Why Revaluation gain and Actuarial Gain & Losses does not sit in P&L instead of Other Comprehensive Income ?
This is one of the most debated questions in accounting theory. The short answer is: To protect the “integrity” of the Profit & Loss (P&L) as a measure of operating performance.
If these gains went into the P&L, they would distort the picture of how the company actually performed that year.
1. Revaluation Gain (IAS 16)
The Scenario: You bought a factory 10 years ago for $1M. Now it is worth $5M. You have a $4M gain.
Why not P&L?
- It is not “Real” Cash (Prudence): You haven’t sold the factory. You are still using it to make widgets. If you put that $4M gain in the P&L, shareholders might demand dividends based on it. But you don’t have the cash—you just have a more expensive building.
- It distorts “Operating” Performance: If your business is making shoes, your P&L should reflect shoe sales. If you include a massive $4M property gain, it looks like you had a record-breaking year, even if you didn’t sell a single shoe.
- The “Held for Use” Logic: Unlike Investment Property (IAS 40), which you hold specifically for capital appreciation (and where gains do go to P&L), a factory is held for use.2 The rise in value is incidental to your business model, not the goal of it.
Key Contrast: If you were a Real Estate Trader, that building would be “Inventory,” and the gain would go to P&L. Since you are a Manufacturer, it goes to OCI.
2. Actuarial Gains & Losses (IAS 19)
The Scenario: Your pension liability drops by $10M because the corporate bond interest rate (discount rate) changed from 4% to 5%.
Why not P&L?
- Massive Volatility (The “Noise” Factor): Actuarial calculations are incredibly sensitive to external market rates. A tiny 0.1% change in interest rates can swing a pension liability by millions.
- Not Management Performance: This change happened because the bond market moved, not because management made good decisions. If this $10M gain went to P&L, the CEO gets a bonus for “high profits” caused entirely by the Federal Reserve/Central Bank changing rates.
- Long-term Nature: Pension obligations last for 30-40 years. Recognizing these massive, temporary swings in the daily P&L distracts investors from the core business trends.
Summary Table: The “Why” Test
| Item | Why is it in OCI? | The Risk if it was in P&L |
| Revaluation Gain (PPE) | Gain is Unrealized and asset is Held for Use. | Investors might think the company has more distributable cash than it really does. |
| Actuarial Gain (Pension) | Gain is due to External Volatility (Rates/Assumptions). | Net Income would swing wildly every year, making it impossible to predict future earnings. |
A “Permanent” Exile?
It is important to note that for both of these items, the gains are effectively “banned” from the P&L forever.
- Revaluation Surplus: Can be moved to Retained Earnings directly (within Equity) when the asset is retired, but never touches P&L.
- Actuarial Gains: Stay in Retained Earnings; never recycled to P&L.
The “Revaluation Surplus” sitting in Equity represents the rest of that profit.
Here is the numerical proof of why the Revaluation Surplus must go directly to Retained Earnings and cannot go to P&L.
Example : –
Imagine you bought a factory for $100. Years later, it was revalued to $150.
Today, you sell it for $160. Total Economic Profit: You bought at 100 and sold at 160. You made $60.
Let’s see where this $60 shows up in your accounts.
Step 1: The Revaluation (Years Ago)
When you revalued from $100 to $150:
- Asset: increased by $50.
- OCI (Revaluation Surplus): increased by $50.
- P&L impact: $0.
Status Check: You have an asset worth $150 and a Revaluation Reserve of $50.
Step 2: The Sale (Today)
You sell the asset for $160.
The P&L Calculation (Gain on Disposal):
Sale Proceeds: $160
(Less) Carrying Amount: ($150) (please note this is the revalued amount)
= Gain on Disposal: $10
This $10 goes to the P&L.
Step 3: The Missing Profit
Wait a minute. You made a total profit of **$60** ($160 sale – $100 cost).
- P&L shows: $10 gain.
- Revaluation Surplus shows: $50 gain.
- Total: $60.
The Crucial Rule:
The $50 sitting in the Revaluation Surplus is a “past” gain. If you recycled it to P&L now, your P&L would show a gain of $60 ($10 disposal + $50 recycled).
But that would be double counting!
Why? Because your Equity is already $50 higher because of the Revaluation Surplus. If you put another $50 into P&L (which flows to Retained Earnings), you would create $50 of equity out of thin air.
Instead, you just move the label:
Dr Revaluation Surplus ($50)
Cr Retained Earnings ($50)
You are simply telling shareholders: “That $50 used to be a ‘paper gain’ (Surplus). Now that we sold the asset, it is a ‘realized gain’ (Retained Earnings). But it is NOT a ‘new’ profit for this year.”
Summary Table
| What happened? | Amount | Where does it go? | Why? |
| Historical Price Increase | $50 | Equity Transfer (Surplus goes to Retained Earnings) | This gain happened years ago. It was already recognized in Equity (OCI). We just unlock it now. |
| Final Sale Bump | $10 | P&L (Gain on Disposal) | This is the only value created this year (the difference between the book value and the cash received). |
| Total Profit | $60 | Split between Reserves & P&L |
Why not just recycle it to P&L?
If you recycled the $50 to P&L, you would be telling investors: “Look! We had a great performance this year, we made $60 profit!“
This is misleading.
- You made $50 of that profit 5 years ago when the market went up.
- You only made $10 of that profit this year.
IAS 16 protects the integrity of the current year’s P&L by forcing you to bypass it for the historical gain.
Discover more from
Subscribe to get the latest posts sent to your email.
Leave a Reply