The balance sheet update consists in the revaluation of the assets that are part of the balance sheet, with the intention of reflecting the actual real value of said items, depending on the increase in the cost of living due to inflation or price increases.
A balance sheet reflects the book value of the assets of a company. This value usually consists of the cost of acquiring the item, so it does not change over the years. With the balance sheet update, the balance sheet is intended to reflect the real value of the assets of the company and not the cost of acquiring them.
Reasons for balance update
One of the main objectives of the balance sheet is to reflect a faithful image of the company’s assets. However, as we have said before, the most common is that the balance sheet elements are valued by the acquisition cost rule. But the following case may occur: a building acquired fifteen years ago whose acquisition cost was € 150,000 and its current market value is € 250,000. On the balance sheet this building is valued at € 150,000, but its current value is € 250,000. Therefore, the balance sheet is not reflecting a faithful image of the company’s assets. With the balance update you try to alleviate this.
On the other hand, with the balance sheet update the company’s equity situation is reinforced. This is because the balance sheet elements increase in value, so the company’s net worth also increases in value. This allows a double improvement in the financing of the company:
- Improvement in the company’s internal financing, due to this increase in net worth.
- Improvement in the external financingof the company, since an improvement in the patrimonial situation of the company also increases the guarantees that can be offered for the request of external financing and, therefore, it will be easier for financial institutions to lend money to this business.
Finally, the State also usually benefits from this balance sheet update. It is common for the revaluation of assets to be associated with a tax or a tax burden, which is usually lower than the income tax. In the previous example of the building, the acquisition cost was € 150,000 while the current value is € 250,000, so the revaluation is € 100,000. It is about these € 100,000 on which the tax would be paid, provided that the State expressly provides for it.
How the balance update is carried out
As a general rule, the update of balances by a company is not allowed on a discretionary basis. It is the legislator of each State that, from time to time (depending on inflation during that period), allows the balance sheets to be updated.
In short, a company cannot update a balance at any time. It is necessary that the legislator allows it, by means of the publication of a regulation of update of balances.