some of its explanation.
The third step is to open up a Revaluation Account. This is the double entry for the T-account that you have opened in the first step. Revaluation account will be the reverse of any increase and decrease to the T-account. In the example above, the increase of $2,000 will be posted into the credit side of a Revaluation account (remember double entry!) At the end of the revaluation account, you will need to arrive at profit or loss on revaluation.
*If you are really good at double entry, you can start this step straight, but I do not really recommend this method because of the tendency to make more mistakes. If you still want to start from this step, do make sure you actually sketch T-accounts in question papers just to map out where the entries are.
The fourth step is to calculate whether or not you are making a profit or loss from the revaluation exercise. If there is more debit than credit, then it’s a revaluation loss, otherwise, it’s a revaluation gain (see Note 1 below).
Finally for the last step, apportion the profit or loss of revaluation according to the partners’ profit and loss sharing ratio (see Note 2 above).
This topic is an easy topic to score. However, in order to score well, you will need to know
- The entries well.
- Remember the format for Revaluation Account and calculate the profit or loss on revaluation.
- Remember to open up Partner’s Capital Account to show the profit or loss of revaluation to their capital. (Remember to read the question carefully, you may or may not be required to open this Capital Account).