Definition
A Revaluation Account in accounting is used within partnerships to adjust the value of assets and liabilities when significant changes occur in the partnership structure, such as the admission of a new partner, the death of a partner, or the retirement of an existing partner. This account helps reflect the current market values of the partnership’s assets and liabilities, ensuring equity and fairness in distributing revaluation profits or losses among the partners based on the agreed profit-sharing ratio.
Examples
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Example 1: Admission of New Partner
- Scenario: A partnership of three individuals decides to admit a new partner, John. The existing assets were initially valued at $100,000, but the current market value is $120,000.
- Journal Entry:
- Debit: Asset Account $20,000
- Credit: Revaluation Account $20,000 The revaluation account shows a $20,000 increase in asset value, which will subsequently be distributed among the existing partners according to their profit-sharing ratios.
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Example 2: Retirement of a Partner
- Scenario: Partner David retires from a partnership. The existing liabilities were recorded at $50,000, but the current market assessment places them at $40,000.
- Journal Entry:
- Debit: Revaluation Account $10,000
- Credit: Liability Account $10,000 The revaluation account reflects a $10,000 decrease in liability, which must be adjusted in the accounts and appropriately divided among the partners based on their agreed ratios.
Frequently Asked Questions (FAQs)
1. Why is a revaluation account necessary in a partnership?
- The revaluation account ensures that any changes in asset and liability values due to shifts in partnership structure are accurately captured and equitably shared among partners.
2. How are profits from revaluation distributed among partners?
- Profits or losses resulting from revaluation are distributed according to the pre-agreed profit-sharing ratios outlined in the partnership agreement.
3. What happens if the carrying values of assets and the market values differ?
- The differences are adjusted through the revaluation account, which then reflects a gain or loss that is shared among the partners.
4. Can intangible assets be revalued through the revaluation account?
- Yes, intangible assets such as goodwill can also be subject to revaluation, reflecting their current market value.
5. Is the revaluation account a permanent account?
- No, the revaluation account is a temporary account designed to capture revaluation events; once adjustments are made, its balance is transferred to the capital accounts of the partners.
Related Terms
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Partnership: A business arrangement where two or more individuals share ownership, responsibilities, and profits.
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Assets: Resources owned by a business that have future economic benefits.
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Liabilities: Obligations of a business, representing debts or future sacrifices of economic benefits.
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Profit-sharing Ratio: The agreed proportion in which partners share profits or losses from the partnership.
Online References
Suggested Books for Further Studies
- “Partnership Accounting: Theory and Practice” by Q. L. Jensen
- “Advanced Accounting” by Joe Ben Hoyle, Thomas Schaefer, and Timothy Doupnik
- “Fundamentals of Partnership Taxation” by Stephen Schwarz and Daniel J. Lathrope
Accounting Basics: “Revaluation Account” Fundamentals Quiz
### Why does a partnership use a revaluation account when there is a substantial change in partnership structure?
- [x] To adjust the values of assets and liabilities to current market values.
- [ ] To calculate annual partnership profits.
- [ ] To assess personal partner expenses.
- [ ] To prepare a balance sheet.
> **Explanation:** A revaluation account helps capture the adjustments in assets and liabilities to reflect their current market values during changes in partnership structure such as admission or exit of partners.
### What happens to the revaluation account's balance after revaluation is complete?
- [ ] It is transferred to the profit and loss account.
- [x] It is distributed among the partners based on their profit-sharing ratio.
- [ ] It is retained in the revaluation account permanently.
- [ ] It is reversed in the next accounting period.
> **Explanation:** The revaluation account balance is distributed among the partners based on their profit-sharing ratio to ensure fair division after revaluation.
### When might a partnership choose to revalue its assets and liabilities?
- [x] When a new partner is admitted or an existing partner retires.
- [ ] When partners decide to change the business name.
- [ ] When partners take a personal loan.
- [ ] On a monthly basis for recording purposes.
> **Explanation:** Revaluation occurs typically when there is a structural change in the partnership, such as admitting a new partner or when an existing partner retires or exits.
### What impact does a profit on revaluation have in partnership accounting?
- [ ] Decreases capital accounts of partners.
- [ ] Goes directly into the operational accounts.
- [x] Increases capital accounts of partners as per the profit-sharing ratio.
- [ ] Reflects a cash inflow in the books.
> **Explanation:** Profits from revaluation increase the capital accounts of partners based on the profit-sharing ratio agreed upon.
### If liabilities are found to be less than their recorded amount, the revaluation account will show a:
- [ ] Credit balance.
- [x] Debit balance.
- [ ] No balance since liabilities don't affect revaluation.
- [ ] It leads to creating a new liability account.
> **Explanation:** If liabilities are less, the revaluation account will have a debit balance, indicating a gain or profit on the reduction of liabilities.
### What is the main reason for distributing revaluation profits or losses among partners?
- [x] To ensure fair and equitable adjustment based on the agreed profit-sharing ratio.
- [ ] To set up reserves for future expenses.
- [ ] To comply with tax obligations.
- [ ] To prepare for asset sale.
> **Explanation:** Distributing revaluation profits or losses ensures fair adjustment among partners as per their agreed ratio, thereby maintaining equity.
### What must be assessed to determine the revaluation account entries?
- [x] The current market values of assets and liabilities.
- [ ] The average daily sale figures.
- [ ] The bank balance of the partners.
- [ ] The expenses for the past three months.
> **Explanation:** To make accurate entries in the revaluation account, the market values of the partnership's assets and liabilities must be assessed.
### How frequently is a revaluation account typically used in partnership accounting?
- [ ] Annually
- [x] When significant changes such as partner admission or exit occur.
- [ ] Monthly
- [ ] Quarterly
> **Explanation:** The revaluation account is used when there are significant changes in the partnership structure, ensuring that asset and liability values are up-to-date.
### What kind of account is a revaluation account considered to be?
- [ ] A permanent account.
- [ ] A liability account.
- [x] A temporary book adjustment account.
- [ ] A revenue account.
> **Explanation:** The revaluation account is a temporary account created to reflect adjustments; its balances are eventually allocated to the partners' capital accounts.
### When liabilities are revalued at an amount higher than their book values, the revaluation account will show a:
- [ ] Zero balance.
- [x] Debit balance, reflecting a loss.
- [ ] Credit balance, reflecting a gain.
- [ ] No change since liabilities don't need revaluation.
> **Explanation:** If liabilities are revalued at a higher amount, the revaluation account will reflect a debit balance, indicating a loss due to the increased liabilities.
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