Are you getting fair value?

Written by Richard Spence, a Director within Deloitte’s Real Estate’s Valuation, Assurance and Professional Advisory Team

FOLLOWING the introduction of the ‘new’ UK GAAP/FRS 102 (applicable in the UK and Republic of Ireland) and adaptions to and reinterpretations of IFRS in from 2015, the umbrella term of fair value has become far more prevalent in preparing property asset valuations for an organisation’s financial statements. This has brought a large number of practical issues into sharp focus which needs to be addressed by both the valuer and the client and preferably with input from a pro-active auditor experienced in real estate issues.

Previously, the valuer would primarily rely on guidance prepared by the Royal Institution of Chartered Surveyors (RICS) in their Valuation – Professional Standards, commonly referred to as the ‘Red Book’ when preparing valuations for accounts.  However, the valuer is now increasingly required to have a detailed understanding of the requisite Accounting Standards, Statement of Recommended Practices (SORPs), Manuals and specific regulations applicable to the particular organisation whose assets are being valued. Even when the valuer gets to grips with this plethora of standards, codes, manuals, and guidelines, issues often arise as the applicable accounting treatments, valuation regulations and guidelines are not always fully aligned, clear or entirely consistent.

It is therefore increasingly important that the valuer liaises with both the client and auditor throughout the valuation process to ensure that the asset valuations are being prepared adopting the correct approach and that all relevant matters are considered and taken into account.

Both as a practitioner, preparing asset valuations for clients and also acting in the capacity as a real estate specialist for our audit teams across the UK, reviewing a significant number of asset valuations, I am aware of the challenges and issues that often arise in preparing fair value accounts valuations.  Often these issues can occur at the very outset, i.e. the commissioning of the asset valuation.  In most cases the onus in commissioning an asset valuation falls to an organisation’s finance team who may not be fully au fait with all the matters which the valuer needs to address in preparing fair values.  This can often result in clients setting a scope that is, at best, vague or even misdirected.  The instructed valuer has an obligation to question the client and where appropriate challenge the approach that is being advocated. Accordingly it is essential that at this stage there is a detailed dialogue between the client and the valuer to agree the exact scope and output of the valuations.  The client’s auditor can assist in this process, particularly those auditors who have in-house real estate specialists, as ultimately the valuations need to be correctly based for audit sign off to be achieved.

Chances are that if there are issues with valuations of property assets many of the problems will originate with valuations being commissioned on either an incorrect or unclear basis.

Accordingly, in order to ensure that there will be no fundamental issues with the asset valuations at year-end, the commissioning of an asset valuation should involve a three way dialogue between client, valuer and auditor. Auditors with real estate expertise can often provide the requisite guidance on various valuation issues and can provide input, ensuring that the scope is sufficiently clear so that client and valuer understand their respective roles, that the valuation methodology is appropriate, and that the output produced provides sufficient detail allowing the client and auditor to be satisfied that the appropriate issues have been addressed. If the auditor is sufficiently experienced in undertaking reviews of real estate assets they can also provide practical solutions to issues faced during the valuation process.

So what does commissioning a valuation have to do with fair value? Well in the past the valuer only really had to determine a valuation of a property on a Market Value basis, the definition of which is well understood and established following years of practical application.  Fair value however offers a number of different ways in which an asset can be valued and, even when the appropriate valuation basis and methodology is applied there are often other nuanced but ultimately essential issues to be considered by both the valuer and the client.

Route map 

The number of issues that need to be addressed can appear overwhelming but if the client and valuer determine a ‘route map’ for each stage then the relevant and correct considerations should be covered.

Clearly the first stage is to understand under which accounting standard the client reports, i.e. in the UK most commonly either UK GAAP (FRS 102) or IFRS, and whether there are any other accounting/reporting regulations/guidelines applicable for the particular organisation (i.e. SORPs, CIPFA, NHS Manuals etc.). If there is any uncertainty over what policies should apply then the valuer should verify this with the client or the client’s auditor and thereafter review the appropriate standards, regulations and guidelines. In some cases these may prescribe a particular approach which might differ from standards/statements set out in RICS’ Red Book.  It is therefore particularly important that the valuer is aware of these before undertaking the valuations. It is also advisable that the valuer makes reference to these in both their terms of engagement and their valuation report as this will provide the client and the auditor with a degree of assurance that the valuations will be or have been prepared adopting the correct accounting and valuation ‘framework’.

The next stage is determining or reviewing the categorisation for each property asset as this should assist in shaping the valuation approach to be adopted for each asset. Typically asset categorisations will include; Property, Plant & Equipment (PPE) (Specialised Operational, Non-Specialised Operational, Non Operational Surplus or Assets under Construction); Investment Property and Non-Current Assets Held for Sale.  A number of other categories may exist which are specific to the organisation including Heritage Assets.

It is critically important that the client and the valuer discuss the categorisation of the assets to ensure that the assets are correctly allocated and ultimately this will depend upon the actual use and type of the asset, which can change

Valuation approach 

The valuation approach to be adopted will largely be governed by various Accounting Standards, namely International Accounting Standards (IAS), International Financial Reporting Standards (IFRS) and Financial Reporting Standard (FRS) 102. Although it should be noted that FRS 102 has been derived from IFRS it is far less detailed.  IFRS 13 Fair Value Measurement sets out how to measure fair value where fair value is required by other standards. Other standards relevant to property include (IAS) 16 Property, Plant and Equipment (PPE); IAS 17 Leases (albeit this will shortly be replaced by IFRS 16); IAS 40 Investment Property, IFRS 5 Non-Current Assets held for Sale and Discontinued Operations and IAS 36 Impairment of Assets.

The valuer and client should also be aware that there are other standards which might be used for property related reporting, for example IAS 28 Investments in Associated and Joint Ventures and IAS 37 Provisions, Contingent Liabilities and Contingent Assets.  Care should be taken at this stage to ensure that elements that make up a valuation are not included, or ‘double counted’ in more than one accounting treatment.  This can happen in areas such as contamination clean-up costs which could be factored into the valuation of an asset under IAS 16 (PPE) and but provision for the cost could also be included in IAS 37 (Provisions, Contingent Liabilities and Contingent Assets).

The above standards prescribe the accounting treatment for properties including the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses that should be recognised. Whilst the valuer needs to fully understand what is being prescribed in these various standards it has to be appreciated that these are principally accounting documents written by accounting authorities and are not restricted to the valuation of property assets. Therefore the valuer needs to review these in conjunction with the relevant sections of the RICS Red Book to formulate the key principals in preparing the valuations of particular categories of assets. This is where both the client and auditor can play a key role as it is all too easy for the valuer to misinterpret the relevant Standard and prepare valuations adopting a basis that will not be consistent with financial reporting.

If the valuer adopts the wrong valuation approach then at best they might be viewed as incorrectly founded but perhaps not material to the accounts. In such cases the real estate audit specialist should provide assistance to the client in determining the materiality of the error and advice on how the valuations could be corrected or provide guidance on how the valuation should be prepared in the future. If the issue is more critical, then, in certain cases the assets will either need to be revalued or in the worst case, the accounts will need to be qualified which highlights the fact that the property valuation cannot be relied upon.

In qualifying an organisation’s accounts there are significant implications for all parties that have a stake in the process in preparing and reviewing the accounts. Having reviewed a significant number of valuations prepared for just about every conceivable type of client, and on an extensive range of property types, common issues regularly arise, and a number of these are highlighted in the table below.  These clearly highlight that it is essential for there to be a three way dialogue between the client, valuer and auditor throughout the valuation process, starting at the initial stages of commissioning an asset valuation.

Therefore in conclusion it is critical that:

1. Valuers fully understand and keep abreast of all the guidance if they are providing this sort of asset valuation work. They also have a responsibility to help guide their clients and to ask the right questions when the client is commissioning a valuation;
2. There needs to be consultation between valuer, client and auditor. This is important particularly when the situation is complex and whilst this may mean that the whole process takes a bit longer, getting it right first time it can save time in the long run; and
3. In the long term we all hope that the guidance will become better understood, more universal and consolidated and straightforward.