Just trying to wrap my little, little head around something.
From what I have read both a asset revaluation and an asset impairment reduce ROE and ROA?
I understand taking ROE as an example, an impairment results in lower assets, and lower retained earnings – therefore lower Net Income. An impairment will affect the bottom line (i.e. net income) and therefore retained earnings as well (i.e. equity). Both the numerator and the denominator decrease but the % change in NI will be greater than the % change in equity. Resulting in a lower ROE.
But how does a revaluation upwards result in a lower ROE and ROA? Seems to me it should go up??
Sincerely yours, I need a beer – such sweet nectar
You’re confusing income statements net income with balance sheet book values. Asset impairments are a one time charge, ROA and ROE go up because you have more efficent capital turnover, on paper.
In the year of the impairment, you’ll likely have lower ROA and ROE, not higher; you’ll have higher ROA and ROE in subsequent years.
Generally, total assets is larger than net income, as is total equity; thus, an impairment reduces net income by a greater percentage than it reduces total assets and total equity.
Thanks guys, but what is really confusing me is a revaluation upwards. I read that a revaluation upwards result in a lower ROE and ROA intially. It seems to me it should in fact go up initally. Is that your understanding? Cheers
Hmmmmmmmmmm, so a gain is recognised in the income statement to the extent of the previous recognised loss, beyond that it is recognised in the balance sheet assets as revaluation surplus - applicable for IFRS only, GAAP does not allow revaluations upwards.
Therefore, for ROE and ROA, revlaution upwards would depend on the extend of the revaluation. Am I on the right path here?
Assuming no earlier recognized loss, there would be no gain recognized on the income statement, but assets and equity would both increase; thus, ROA and ROE would decrease: same numerator, bigger denominator.