A revaluation reserve is a way of accounting for an increase in the value of a company asset since its last set of accounts. It is designed to take care of the situation that the company's overall balance has increased, but this increase is not technically a profit. In most cases, the extra money gained through the revaluation reserve is not eligible to be distributed to shareholders.
The revaluation reserve is a category in a company's accounts. It is usually used for fixed assets such as land. As and when the company revalues such an asset, any increase is marked up in the accounts.
The most common use of the revaluation reserve comes when there is an increase in the fair market value of an asset. While most assets lose value over time, a concept covered by depreciation, some assets can increase in value. The main example of this is land, which tends to become more valuable over time as the supply of unused land inherently drops. There may be more drastic increases in value if an area becomes more attractive to potential users, for example if a freight railway line opens up near a set of factories.
Different countries have differing approaches to asset revaluation. For example, accounting laws in the United States bar companies from revaluing fixed assets to show an increase, even when there really has been an increase in market value. Other countries allow an upward increase, but require clear details to be made available about how the revaluation was calculated.
Any increase in the company's balance caused by a revaluation is classed as a surplus rather than a profit. This means it is not counted towards profits and the money cannot be distributed to shareholders in dividends. It can be used as part of a scrip issue, in which the company creates new shares and gives them to shareholders in proportion to their current holdings. Accounting rules mean that when a company uses a scrip issue, it must decrease one or more sections of its balance by the total cost of the new shares. The revaluation reserve is one of the sections often decreased to fund a scrip issue.
The revaluation reserve can be used as an ongoing account within the company's financial accounts. If the company revalues an asset to decrease its value, some or all of the money can be deducted from the revaluation reserve. If this isn't enough to cover the entire decrease in value, the remainder of the decrease must be listed as a loss on the main profit and loss account. On the other hand, an increase in value from a revaluation doesn't have to automatically go to the revaluation reserve; some or all of it can be listed as a profit to cover a specific loss from previous years.