VALUATION FOR FINANCIAL REPORTS – ANZ NOTE

Reproduced with permission

This guidance note should be read in conjunction with International Valuation Application 1 (IVA 1) & International Valuation Guidance Note 8 (IVGN 8)

1.0 Introduction
1.1 Purpose
The purpose of this guidance note is to provide information, commentary, opinion, advice and recommendations to Members producing valuations of property, plant & equipment assets (including heritage and infrastructure assets) for use in Australian financial reports and to assist users of those financial reports to understand the basis upon which property, plant and equipment valuations are undertaken.

1.2 Objectives
The objectives of this guidance note are to:
• Provide guidance to Members when preparing property, plant and equipment asset valuations for use in financial reports;
• Assist users of financial reports to understand the basis upon which property, plant and equipment asset valuations are undertaken; and
• Address general concepts and principles for use in the preparation of valuations for use in financial reports.

1.3 Status of Guidance Notes
Guidance notes are intended to embody recognised ‘good practice’ and therefore may (although this should not be assumed) provide some professional support if properly applied. While they are not mandatory, it is likely that they will serve as a comparative measure of the level
of performance of a Member. They are an integral part of ‘Professional Practice’

1.4 Scope
This guidance note applies to Members valuing property, plant and equipment assets for use in Australian financial reports.
This guidance note does not apply where a valuation is undertaken for purposes other than for use in Australian financial reports.

1.5 Development of Accounting Standards
The development of Accounting Standards involves an extensive process, including the preparation and publication of discussion papers and exposure drafts, and extensive industry consultation, by the Australian Accounting Standards Board (AASB).

1.6 Relationship to Accounting Standards
Australian Standards issued by the AASB have the force of the Corporations Law.
1.7 Financial Statements
Financial statements report the assets, liabilities, equity, revenues, expenses (the “elements” of financial statements) and cash flows of the entity.
1.8 Materiality
Accounting Standards are subject to the concept of materiality which is defined to mean “in relation to information, that information which if omitted, misstated or not disclosed has the potential to adversely affect
decisions about the allocation of scarce resources made by users of the financial report or the discharge of accountability by the management or governing body of the entity”.
Members should reflect this concept when completing valuations for financial reporting purposes.

2.0 Accounting Framework
2.1 Introduction
The 2005 AASB accounting standards apply to annual reporting periods beginning on or after 1 January 2005.
This guidance note has been developed to reflect with the adoption of the Australian equivalents to International Financial Reporting Standards.
In the Australian context it is important to consider the relationship between Australian Standards and International Standards.
The International Accounting Standards Board (IASB) was charged with preparing a set of International Financial Reporting Standards in 2000.The intention was to develop a single set of Accounting Standards that would be accepted by capital markets worldwide.
The International Valuation Standards Committee (IVSC), has formulated and published, in the public interest, valuation standards and promotes those standards for worldwide acceptance and observance. IVSC valuation standards have been developed for the procedural guidance of the valuation of assets for a variety of purposes including for use in financial statements and to harmonise standards amongst the world states and bring uniformity.
The IVSC works closely with the IASB and other international bodies such as the International Federation of Accountants, International Organisation of Security Commissions and BASEL Committee on Banking supervision. The IVSC also provides advice and counsel
relating to asset valuation to the accounting profession.
The IVSC has developed International Valuation Standards 7th Edition, 2005, the relevant sections of which comply with the International Financial Reporting Standards as at 1 January 2005. In it’s press release regarding the publication of its new standards dated 9 February 2005, the IVSC stated:
In 2004 the International Accounting Standards Board (ISAB) made a number of significant changes to the Accounting Standards concerned with Real Estate and other fixed assets as part of its own improvements project. The IVSC revised its standards for the 2005 edition to reflect these changes.
The two standards most affected by the revised International Financial Reporting Standards are International Valuation Application 1 – Valuation for Financial Reporting; and International Valuation Guidance Note 8 – The Cost Approach for Financial Reporting – DRC.
In Australia the Corporate Law Economic Reform Program Act of 1999 established the basis for new standard setting arrangements as a part of the Commonwealth Government’s Corporate Law Economic Reform Program.
The Financial Reporting Council is responsible for the broad oversight of the process for setting accounting standards for use in for-profit and not-for-profit public and private sectors. The key function of the Financial Reporting Council is to advise the Commonwealth Government on the accounting standards setting process and development of International Financial Reporting Standards and to
determine the broad strategic direction of the AASB.
The Financial Reporting Council is not able to influence the AASB’s technical deliberations and hence the content of any particular accounting standards.
The International Financial Reporting Standards are adopted in Australia through the Australian equivalents to IFRSs made by the AASB.
The AASB accounting standards that affect the valuation of property, plant, and equipment are summarised as follows: -
• AASB 116 – Property Plant and Equipment;
• AASB 117 – Leases;
• AASB 136 – Impairment of Assets;
• AASB 140 – Investment Property;
• AASB 141 – Agriculture;
• AASB 3 – Business Combinations1; and
• AASB 5 – Non Current Assets Held For Sale and Discontinued Operation.
The table below shows the relationship between the previous and new standards:
Previous Standards Current Standards
AASB 1015 – Acquisition AASB 3 – Business
of Assets Combinations
AASB 116 – Property
Plant and Equipment
AASB 1021 AASB 116 – Property
– Depreciation Plant and Equipment
AASB 1041 – Revaluation AASB 116 – Property
of Non Current Assets Plant and Equipment
AASB 1008 – Leases AASB 117 – Leases
AASB 1010 – AASB 136 – Impairment
Recoverable Amount of Assets
of Non Current Assets
No Previous Standard AASB 140 –
Investment Property
AASB 1037 – Self-Generating AASB 141 – Agriculture
& Regenerating Assets
AASB 1042 – Discontinuing AASB 5 – Non Current
Operations Assets Held For Sale and
Discontinued Operations.

2.2 International Valuation Standards
The International Valuation Standards Committee (IVSC) publication International Valuation Standards 2005, discusses the term Fair Value at paragraph 8.1 (Pg 31-33) of General Valuation Concepts and Principles by stating:
The expression market value and the term fair value as it commonly appears in accounting standards are generally
compatible, if not in every instance exactly equivalent concepts. Fair value, an accounting concept, is defined in international financial reporting standards and other accounting standards as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.
Fair value is generally used for reporting both market and non-market values in financial statements. Where the market value of an asset can be established this value will equate to fair value.

2.3 AASB 116 – Property, Plant and Equipment
This standard prescribes requirements for the recognition, measurement at recognition and measurement after recognition, and de-recognition of property, plant and equipment assets. After recognition as an asset, an item of property, plant & equipment is measured using the cost model or the revaluation model (at fair value).
The objective of AASB 116 is to prescribe the accounting treatment of property, plant and equipment so that the users of any Financial Report may discern information about the entity’s investments in its property, plant and equipment and any changes in such investments.
The standard also prescribes requirements for depreciation of property, plant and equipment assets.
AASB 116 is equivalent to IAS 16 Property, Plant and Equipment issued by the IASB.
Current Australian standards require heritage assets to be recognised as they satisfy the definition of property, plant and equipment. Therefore AASB 116 applies to heritage assets.

    1. Relationship with Other Standards
AASB 116 is related to other standards which consider the Fair Value concept in certain specific areas. Depending on the classification of an asset it may be necessary to consider asset valuation requirements of the following:-

AASB 117 – Leases
It is noted that AASB 117 may apply to the disposal of an asset by way of sale and leaseback.This is important in considering the valuation of an asset by way of sale and leaseback where necessary (Refer definitions under Addendum “A” of IVA 1).

AASB 136 – Impairment of Assets
The main requirement of this standard is to ensure that assets are carried at amounts that are not in excess of their Recoverable Amount. The requirement to test for impairment is the responsibility of the directors of the reporting entity.
The Recoverable Amount of an asset or cash-generating unit is defined as the higher of its Fair Value less costs to sell and its Value In Use.
Value in Use is defined as the present value of future cash flows expected to be derived from the asset or cash-generating unit or, the depreciated replacement cost of the asset (when the future economic benefits of the asset of a not for profit entity are not primarily dependent
on the assets ability to generate net cash inflows and where the entity would, if deprived of the asset, replace its remaining future economic benefit).
The standard also requires that where the Recoverable Amount of an asset is less than the assets Carrying Amount the Carrying Amount of the asset is reduced to its Recoverable Amount and the reduction is an
Impairment Loss.
The standard also requires the immediate recognition of Impairment Loss as an expense in the Profit and Loss for assets carried at cost or in accordance with the revaluation accounting for assets carried out at the revalued amount.

AASB 140 – Investment Property
This standard requires an entity to measure an investment property after recognition at Fair Value or using the Cost Model specified in AASB 116.The standard applies to reporting periods beginning on or after 1 January 2005.
Investment property is defined as “Land or a Building or a Part of a Building or Both” held by the owner (or by the Lessee under a Finance Lease) to earn rentals or for capital appreciation or both rather than for:
• use in the production or supply of goods and services or administrative purposes; or
• sale in the ordinary course of business.
Owner occupied property is property held (by the owner or by the Lessee under a Finance Lease) for use in the production of supply of goods or services for administrative purposes.

AASB 3 – Business Combinations
This standard requires business combinations to be accounted for by applying the purchase method. It requires an acquirer to recognise separately, at the acquisition date, the acquiree’s identifiable assets that
meet certain recognition criteria, regardless of whether they had been previously recognised by the acquiree.

The standard requires the identifiable assets that satisfy the stipulated recognition criteria to be measured initially by the acquirer at their fair values at the acquisition date, irrespective of the extent of any minority interest.

AASB 5 – Non Current Assets Held For Sale and Discontinued Operation.
This standard requires that assets that are classified as Held For Sale be measured at the lower of the Carrying Amount and Fair Value less costs to sell. It also requires that assets that meet the criteria as being classified as Held For Sale be separately presented on the face of
the balance sheet.

2.5 Fair Value
Fair Value is defined in AASB 116 as follows:
    . . . . . the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.”
Fair value is considered further in non-mandatory “Australian Guidance” as an accompaniment to AASB 116 set out below.

Fair Value
G1 The fair value of an asset is the best estimate of the price reasonably obtainable in the market at the reporting date in keeping with the fair value definition.
It is the most advantageous price reasonably obtainable by the seller and the most advantageous price reasonably obtainable by the buyer. The estimate specifically excludes an estimated price inflated or deflated by special terms or circumstances such as atypical financing,
sale and leaseback arrangements, or concessions granted by anyone associated with the sale.
G2 Underlying the paragraph 6 definition of fair value is a presumption that the entity is a going concern without any intention or need to liquidate, to curtail materially the scale of its operations or to undertake
a transaction on adverse terms. Similarly, to determine the fair value of an asset, it is assumed that the asset is exchanged after an adequate period of marketing to obtain its most advantageous price.
The fair value of an asset is determined by reference to its highest
and best use, that is, the use of the asset that is physically possible, legally permissible, financially feasible, and which results in the highest value. Opportunities that are not available to the entity are not taken into
account. Where it is the market’s assessment that it is rational to continue to use the asset, the revalued amount shall include estimated entry costs.
Where the asset is held for sale AASB 5 Non-current Assets Held for Sale and Discontinued Operations applies.
G3 Where a quoted market price in an active and liquid market is available for an asset, that price represents the best evidence of the asset’s fair value. When a quoted market price for the asset in an active and liquid market is not available, the fair value is estimated by reference to the best available market evidence of the price for which the asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. This evidence includes current market prices for assets that are similar in use, type and condition (‘similar assets’) and the price of the most recent transaction for the same or a similar asset (provided there has not been a significant change in
economic circumstances between the transaction date and the reporting date). Current market prices for the same or similar assets can usually be observed for land, non-specialised buildings, used motor vehicles, and some forms of plant and equipment. For land and buildings, these prices can also be derived from observable market evidence (e.g. observable current market rentals) using discounted cash flow analysis.
G4 In some circumstances the fair value of the asset is not able to be determined from market-based evidence as the market buying price and market selling price of an asset differ materially because the asset usually is bought separately in the new asset market, but if sold separately, could only be sold for its residual value. In other circumstances the fair value of the asset is not able to be determined from marketbased evidence as there is no market evidence of the
asset’s market selling price.

These circumstances will usually arise where the transaction price evidence arises in a monopoly context or the asset is specialised
and rarely sold, except as part of a continuing business.
G5 Where the fair value of an item of property, plant and equipment cannot be reliably determined using market-based evidence as outlined in paragraph 33 of AASB 116 , the asset’s fair value is measured at its
market buying price and the best indicator of an asset’s market buying price is depreciated replacement cost or an income approach. Depreciated replacement cost is the current replacement cost of an asset less, where applicable, accumulated depreciation calculated
on the basis of such cost to reflect the already consumed or expired future economic benefits of the asset.

2.6 Depreciated Replacement Cost IVSC Definitions
Depreciated Replacement Cost. The current cost of reproduction or replacement of an asset less deductions for physical deterioration and all relevant forms of obsolescence and optimisation.
Specialised Property. Property that is rarely, if ever, sold in the market, except by way of a sale of the business or entity of which it is part, due to uniqueness arising from its specialised nature and design, its configuration, size, location, or otherwise.
Improvements. Buildings, structures, or modifications to land, or a permanent nature, involving expenditures of labour and capital, and intended to enhance the value or utility of the property. Improvements have differing patterns of use and economic lives.
Adequate Profitability. When an asset has been valued by reference to depreciated replacement cost, adequate profitability is the test that the entity should apply to ensure that it is able to support the depreciated replacement cost conclusion.
Service Potential. The capacity to provide goods and services in accordance with the entity’s objectives, whether those objectives are the generation of a net cash inflows or the provision of goods and services of a particular volume and quantity to the beneficiaries thereof. In the public sector, the concept of service potential takes the place of the test of adequate profitability applied in the private sector.

Modern Equivalent Asset (MEA). An asset similar to an existing asset and having the equivalent productive capacity, which could be built using modern materials, techniques, and design. Replacement cost is the basis used to estimate the cost of constructing a modern equivalent asset.
Impairment Loss. The amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount. International Accounting Standard 36 (IAS 36), para. 6.
Optimisation. The process by which a least cost replacement option is determined for the remaining service potential of an asset. It is a process of adjustments reducing the replacement cost to reflect that an asset may be technically obsolescent or over-engineered, or the asset may have a greater capacity than that required. Hence optimisation minimises, rather than maximises, a resulting valuation where alternative lower cost replacement options are available. In determining the depreciated replacement cost, optimisation is applied for obsolescence and relevant surplus capacity.

2.7 IVSC Guidance
Depreciated replacement cost is used where there is insufficient market data to arrive at Market Value by means of market-based evidence.
AASB 116, Property, Plant and Equipment, paragraph 33, provides that in the absence of market-based evidence an entity may need to estimate the fair value of a specialised asset using an income or a depreciated replacement cost approach.
International Public Sector Accounting Standard (IPSAS) 17, Property, Plant and Equipment, paragraphs 42 and 43, prescribe the use of depreciated replacement cost for valuing specialised buildings and other man-made structures as well as items of plant and equipment of a specialised nature.
Property, plant and equipment that is commonly traded in the market should be distinguished from specialised assets.
The classification of an asset as specialised should not automatically lead to the conclusion that a depreciated replacement cost valuation must be adopted. Even though an asset may be specialised, it may be possible in some cases to undertake a valuation of a specialised property using the market comparison approach and/or the
income capitalisation approach.
In the absence of direct market evidence, depreciated replacement cost is regarded as an acceptable method of assessing the value of specialised assets but the methodology must incorporate market observations by the Valuer with regard to land value(for property assets), current cost, and depreciation rates. The methodology is based on the same theoretical transaction between rational informed parties as the Market Value concept.
In applying the depreciated replacement cost methodology, the Valuer should refer to IVGN 8.

2.8 Specialised Properties
The conceptual approach to the valuation of specialised assets has not altered in relation to assets which are not traded in the market place. In the absence of direct market transaction evidence for specialised assets, the use of depreciated replacement cost or income methodologies, is endorsed at paragraph 33 of AASB 116 as follows:
If there is no market-based evidence of fair value because of the specialised nature of the item of property, plant and equipment and the item is rarely sold, except as part of a continuing business, an entitymay need to estimate fair value using an income or a depreciated replacement cost approach.

The depreciated replacement cost approach for financial reporting is considered in GN8, IVSC Standards 2005.

The term fair value less costs to sell used in Australian Accounting Standards is not applicable unless the asset is held for disposal. Market value will still apply in this circumstance to property, plant and equipment, but not as part of a going concern.

2.9 Application
Points that valuers should note are:
• in the majority of instances in relation to property, fair value will be equivalent to market value;
• for specialised properties the application of the depreciated replacement cost approach or the income approach is an acceptable methodology for valuations for financial reporting purposes provided the value determined is consistent with the fair value definition;
• in the absence of direct (market) transaction evidence, when the depreciated replacement cost approach methodology is applied, valuers should consider the elements of depreciation and their application;
• wherever possible, depreciation should be based on market evidence (see IVSC GN8).Valuers constantly analyse market transactions which indicate a relationship between new cost, depreciation and value. These transactions can be indicative of depreciation for depreciated replacement cost purposes if care is taken to exclude influences such as economic depreciation affecting property sold for a use other than its original purpose-design use;
• where the depreciated replacement cost approach is adopted and the value of the land for an alternative use is equal to or higher than the value of the (total) asset - after allowing for the cost of works to bring the land to a state in which the alternative use can be exploited (e.g. demolition and removal of plant and equipment and its cost of relocation) - then the land value, net of these costs, is the value of the asset;
• consideration should also be given to the potential alternative use value of improvements on the land e.g. a building shell after removal of all plant and equipment. The alternative use value assessment does not necessarily mean that the improvements have no value for the alternative use;
• when an asset used in a for-profit enterprise has been valued by reference to the depreciated replacement cost, adequate potential profitability becomes the test (an “impairment” test) applied by the entity to the depreciated replacement cost estimate to determine whether the asset can be carried at that amount; and
• the depreciated replacement cost approach methodology is expressed as subject to the test of the adequate profitability (or service potential in the case of assets employed in a not-for-profit enterprise) of the assets held by the entity.

2.10 Fair Value Responsibility
The application of Australian Accounting Standards and International Accounting Standards is complex. Valuers of property, plant and equipment assets for financial reporting purposes should be aware of the inter-relationships and complexities.
The application of market value concepts by professional valuers will normally be the foundation of an independent assessment of value for financial reporting purposes.
However, ultimately the determination of fair value is the responsibility of the reporting entity.

3.0 Categorisation of Assets
3.1 Operational Assets
Operational Assets are categorised as follows:
• non-Specialised, or
• specialised.

3.2 Degree of Specialisation
Operational assets may be non-specialised or specialised in whole or part. The valuer assesses the degree of specialisation having regard to the following:
• the use to which the asset is put;
• the degree of special adaptation;
• the location;
• whether that category of asset has a readily definable market; and
• any guidance by the directors and/or technical staff of the entity.

3.3 Non-Specialised Assets
Non-specialised assets are those normally traded in an open market where market-based price indicators are available to guide both market participants and market observers. These non-specialised assets can be further categorised as those assets which are common and regularly traded in the marketplace and include offices, warehouses, shops, etc. and those that generate an income or profit by their operation and are traded in the open market and include trading hotels, hospitals and casinos.

3.4 Specialised Assets
Specialised assets are those not normally traded in any market, except as part of a total enterprise by reason of their specific design, size, location or other factor. These assets include, but are not limited to, oil refineries, power stations, communication towers, notable public buildings, roads and drains, parks and gardens, and can include standard buildings such as offices or warehouses in a market where
there is little or no demand for the asset if it is no longer an operational asset.

3.5 Other Considerations
The degree of specialisation will determine the valuation methodology adopted.
Some assets may possess elements that fall into more than one category, for example multi-purpose or mixed use properties. Each element of the asset should be valued on the designated basis reflecting the degree of specialisation or non-specialisation.
A Value in Use determination is entirely the prerogative of the entity.
Where the Fair Value of specialised assets is calculated by the depreciated replacement cost approach and advised to the entity for inclusion in financial statements, the valuation will be subject to the impairment test. Both Fair Value and Fair Value less costs to sell are said to be asset specific whilst Value in Use is entity specific. In current Australian financial reporting practice, carrying amounts reported at Fair Value are tested for impairment by the Fair Value of the cash
generating operation.
The depreciated replacement cost of specialised assets and their Value in Use are different approaches to value, which may not yield consistent figures. Valuers should be aware that depreciated replacement cost determinations will include items of functional and economic obsolescence as well as physical depreciation. These items are asset specific and will take into account current market conditions for
the particular assets at the date of valuation.

4.0 Other issues
4.1 Liaison with Auditors
Auditors may request a valuer to provide information or explanations related to the valuations and may also seek assurance that valuers have experience in the location and category of the assets being valued.
Auditors may also communicate with valuers to:
• specify items the auditor expects the valuation report to cover;
• clarify the valuers relationship with the client; and
• clarify the assumptions and methods to be used by the valuer.

Auditors require assurance that the valuers work constitutes appropriate audit evidence. Issues which are of particular relevance to auditors are the sources of data used, assumptions and methods used and their appropriateness and consistency with the prior period. The auditor will consider these matters and the valuation itself in the light
of the auditors overall knowledge of the entity’s business.
The appropriateness and reasonableness of assumptions and methods used and their application are the responsibility of the valuer. The audit needs to determine that they are not unreasonable, based on the auditors knowledge of the entity’s business.
Internal valuers will normally be under instruction to comply with any request from an auditor. While independent valuers may not be under a statutory or contractual obligation to comply with any reasonable request from an auditor, it is in the interests of the entity, its ownership group and the valuer that the valuer should comply as failure to do so
may mean that the auditor will not be able to express an unqualified opinion. In such circumstances the approval of the client should be obtained.
The valuer, whether internal or independent, should co-operate reasonably and responsibly if approached by the auditor.
It is of particular importance that any special assumptions and/or limiting conditions be clearly and unequivocally disclosed by the valuer.



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