Simplifying land and building valuations for financial reporting

Simplifying land and building valuations for financial reporting
August 8, 2019 Malcolm Ashby

It’s that time of year when so many organisations are preparing their annual accounts along with their valuations of land and building assets.

And so many organisations struggle with the complexity and compliance with the relevant accounting standards, especially if having to queries to external auditors.

But like most things, with the right help, it needn’t be difficult.

The valuation of property for Financial Reporting is regulated for Accounting purposes by a number of definitions provided by the Australian Accounting Standards Board, more particularly in standards including AASB 13, 116, 136 and 140. The definition of value is termed “Fair Value”.

In accordance with AASB 13 Fair Value Measurement, land and building assets are to be measured on the fair value basis and is defined as follows.

“This Standard defines fair value as 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.”

And the measurement of Fair Value is defined as follows:

“A fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date under current market conditions.”

And

“An entity shall measure the fair value of an asset or a liability using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest.”

Entities will also need have regard to the asset’s highest and best use as follows:

Highest and best use is determined from the perspective of market participants, even if the entity intends a different use. However, an entity’s current use of a non-financial asset is presumed to be its highest and best use unless market or other factors suggest that a different use by market participants would maximise the value of the asset.” 

This means that if the current use value is lower than the Highest and Best Use then the higher value will prevail.

There are various techniques to the valuation of land and building assets described in the standards as follows:

Market Approach: “The market approach uses prices and other relevant information generated by market transactions involving identical or comparable (ie similar) assets, liabilities or a group of assets and liabilities, such as a business. “

Cost Approach: “The cost approach reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost). 

From the perspective of a market participant seller, the price that would be received for the asset is based on the cost to a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. That is because a market participant buyer would not pay more for an asset than the amount for which it could replace the service capacity of that asset. Obsolescence encompasses physical deterioration, functional (technological) obsolescence and economic (external) obsolescence and is broader than depreciation for financial reporting purposes (an allocation of historical cost) or tax purposes (using specified service lives). In many cases the current replacement cost method is used to measure the fair value of tangible assets that are used in combination with other assets or with other assets and liabilities.”

Income Approach: “The income approach converts future amounts (eg cash flows or income and expenses) to a single current (ie discounted) amount. When the income approach is used, the fair value measurement reflects current market expectations about those future amounts.”

In practical terms, where there is considered to be an “active and liquid” market for the asset, a market approach is to be taken. The assets in this class tend be standard properties that are readily traded and commonly residential, commercial or industrial premises. These valuations can be slightly different from the standard Bank or “mortgage valuation”. When a property is owner occupied, the mortgage valuation is required to treat the property as being vacant. When this is the case the valuer, when using the capitalisation approach, are required to take account of vacant possession and allow for a letting-up period, leasing fees and holding costs. In the Financial Reporting situation the Fair Value is calculated using an estimated market rent and then capitalised at a market yield and no deductions are made for a letting up period, leasing fees or vacancies. This could affect the valuation by as much as 5% or even more.

The Depreciated Replacement Cost (DRC)method represents the replacement cost of the building/component after applying an appropriate depreciation rate, on a useful life basis after making adjustments for condition and general maintenance. The DRC method is used where the market approach is not suitable as the asset is rarely sold except as part of a continuing business, or alternatively, the improvements are of a specialised nature and the market buying price would differ materially to the market selling price as the asset is normally bought as a new asset but could only be sold for its residual value. Some examples include specialised council or government assets such as sporting grounds, civic buildings, schools and hospitals.

For help with your financial reporting valuations, whether for one property, or a large portfolio, please click on the button below and we’ll be in touch shortly.

 

For help with your financial reporting valuations, whether for one property, or a large portfolio, please contact us today.