All over the world, accounting works with a concept that, until 2008, was rarely used in Brazil: fair value. Under the standard (CPC 46 — CPCs are the Brazilian accounting pronouncements, aligned with IFRS), fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Put simply: it is the price that independent parties, with no favouritism and no rush, would agree to.The idea behind the concept is that the parties are free to negotiate. No one is forced to buy or sell; if the deal happens, it is because both sides accepted that price.In a balance sheet without fair value, assets only lose value over time (through depreciation), and investments would stay recorded at cost, as if they never fluctuated. The real world does not work that way.For financial assets, fair value matters even more, because a company may hold these assets for a long time without trading them, and during that period their value can change considerably.The original wording of Law 6,404/1976 (the Brazilian Corporations Law) did not deal well with this. If a company bought financial assets for R$ 1 million, earning 10% interest a year, after one year they would be worth R$ 1.1 million. But what if there were an unexpected rise and the fair value of those assets reached, say, R$ 1.5 million?Recording fair value requires a counterpart for every change in value. When a company sells for R$ 1,500.00 inventory that cost R$ 1,000.00 and has R$ 200.00 of expenses, the R$ 300.00 profit goes through the income statement and, if it stays in the company, ends up in equity. But what about when an asset gains or loses value without being sold? Where on the balance sheet is that recorded? That is what we will see next.Present value adjustmentThe Present Value Adjustment (AVP, in Portuguese) brings to the balance sheet date the value of rights and obligations that will be received or paid in the future, stripping out the interest embedded in them. The requirement was created by Law 11,638/2007, which amended articles 183 and 184 of Law 6,404/1976, and the topic is governed by CPC 12 (Present Value Adjustment).The goal is to show investors and the market what the company's receivables and debts are worth today, taking into account the time value of money (interest and inflation) and the risks involved.Under the law and CPC 12:long-term assets and liabilities (realisable or payable after the following financial year) must be adjusted to present value;short-term ones too, when the effect is material;the adjustment applies mainly to monetary items with explicit or implicit interest: receivables from credit sales, trade payables, loans and financing.Non-monetary items, such as inventories, property, plant and equipment, prepaid expenses and advances to be settled by delivering goods or services, are generally not adjusted to present value.Example: a store sells an item for R$ 11,000.00 to be received in one year, when the cash price would be R$ 10,000.00. The R$ 1,000.00 difference is embedded interest. On the date of sale, sales revenue is R$ 10,000.00, and the R$ 1,000.00 goes to a contra account of Accounts Receivable (unearned interest), which becomes financial income month by month over the year.A store sells on credit, for R$ 22,000 to be received in one year, a product whose cash price is R$ 20,000. With the present value adjustment, what sales revenue is recognised on the date of sale?Answer: R$ 20,000, with R$ 2,000 recognised as financial income over the year — the difference between the credit price and the cash price is embedded interest; it sits in a contra account of Accounts Receivable and becomes financial income month by month. Recording R$ 22,000 of sales revenue would inflate operating revenue with interest.Fair value and the Equity Valuation Adjustments accountLaw 11,638/2007 created, within equity, the account Equity Valuation Adjustments (Ajustes de Avaliação Patrimonial, AAP) (art. 182, § 3, of Law 6,404/1976). It receives the fair value changes that, under the standards, should not yet go through profit or loss for the period. The most common cases are:financial instruments classified as "fair value through other comprehensive income" (CPC 48, equivalent to IFRS 9), such as shares the company chose to hold in that category;the effective portion of cash flow hedges;translation differences on investments abroad.Note: not every fair value change goes to this account. Financial instruments classified as "fair value through profit or loss" and investment properties measured at fair value have their changes recorded directly in profit or loss for the period, as a gain or loss.Let us look at an investment at fair value. Company "A" bought R$ 100 thousand in shares and, at the time of purchase, classified the investment as measured at fair value through other comprehensive income. At the end of the period the shares had risen 30% and were worth R$ 130 thousand.How does company "A" record this? It increases the investment in assets from R$ 100 thousand to R$ 130 thousand. The counterpart, on the other side of the balance sheet, is the Equity Valuation Adjustments account in equity, which receives the R$ 30 thousand gain. When the shares are sold, this amount is transferred within equity itself (to retained earnings), without going through profit or loss. If the investment were an interest-bearing security, the interest would still go to profit or loss as financial income, and only the change beyond it would stay in AAP.Investment propertyInvestment property is real estate (land or a building) that the company does not use in its operations: it holds it to earn rent, to profit from appreciation and sell it in the future, or both. The sale may happen soon or take several financial years.Under CPC 28 (equivalent to IAS 40), the company chooses to measure these properties at cost or at fair value. If it chooses fair value, increases and decreases in value are recognised in assets and, as the counterpart, in profit or loss for the period (as a gain or loss), not in Equity Valuation Adjustments.Example: a company bought a five-storey office building for R$ 1 million, intending to sell it once it appreciates. At year end, the building's fair value had fallen to R$ 700 thousand. The building is now carried at R$ 700 thousand in assets, and the R$ 300 thousand decrease goes to profit or loss as a loss, reducing profit.Note: the figure above records the R$ 300,000 loss in value in Equity Valuation Adjustments (Ajustes de Avaliação Patrimonial), which is wrong under CPC 28. The correct entry is the one in the text: the loss goes to profit or loss for the period.Leased assets: control without ownershipWhen we talk about an asset, the item may or may not belong to the company; that is why we speak of ownership or control. But can there be control without ownership?Yes. An asset can be used by a company without belonging to it, as happens with leases and rental contracts. The asset may be a property, a machine, a vehicle and so on. Since 2019, under CPC 06 (R2) (equivalent to IFRS 16), the lessee recognises the right to use the asset in assets and the lease liability in liabilities. The old distinction between operating and finance leases now exists only for the lessor.The right-of-use asset is measured at cost and depreciated over the contract. If the market value of the leased machine rises by, say, R$ 60 thousand, nothing changes in the lessee's books: the financing stays the same and this increase is not recorded, neither in assets nor in Equity Valuation Adjustments. In Brazil, since Law 11,638/2007, upward revaluation of property, plant and equipment is also not allowed.Note: the figure above shows the leased machines revalued to R$ 300,000, with R$ 60,000 in Equity Valuation Adjustments. This entry is not allowed (CPC 06 and Law 11,638/2007). The correct treatment is the one in the text: the right-of-use asset stays at cost less depreciation, and the increase in value is not recorded.A company measures an investment property at fair value. The property cost R$ 800 thousand and is now worth R$ 950 thousand. Where does it record the R$ 150 thousand increase?Answer: In profit or loss for the period, as a gain — under CPC 28, in the fair value model changes in investment property go to profit or loss. The Equity Valuation Adjustments account receives, for example, changes in financial instruments classified as fair value through other comprehensive income.DepreciationDepreciation is the way to spread the cost of an item of property, plant and equipment (machinery, vehicles, computers, furniture, buildings) over the periods in which it is used. It recognises that use, wear and obsolescence reduce, over time, the item's ability to generate benefits for the company. The accounting rules are in CPC 27 (Property, Plant and Equipment, equivalent to IAS 16). Land, as a rule, is not depreciated.So depreciation gradually moves the value of the asset from the balance sheet to the DRE (Demonstração do Resultado do Exercício, the Brazilian income statement), as an expense (or as a production cost, when the asset is used in the factory).Think of a computer. Over time, wear and technological progress reduce its usefulness. Keeping the computer in assets at its purchase price forever would not make sense. Depreciation recognises this loss of usefulness.To calculate depreciation by the straight-line method, three steps are needed:estimate the asset's useful life, in months or years;estimate the residual value, that is, how much the company expects to get for the asset at the end of its useful life;calculate the depreciation for the period with this information.Let us consider a computer bought for cash at R$ 3,100.00. On purchase, the entry is:Dr – Computers (Property, Plant and Equipment): R$ 3,100.00Cr – Cash: R$ 3,100.00Suppose the computer has a useful life of five years (60 months) and that, at the end of this period, the company expects to sell it for R$ 100.00. The residual value is therefore R$ 100.00. Monthly depreciation is calculated as follows:\[ \text{Monthly depreciation} = \frac{\text{Purchase price} - \text{Residual value}}{\text{Useful life in months}} \]\[ \text{Monthly depreciation} = \frac{3100 - 100}{60} = 50 \]This means that every month the company recognises R$ 50.00 of depreciation expense. After 60 months, accumulated depreciation will be R$ 3,000.00 (60 × R$ 50.00), and the computer will appear on the balance sheet only at its residual value of R$ 100.00.The monthly entry is:Dr – Depreciation Expense (income statement): R$ 50.00Cr – Accumulated Depreciation (contra account to Property, Plant and Equipment): R$ 50.00Note that the credit is not made directly to the Computers account, but to Accumulated Depreciation. This way, the balance sheet keeps showing how much the asset cost and, just below it, how much has already been depreciated. Each month Accumulated Depreciation increases by R$ 50.00. The depreciation rate is 20% a year (1/5 of the depreciable amount, or about 1.67% a month), calculated on the depreciable amount of R$ 3,000.00, not on the cost of R$ 3,100.00.For tax purposes (deduction for income tax), the Brazilian Federal Revenue publishes annual depreciation rates by type of asset in Annex III of RFB Normative Instruction No. 1,700, of March 14, 2017. The table lists each type of asset and its rate (computers, for example, 20% a year, or five years). In the accounts, however, useful life must reflect the expected use of the asset in the company and be reviewed at least at the end of each financial year (CPC 27). When the accounting useful life differs from the tax one, the difference is tracked in the Lucro Real (actual-profit regime) tax calculation.A machine cost R$ 50,000, has a useful life of 5 years and an estimated residual value of R$ 5,000. Under the straight-line method, what is the accumulated depreciation after 18 months of use?Answer: R$ 13,500 — the depreciable amount is 50,000 − 5,000 = 45,000; divided by 60 months it is R$ 750 a month; times 18 months, R$ 13,500. The R$ 15,000 figure comes from forgetting to deduct the residual value.How depreciation appears on the Balance Sheet and the DREThe two balance sheets above come from public exam questions. Cia. Alfa's follows the model used before Laws 11,638/07 and 11,941/09: it still shows Deferred Assets and Prepaid Expenses for the Following Year, which no longer exist under those names. What matters here is seeing accumulated depreciation as a contra account, right below property, plant and equipment.Accumulated Depreciation is a contra-asset account: it appears in Non-Current Assets, in the Property, Plant and Equipment group, with a credit balance, right below the asset it relates to. The asset's net value (carrying amount) is cost minus accumulated depreciation. For the entry, remember:Dr – Depreciation Expense (DRE)Cr – Accumulated Depreciation (contra account to Property, Plant and Equipment)In the DRE, depreciation expense reduces profit for the period. At year end, the result is transferred to equity: if there is a profit, it will be smaller because of depreciation; if depreciation and other expenses exceed revenue, the result is a loss, which appears in equity as accumulated losses. Even an idle company with no sales keeps recording depreciation on its assets, and this expense goes into the result even if it produces a loss.Remember that depreciation is not a cash outflow: the cash left when the asset was bought. That is why, in the Statement of Cash Flows under the indirect method, it is added back to profit.Where does the Accumulated Depreciation account appear on the Balance Sheet?Answer: In non-current assets, with a credit balance, reducing property, plant and equipment — it is a contra-asset account: the balance sheet shows the cost of the asset and, right below it, how much has already been depreciated. What appears in the DRE is the depreciation expense for the period, not accumulated depreciation.Exercises1) (Fundação Getulio Vargas - FGV - 2023) On 01/01/X0, a public-sector hospital acquired a vehicle for R$50,000 to use as an ambulance. The hospital estimated that it would use the ambulance for 3 years and then sell it for R$20,000. On 12/31/X0, after recording the depreciation expense, the hospital reviewed the ambulance's residual value and found that it could be sold for R$40,000 at the end of its useful life. Select the option that indicates the ambulance's depreciation expense on 12/31/X1.A) Zero.B) R$5,000.C) R$10,000.D) R$20,000.E) R$25,000.2) (Centro de Seleção e de Promoção de Eventos UnB - CESPE CEBRASPE - 2022) Depreciation will be interrupted when the asset is temporarily withdrawn from use. True or False?3) (Fundação Carlos Chagas - FCC - 2022) A public entity received from the supplier, on 09/01/2021, a new vehicle acquired for R$ 72,000.00. On that same date, the vehicle was put into use by the entity and its useful life and residual value were estimated, respectively, at 6 years and R$ 7,200.00. To record the depreciation of the vehicle for September 2021, calculated by the straight-line method, the entity made, in the Chart of Accounts Applied to the Public Sector (PCASP), an entry as aA) credit to an account belonging to class 1 in the amount of R$ 900.00.B) debit to an account belonging to class 1 in the amount of R$ 1,000.00.C) debit to an account belonging to class 3 in the amount of R$ 1,000.00.D) credit to an account belonging to class 3 in the amount of R$ 900.00.E) debit to an account belonging to class 4 in the amount of R$ 1,000.00.4) (Fundação Getulio Vargas - FGV - 2022) A public entity acquired equipment on 07/01/20x0 for use in a health unit. The price of the equipment was R$ 345,000.00, payable in three instalments due in 60, 90 and 120 days, respectively. The cash price of the equipment would be R$ 300,000.00. The entity's policy is straight-line depreciation and it estimated a useful life of twelve years for the equipment, with a residual value of R$ 15,000.00. Based on the information in text 1 and on the provisions of the MCASP (Brazilian Public Sector Accounting Manual) on Equity Accounting Procedures, the annual depreciation charge for the equipment is:A) R$ 23,750.00;B) R$ 25,000.00;C) R$ 26,875.00;D) R$ 27,500.00;E) R$ 28,750.00.5) (Fundação de Apoio ao Desenvolvimento Unicentro - FAU UNICENTRO - 2022) Suppose a Public Company acquired a machine to be used for paving the city's streets. The equipment was acquired on 03/02/2021 for R$ 660,000.00 and went into operation the following day. The machine's residual value, after its useful life, is R$ 120,000.00. The machine's estimated useful life is 10 (ten) years. Select the net book value of the asset in the Public Company's accounts, net of accumulated depreciation, on 12/31/2021:A) R$ 485,000.00.B) R$ 495,000.00.C) R$ 605,000.00.D) R$ 615,000.00.E) R$ 630,000.00.6) (Fundação de Apoio ao Desenvolvimento Unicentro - FAU UNICENTRO - 2022) On 07/01/2021, the City Hall acquired a vehicle for use by the Municipal Department of Public Works. The amount paid for the asset was R$ 600,000.00. The vehicle went into use on the same day it was acquired. The asset's useful life was set at 05 (five) years and its depreciation is calculated by the straight-line method, that is, the depreciation amount is uniform throughout its useful life. The residual value of this asset at the end of its useful life was estimated at R$ 240,000.00. Considering the data presented, select the net book value of this asset in the trial balance prepared on 05/31/2022:A) R$ 250,000.00.B) R$ 294,000.00.C) R$ 330,000.00.D) R$ 490,000.00.E) R$ 534,000.00.Answer key with explanations1) A. Depreciation in X0: (50,000 − 20,000) ÷ 3 = R$ 10,000; carrying amount at the end of X0: R$ 40,000. With the new residual value of R$ 40,000, nothing is left to depreciate in X1.2) False. Depreciation continues even when the asset is temporarily idle; it only stops when the asset is derecognised or classified as held for sale (under the straight-line method).3) A. (72,000 − 7,200) ÷ 72 months = R$ 900 a month, credited to accumulated depreciation (class 1, assets) and debited to a decrease in net assets (class 3).4) A. Under the MCASP, the asset is recorded at the cash price; the R$ 45,000 difference is interest. (300,000 − 15,000) ÷ 12 = R$ 23,750 a year.5) D. (660,000 − 120,000) ÷ 10 = R$ 54,000 a year, or R$ 4,500 a month. From March to December there are 10 months: R$ 45,000. Net value: 660,000 − 45,000 = R$ 615,000.6) E. (600,000 − 240,000) ÷ 60 months = R$ 6,000 a month. From July 2021 to May 2022 there are 11 months: R$ 66,000. Net value: 600,000 − 66,000 = R$ 534,000.
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