Revaluation, excess depreciation and disposal of a revalued lathe
Ravindu Engineering is a sole trader with a 31 March year end. On 1 April 2019 it bought a computer-controlled lathe for Rs 4,800,000 and depreciated it straight-line over eight years to nil residual value. On 1 April 2022, after three full years of use, an independent valuer put the lathe at Rs 4,200,000 and the remaining useful life was reassessed at five years, residual value nil. The revaluation was brought into the books. On 30 September 2023 the lathe was sold for Rs 1,500,000 because a larger model was required. The accountant was unsure how to treat the matter, so the whole revaluation surplus was credited to the income statement for the year ended 31 March 2023 'because the gain is real', and depreciation for the year ended 31 March 2024 was charged at a full year's rate. The owner's draft statement of financial position at 31 March 2024 therefore shows no revaluation reserve at all, and he cannot explain why profit for 2024 fell so sharply.
1. Compute the revaluation surplus at 1 April 2022 and the depreciation charge that should appear in the years ended 31 March 2023 and 31 March 2024.
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Carrying amount at the date of revaluation
| Item | Rs |
|---|---|
| Cost, 1 April 2019 | 4,800,000 |
| Depreciation 3 years x (4,800,000 / 8) = 3 x 600,000 | (1,800,000) |
| Carrying amount, 1 April 2022 | 3,000,000 |
| Revalued amount | 4,200,000 |
| Revaluation surplus | 1,200,000 |
The surplus is not income. It is credited to other comprehensive income and accumulated in a revaluation reserve within equity, because no realisation has occurred - the machine has not been sold and the gain has not been converted into cash.
Depreciation
- Year ended 31 March 2023: the new carrying amount of Rs 4,200,000 is written off over the revised remaining life of five years = Rs 840,000.
- Year ended 31 March 2024: the asset is held for only six months (1 April to 30 September 2023), so the charge is 4,200,000 / 5 x 6/12 = Rs 420,000. No depreciation is charged after disposal.
The accountant charged Rs 840,000 in 2024, overstating the expense by Rs 420,000.
2. Prepare the lathe disposal account for the year ended 31 March 2024 and state the corrections needed to the accountant's profit figures.
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Lathe disposal account
| Dr | Rs | Cr | Rs |
|---|---|---|---|
| Lathe (revalued amount) | 4,200,000 | Provision for depreciation (840,000 + 420,000) | 1,260,000 |
| Income statement – loss on disposal | 1,440,000 | Bank (proceeds) | 1,500,000 |
| 5,640,000 | 5,640,000 |
Check: carrying amount at disposal = 4,200,000 − 1,260,000 = 2,940,000; proceeds 1,500,000; loss 1,440,000.
Corrections
- The Rs 1,200,000 revaluation surplus must be removed from the 2023 income statement and credited to the revaluation reserve. Profit for 2023 was overstated by Rs 1,200,000.
- The 2024 depreciation charge must be reduced from Rs 840,000 to Rs 420,000; profit for 2024 was understated by Rs 420,000.
Why the loss looks so large: on the original cost basis the loss would have been only Rs 600,000 (proceeds 1,500,000 less carrying amount 2,100,000). The extra Rs 840,000 is the unrealised revaluation surplus being flushed out on sale - which is exactly why the surplus must sit in equity, not in profit, until disposal.
3. Explain the excess depreciation transfer and compute the balance on the revaluation reserve at 31 March 2024 and its treatment on disposal.
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Excess depreciation. If the asset had not been revalued, depreciation would have been Rs 600,000 a year. The revaluation raised the annual charge to Rs 840,000, so Rs 240,000 a year of the charge is a direct consequence of the revaluation. A transfer of that amount each year from the revaluation reserve to retained earnings (a movement within equity, not through profit or loss) realises the surplus in step with the extra depreciation actually borne by the income statement.
Revaluation reserve movement
| Item | Rs |
|---|---|
| Surplus on revaluation, 1 April 2022 | 1,200,000 |
| Transfer y/e 31 March 2023 (840,000 − 600,000) | (240,000) |
| Transfer y/e 31 March 2024 (6 months: 240,000 x 6/12) | (120,000) |
| Balance at date of disposal | 840,000 |
| Transfer to retained earnings on disposal | (840,000) |
| Balance at 31 March 2024 | Nil |
On disposal the remaining Rs 840,000 has been fully realised, so it is transferred directly from the revaluation reserve to retained earnings. It is not routed through the income statement as a gain, because that would double-count the revaluation effect already reflected in the Rs 1,440,000 loss. Presentation in the statement of changes in equity keeps the realised and unrealised elements visibly separate.