Terms Beginning With 'r'

Revaluation

What is meant by revaluation?

Revaluation refers to deliberately exerting an upward pressure on the prices of goods, assets and even currencies. In accounts, revaluation may refer to readjustments made to the prices of commodities and assets. For a central bank, revaluation refers to applying an upward pressure to the exchange rate.

Countries that maintain a fixed exchange rate can adjust the value of their currency against a baseline. This baseline can be another currency or the value of a commodity like gold. Revaluation can be understood as the opposite of devaluation, wherein countries deliberately decrease the value of their domestic currency against the baseline.

Revaluation and devaluation cannot occur in a floating exchange rate system where the exchange rate is determined by market forces. In a floating exchange rate system, there is minimal to no intervention by the government or central bank of a country in increasing or decreasing the value of their currency.

How is revaluation carried out?

If the exchange rate of Country A is maintained at 10:1, then the home country can simply announce that the value of the domestic currency will be revalued to 2:1. This would increase the value of the domestic currency. Further, if the central bank announces that the exchange rates are being maintained at 12:1, then this is called devaluation.

Countries may also choose to revalue their currency by changing the supply of foreign currency reserves in their country. Changing the supply of foreign currency affects the exchange rate.

Consider the following example depicting the exchange rate determination of Dollar in terms of Euro. The supply of Euro is the quantity of Euro available as foreign exchange with the US, while the demand for Euro reflects its demand in the US. Here, Dollar is the domestic currency and Euro is the foreign currency.

In the above diagram, the supply of Euro in the economy is increasing, while the demand for Euro remains the same. As more units of Euro are kept as foreign exchange, Euro depreciates while Dollar appreciates. This is how countries can influence the value of the currency by changing the supply of foreign exchange reserves.

What is the effect of a revaluation?

If the exchange rate of country A is maintained at 7:1, then it can be said that 7 units of domestic currency are required to get one unit of foreign currency. However, when the exchange rate is revalued to 5:1 then it means that now only 5 units of domestic currency are required to get one more unit of the foreign currency.

This means that the foreign currency has lost its value as it has become cheaper, while the domestic currency has gained value as it is more expensive. Lesser units of domestic currency must be foregone to get the same amount of foreign currency.

A revaluation would impact the domestic currency in the following ways:

  • Exports become more expensive: As the value of domestic currency rises compared to a foreign currency, exports become more expensive. This would end up hurting the country as exports would decline.
  • Imports become cheaper: Domestic consumers would prefer cheaper imports over domestic goods because the value of foreign currency is less. Thus, there would be a decline in net exports.
  • Lower inflation: Inflation would decline as lesser amount of cash would hold greater value than before. Therefore, purchasing power of domestic currency would increase and lesser units of currency would be required to purchase the same amount of money.
  • Lower Economic Growth: As the demand for domestic goods falls domestically as well as internationally, the overall output in the economy would also fall. This could lead to lower productivity and therefore, lower economic growth and lesser number of jobs would be available in the economy.
  • Current Account Deficit: As imports increase and exports decline, the current account balance would decrease. This would have a negative impact on the Balance of Payments of the domestic country.

Why do countries revalue their currency?

  • Interest Rates: Interest rates are a major factor influencing the demand and supply of foreign exchange reserves with a country. As the interest rates in a country increase, there is greater demand for the currency of that country. This happens because investors would have an incentive to invest in that country rather than in their own. Interest rate changes between countries could lead to one country revaluing its currency to keep it at par.
  • Consider the case when interest rates in the UAE are higher than in Saudi Arabia. Then the demand for UAE’s Dirham would increase, thus, Dirham would appreciate, and the Saudi Riyal would depreciate. To increase the value of the Riyal, the Saudi Arabian government, under a fixed exchange rate system, would revalue their currency.
  • Current Account Surplus: Countries might look at revaluation when they experience a current account surplus and want to reduce it. A current account surplus could lead to lower domestic employment if it is caused by a recession or a lack of demand.
  • Containing Inflation: Currency revaluation can be used to countries to contain inflation. Revaluation reduces the value of currency, thus, leading to a downward pressure on prices.

What is meant by Balance of Payments or BOP? Balance of Payments refers to the record of transactions maintained by a country with the rest of the world. It is a detailed list of international transactions that a country has with its trading partners. These transactions can be made by the residents, domestic businesses or by the government. In an ideal situation, the sum of all the elements of BOP should be zero. However, this is rarely witnessed as most countries do not have the exact same amount of inflow as that of outflow. The inflow and outflow from the rest of the world, can be with respect to goods, services, assets, investments, etc. Notably, a deflection from the ideal zero BOP state may not always be harmful. A surplus (positive BOP) might indicate a strong economy as it means exports are greater than imports. While, a deficit (negative BOP) might point to an increased debt on the home country. The Balance of Payments is highly reflective of the economic strength of a country. Most of the impacts of BOP are indirectly observed on various macroeconomic indicators. What are the Components of BOP? BOP comprises of two broad components, namely, Current Account and Capital Account. Sometimes the Capital Account is referred to as the Financial Account, along with a separate capital account. The Financial Account includes transactions in financial instruments and central bank reserves. While the capital account includes transactions in capital assets. A balance in inflow and outflow of all these accounts makes for a BOP equal to 0. CURRENT ACCOUNT: In technical terms, Current Account is the sum of Balance of Trade, Factor Income (net income from foreign investments) and unilateral transfers (net gifts and grants received). Put simply, current account records the transactions done in goods and services, investments and the net transfer payments or unilateral payments. Exports are maintained as credits, while imports are maintained as debits in the balance of payments. A positive current account balance means that the domestic country is a net lender, while a negative current account balance indicates that the home country is a net debtor. According to the double-entry accounting method, any entry on the export side would be adjusted with an appropriate entry on the import side. For example, for a good exported by the home country to a foreign country, the corresponding import transaction would be the inflow of foreign currency received in exchange for the good exported. CAPITAL ACCOUNT: The capital account involves all transactions relating to international asset It involves transactions made in the reserve account as well as loan payments and investment made across nations. These loans, however, do not include the future stream of interest or dividend payments as they are a part of current account. This is so because they form a part of nation’s spending or income, depending on the type of flow. A capital account is said to be in deficit when a country purchases more assets than the assets it sells to the rest of the world. An increase in assets is followed by a corresponding decrease in cash and vice versa. In some countries, the capital account is known as the financial account and has separate component called the capital account. This capital account records the transactions that do not affect the income, production or savings like international transfer of trademarks and rights, etc. What do BOP deficit and surplus mean for the home country? In layman’s language, BOP tells us whether the country is earning enough to meet its expenditure. If there is a deficit, then it can point towards the country’s growing expenses which are not sufficed by the income generated. Thus, there is a need to generate debt in order to fund the current requirements. Many a times the need to repay current debt gives rise to more debt. Therefore, an endless cycle of financing previous debt with current period loans takes place. The credit received from the rest of the world is generated either by taking a loan, which adds as a liability in the accounts or by selling off the assets currently possessed by the country. These assets can be natural resources, land, commodities, etc. A surplus on the other hand means that a country is exporting more than it is importing in all its existing BOP accounts. This can be a positive sign in most instances as it points towards stronger economic movements. A surplus can encourage the home country to invest in production of goods and services and in turn promote GDP growth. However, an export-driven growth in the long run could point to lack of sufficient demand in the home country. In such a case, the government should boost consumer spending in home country in order to become more self- reliant.   What are the factors affecting BOP? BOP depends on various factors. These include: The domestic exchange rate: Exchange rate is a measure of foreign currency with respect to the domestic currency. Governments can revalue or devalue the exchange rate with the help of appropriate policies. This affects the BOP by making exports cheaper as the exchange rate falls and making imports cheaper when the exchange rate rises. The spending capacity of domestic consumers: As businesses and households are left with greater disposable income, they can spend more on imports and this can affect the BOP. Price competitiveness offered by domestic goods: For a country that is going through higher rates of inflation than its trading partner, the goods and services offered by it would be relatively more expensive. Thus, the country becomes less competitive in terms of price competitiveness. The country with lower inflation would thus have cheaper exports. In such a case, domestic consumers would prefer foreign goods and services causing increased imports and eventually a BOP deficit. Domestic policies: Trade based taxes and tariffs are a huge influencer on the BOP. Policies boosting exports are always beneficial to a country. It is important to pay attention to imports by imposing restrictions using tariffs or quotas. Apart from trade centric policies, domestic policies aimed at economic growth may cause changes in BOP. For instance, increased interest rates can promote FDI in the home country, which would affect the Current Account in BOP.

Revaluation Reserve is generally a line item on the company?s balance sheet for keeping a reserve account for a certain asset. Companies typically use the revaluation reserve when the market value of an asset largely fluctuates against the change in currency relationships.

What is Meant by Devaluation? Devaluation refers to the act of deliberately decreasing the value of the domestic currency with respect to the currency of a trading partner. It is different from depreciation in the sense that it is done on purpose by the domestic monetary authority. The opposite of devaluation is revaluation, where the value of the domestic currency is deliberately increased. Countries having a fixed exchange rate system, or a semi-fixed exchange rate system can use devaluation. The decision to devalue or revalue the currency is taken by the central bank of a country or the monetary policy authority. How do Countries Devalue their Domestic Currency? Consider the following example showing the determination of the exchange rate of Dollar in terms of Euro. In other words, the exchange rate here represents the Dollar-Euro exchange rate. The supply of Euro refers to the quantity of Euro available as foreign exchange, while the demand for the Euro reflects its demand in the domestic country. Related Read on Forex Trading! Considering the above diagram, the supply of Euro in the economy is increasing, while the demand for Euro remains the same. As more and more units of Euro are accumulated as foreign exchange, Euro depreciates while Dollar appreciates. Now consider the following example when the domestic demand for Euro rises. Here the increased demand for Euro leads to Dollar depreciating with Euro appreciating. Thus, the Dollar-Euro exchange rate rises. Therefore, it is possible to change the value of the domestic currency with respect to foreign currency by changing the supply of foreign exchange reserves of the latter. This method is used by central banks of various countries to devalue or revalue their domestic currency. If the current exchange rate is maintained at 2:1, then the home country can just announce that the value of the domestic currency will be devalued to 10:1. This further decreases the value of the domestic currency. Why do Countries Decide to Devalue their Currency? Devaluing domestic currency decreases its value with respect to a foreign currency. This means that if previously, 20 Dollars could be bought in exchange for 1 unit of the domestic currency, after devaluation, one unit of domestic currency would be equal to less than 20 Dollars. Devaluation is a quick and risky way for countries to come out of debt. It is also done to boost exports, as the domestic goods become relatively cheaper as compared to the goods of the trading partner. Further, it makes imports more expensive, as the foreign currency seems to have gained value with respect to domestic currency. This urges domestic consumers to prefer domestic goods instead of imports. As imports fall and exports rise, the current account strengthens and deficits in the Balance of Payments can be recovered. Moreover, devaluation allows countries to make the domestic products competitive with respect to foreign produce. It offers an edge over internal devaluation which relies on implementing a deflationary policy. These advantages offered by devaluation can be misused by countries as they try to reduce the debt burden on them. As countries usually borrow from each other, the amount of interest that they must repay to the lenders depends not only on the interest rate but also on the foreign exchange rate. As the domestic currency becomes cheaper, the foreign country can repay a larger amount of debt with the same amount of foreign currency. For instance, as the USD becomes cheaper, the European nation can repay a larger amount of debt with the same amount of foreign currency. What are the Challenges Faced by the Economies which Devalue their Currency? Inflation: The biggest issue that arises because of devaluation is inflation. As the aggregate demand increases in the economy because goods become cheaper, demand-pull inflation takes its course. This may also lead to lack of productivity in firms as they enjoy price competitiveness due to devalued currency. Travel: Foreign travel is hampered as it becomes relatively more expensive to go on a foreign tour. This may affect the tourism industry in the home country along with the foreign country. Real Income: Inflation and devaluation both reduce the purchasing power of domestic consumers. Investment: Foreign investors would be wary of depositing funds in the home country as they would not enjoy the same amount of returns as before. How should Devaluation be Implemented? Under tight circumstances when a boost to aggregate output is much needed, then devaluation can be implemented. However, an economy that sees prolonged devaluation can be an underperforming economy. Devaluation is used as a regulation tool; however, if it is misused by one country, other countries might be tempted to retaliate. This could lead to a trade war, which would further be a threat to global economic growth. International asset market would take a hit, and it may lead to a global recession. The Year 2019 observed escalation of a trade war between the US and China. To Read More on the US-China Trade War, Click Here! The devaluation could prove to be more harmful than beneficial as it can cripple the domestic markets. Thus, implementing it for a short period of time could be a good solution; however, in the long run, other alternatives should be adopted.

What is Amortisation of Intangibles? Amortisation of an asset refers to an accounting process of spreading cost of an intangible asset over its useful life. Amortisation is applied alongside Depreciation to expense the cost of capital investments made in assets that are capitalised on balance sheet. Similar to Depreciation, it allows businesses to lower the tax liability since it is recorded on income statement as an expense. Intangible assets are recognised when cost of the asset is measurable, and future economic benefits are likely. A business should be able to measure cost of intangible asset to capitalise on balance sheet. Despite no physical substance, it should have legal rights over the asset and ability to transfer ownership. Intangible assets are expected to generate future economic benefits for an enterprise. Future economic benefits such as an expected increase in operating revenue of the company. Consider ABC Ltd has a five-year license to export specific goods in Japan, therefore ABC Ltd can generate sales through the license.   But sometimes firms can develop intangible assets internally. Generally, it is research and development. Firms cannot capitalise expenses of a potential asset during the research, and expenses are recorded in income statement. During the development phase, firms can capitalise the expenses after: Internally generated goodwill is never capitalised, and goodwill can only be recognised during a business combination. Firms may generate intangible assets internally, but they should be able to measure cost to capitalise it. How are intangible assets measured? An enterprise can separately purchase an intangible asset, which is recorded at cost. Internally generated assets should be able to meet above criteria (image), and others are mostly measured at fair value. Cost of the asset includes the purchase price of the asset including any non-refundable expenses and excluding discounts. It also includes directly attributable expenses such as delivery and handling costs, installation costs, consulting fee etc. Costs will be capitalised when firms acquire asset or internally generate an asset through above criteria (image). A firm is also required to measure the asset in subsequent periods. Cost and revaluation models are applied to measure intangible in subsequent periods. In cost model, the asset is recorded at cost less accumulated amortisation and any impairment loss. In revaluation model, the asset is recorded at fair value minus accumulated amortisation and any impairment loss. Revaluation model is used when the firm can measure the fair value of the asset, which can only be measured in case of an active market for the asset. How are intangibles assets amortised? Intangible assets are amortised over the useful life. The amount of amortisation allocated to each year is the cost of the asset less residual value. It is important to have a useful life for the asset to allocate amortisation expense each year. After arriving at the useful life of the asset, firms may use any method of amortising an asset like the straight-line method, accelerated method or units of production method. The expected life of the asset can be estimated by assessing the longevity of the asset to produce gains for the firm. Businesses are also required to test the useful life of the asset each year since developments in the ecosystem could impact the life of the asset. For instance, a significant deterioration of a brand’s market share.   What about indefinite life of intangible assets? Firms do not amortise assets that have an indefinite life, which are tested for impairments each year, and impairments are charged over the asset when required. In the event of sale of an intangible asset, it can be derecognised. Firms can also derecognise intangible asset when future economic benefits are not viable. Amortisation of goodwill – the debate continues IAS 38 says that internally generated goodwill should not be recognised as an asset since it is not identifiable and measurable. But goodwill arising due to business combinations is recognised and capitalised under IFRS 3 Business Combinations. IFRS 3 roughly says that goodwill is measured as the difference between consideration of the business and fair value of separable net assets acquired during the transaction. Just like intangibles with an indefinite life are tested annually for any potential impairments, purchased goodwill is also subject to annual impairment testing. Stakeholders and investors have been critical of the annual impairment approach used by corporations to evaluate accumulated goodwill. They noted that businesses are recognising impairment losses ‘too little, too late’. Consider a distressed business is acquired by a high performing business, the subsequent impairment test will be conducted on the combined entity, resulting in higher levels of internally generated goodwill. Although internally generated goodwill is not recognised in the balance sheet, it creates a premium as a difference between the book value of the net assets of combined entity compared to market value of combined business. Since combined entity has higher internally generated goodwill, there is no impairment charged, but the combined entity also has a distressed business in its books. The topic is also getting attention as impairment testing requires significant estimates and judgements that includes measurement of future cash flows. Management can also influence the timing and scale of impairment. In 2004, the impairment approach to goodwill valuation was introduced. Before that, goodwill used to be amortised, assuming that life is not more than 20 years. It was also required to test goodwill for impairment purpose under certain circumstances. Proponents of amortisation of goodwill say that using amortisation allows to avoid complexities involved in impairment testing and provide a steady decline in the recorded value of goodwill. Likewise, a steady charge to goodwill would alleviate the fluctuations of reported profits. The International Accounting Standards Board is conducting 2020 agenda consultation, and responses are welcomed by the body until 31 December 2020.  

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