ifrs first case

5/14/2018 IFRS First Case

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PART 2 BUSINESS ANALYSIS AND VALUATION TOOLS .Iding Land Securities,firmS Inc U bstanti Iover 4 billion in property).' While most of the U.K. '. s also had su stantiaowned properties principally within the U.K., several fIrmproperty holdings in other countries. companies in the worldLand Securit.ie~was ~ne of the largest in.vestment prope:lance sheet at March .31,with over 7.8 billion of investment properties valued on l~S f 11within two categones:2003(see Exhibit 1). Land Securities' investment propertIeS ef the full use of realfreehold and long leasehold. Freehold is a special right gran. W r y owned its freeholdestate for an indeterminate time. Thus, Land Securiti~s e~ectlve nt properties. Theproperties, which made up approximately 75% o~ Its wvest~e leases with unex-remaining were long leaseholds, which are propertle~ ~eld ~ :~en profitable andpired terms of generally over 50 years. Land SecuntIes hagrowing since 1990 (see Exhibits 2, 3, and 4). .' 0 ment roperties,In 2003 Land Securities had a portfolio of 231illdivldualmvest POd'. ' 0 . y be characterIze IIIall of which were located ill the U.K. Investment properties rna .

o 'f' d . t several categones:a number of ways. Operationally, they may be classi Ie m 0offices (such as corporate office buildings); retail (such as shops and stor.es,including shopping centers); industrial (such as warehouses and manufactunngfacilities); leisure (such as hotels); and residential (such as apartment complexes).Investment properties may also be characterized by location, such as urban orsuburban, or within particular districts (such as a financial district). Finally, prop-erties may be characterized by various attributes, such as their size (square feetavailable for rent), use (e.g., a high-technology building), age, the type and numberof clients using the space, as well as the nature of the contracts relating to theproperty (e.g., do the tenants have short-term versus long-term rent agreements).Exhibit 5 shows that Land Securities' portfolio had two primary segments: offices(which made up 42% of the value of its investment properties and were locatedprincipally in London) and retail (which made up 50% of the value of itsinvestment properties). Almost one-quarter of rental income was obtained fromthe 10largest tenants.

U.K. investment property market: Property valuesOver th~ past 20 years, the U.K. investment property market had . dsubstantIal upward and downward move' expenenceExhibit 6). Following a dramatic increase i:e~s :n the val~es of properties (seesignificant decrease coinciding with the p.p ~ values Inthe late 1980s was arecession In the U K f hValues recovered in the late 1990s. Since 2000 h : . 0 t e early 1990s.been mixed. ' t e change Inproperty values had

Exhibit 7 shows the historical values for the m k . .substantial property interests in 2003 Th ar ets m WhIChLand Securities had. . e central Lond ff iexpenenced a downturn, though not as . on 0 ce market recentlyprospects appeared to be imprOVing' f severe as m the early 1990s. Howeverrecently stated "we now believe th t' o~ example, Land Securities' management hadt~e Central London office market~'4 ~e ~:e ~~ached t~e low point for asset values innencmg as sharp a decline in values . h tal propertIes had fared better, not expe-as m t e early 1990s.

3 "n .;;o referstopounds sterlin hto 1 . g, t. e currency used in the UK. The exchange ratio at May 2004 was about U.4. ''Preliminaryresultsfi h S $1.75or t eyearended 31March 2004," Land Securities Group, May 18, 2{)( )4,po 1.


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Accounting for investment properties in the U.K.. t adoption of IFRS, Land Securities applied the domestic financial reportingpno~ ments of U.K accounting standards. One of the key standards was Statement

re~llre dard Accounting Practice 19,Accounting for Investment Properties (SSAP 19).o~;;n19 required that investment properties be reported using the revaluationS d 1 Under this model investment properties are not depreciated; rather, they mustmo ~~lued each year and listed on the balance sheet at "open market value." SSAP~~~:fines "open market value" as "an opinion of the best price at which the sale of an. t rest in property would have been completed unconditionally for cash consider-~. on on the date of valuation assuming (among other things) that both parties to the;Insaction had acted knowledgeably, prudently, and without compulsion." SSAP 19:rther required that any changes in the value of investment properties be recorded torevaluation reserve, which is a component of the equity section of the balance sheet

(see Exhibit 1) .5 Only decreases in the value of properties that exhaust the revaluationreserve (and thus go below historical cost) are recorded to the income statement asimpairment charges. Thus, all of Land Securities' investment properties werereflected on the balance sheet at "open market value," assessed at March 31, 2003 tobe 7,824million.Under SSAP 19 firms may use either internal or external appraisers to perform therevaluation; however, an external appraisal is required at least once every five years.Internal appraisers typically include directors within the firm, who have the necessaryproperty valuation credentials and experience with the particular type of property to bevalued. External appraisers include a number of independent property appraisal firms.Historically, approximately 25% of investment property firms have used internalappraisers to perform the valuation, though this is concentrated within the smallerinvestment property firms,' Ineither case, appraisers must adhere to the guidanceprescribed by the Royal Institute of Chartered Surveyors, which has promulgated valu-ation standards in the U.K. for over 100 years. Further, auditors must opine on theopen market values of properties as part of the investment property firm's audit. Since1990,Land Securities had employed the external appraiser Knight Frank. to revalue itsinvestment property portfolios and PricewaterhouseCoopers to audit them.

Adoption of International FinancialReporting Standards

The required adoption of IFRS effective in 2005 would have a number of effects onEuropean investment property firms, including Land Securities.' One of the primaryreporting issues related to International Accounting Standard 40, In ve st me nt P ro p er ty(lAS 40), which is the international equivalent of SSAP 19. Under lAS 40, LandSecurities had to choose either the cost or fair value model and apply the chosen

5 . U n ~er U K . g ene rally ac cep ted a cco un ting p nncip les ( GA AP ), c ha ng es in o pen m arket va lu e are co nsid eredu nre aliz ed g ain s/lo sse s. T he se a re n ot re po rt ed o n t he in com e st at em en t; ra th er, t he y a pp ea r o n a su pp le me nt alst at em en t r e fe rre d t o a s t he "S ta te me nt o f T ot al R ec og niz ed G ain s a nd L osse s. "6 . K arl M uller and E dw ard R iedl, "E xternal M onito ring o f Pro perty A pp raisa l E st im ates and Info rm atio n:m~etry:" Journal of Accounting Research 40 (June 2002): 865-881. T he a bo ve p ercen ta ge fo r in tern alt : ~ e r sS fro m t he la rg er s a mp le re fe rre d t o in fo o tn ot e 13o f t his p a pe r.all '; mo st Euro pean co mp anies had to ado pt IFRS beginning January 1, 2005, a te mp ora ry excep tio n w ass e;w~ . fo r (1 ) co mp anies tha t traded in the US. and used U S. G AAP, and (2) co mp an ies th at ha d issued de btun tle s b ut n ot e qu ity secu rities. In b ot h c ases, th ose co mp anies ha d to co mp ly w ith IF RS by January 1, 2007.


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-PART 2 BUSINESS ANALYSIS AND VALUATION TOOLS

. . . der the cost model, investl1'lmodel across all of Its investment properties. Un ulated depreciation and entproperty is stated on the balance sheet at cost less a~Utmhefootnotes." Under the afan~. . . b d' closed In . I[impairment losses, and fair value must e IS lance sheet at fair value, with allvalue model, investment property is stated on the ba t Fair value is defined in lAS40changes in fair value reported inthe income statem~b~tween knowledgeable, willingas the amount for which an asset can be exc~a?ge: ilar to the U.K.'s "open marketparties in an arm's-length transaction; thus. It IStfai value be assessed at the indi-. that airvalue."? Similar to SSAP 19, lAS 40 requrres es a finn to use an external. . . lAS 40 encourag . 8 'd s sVIdual property level. In additIOn, . it Exhibit proVl e a ummarydot reqUIre 1 .appraiser in deriving fair value but oes n .of the relevant accounting models. first time the IASB had mtroduced aIAS 40 was significant, as it represent~d the onfinancial assets. Wh~n the IASB

fair value accounting model for long-lIved ~ 40 there was substantial de?~te onsolicited comments for the exposure draft of. t~ent properties (see Exlublt 9).10the merits of applying the fair value model to 1~;:~ith U.S. GAAP, which gener~llyFurther the use of the fair value model ~ntra t properties, to be reported USing.' .' . luding mvestmen .' , h . e of cost or fa'required nonfinancial assets, me .' 0 Land SecuntIes c OlC irthe cost model. Thus, as reflected inExhlb~t.l ~th other large real estate.firms, b.othvalue had the potential to affect comparabilIty f ancial statements requlfe multiPleU.K. and non-U'K based. Nonethe~ess, bec~~;; C:'g., two years of b~~nce s~eets areyears of presentation for compara~IVe~;&RS required Land Secur~tIes to unmedi_typically presented), im'plementat1o~s' impact on its financial reportmg.ately assess the internatIOnal standar

8 . Impairment losses must be calculated under the requirements of lAS 36 , Impairment of A s s e t s . A nim p ai rm en t is a c ha rg e t o r ed uc e an a ss et t o it s f air v alu e. O f no te , if c er ta in r eq ui reme nt s are met, i m p a i m t t r Jchargesmay be reversedunder lAS 36 . Th is con tr as ts w it h U .S. G AA P, w hic h p ro hib its reversals o f i m p a i r m t l l l . ! .9. I nt erna t io nal Accoun ti ng S t andard 40 , I nv es tment Property, 2 003 ( pa ra gr ap h 5), International Ac~Standards Board.1 0. A n " ex po su re d ra ft " is a p relim in ary ve rsio n o f a n a cc ou nt in g st an da rd . As does the FASB in th e U . S . , INIA SB fo llo ws a d ue p ro ce ss in g en era tin g a cc ou nt in g s ta nd ard s. This in clud es o bta in in g feed ba ck o n d r a f t s ~st an da rd s from va rio us c on st it uen ts, in clu din g a cc ou nt in g firm s, t ra de g ro up s, a nd c om pa nies t o b e affectedthe standard. The IA SB may incorp orate this feedback into changes in the standard befo rt! i t is f o w J i 2 t d .E xp osu re d ra ft s a re a p rim ary m ea ns o f o bt ain in g s uc h fe ed ba ck .


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CHAPTER3 OVERVIEW OF ACCOUNTING ANALYSIS 111

EXHI BIT 1 Land Securities Group 2002-2003 balance sheets (millions)March 31,2002 March 31, 2003

Fixed assetsIntangible asset - goodwill 38.9 36.7Tangible assets

Investment propertiesFreehold 5,715.3 5,759.9Leasehold 2,084.7 2,064.0Total investment properties 7,800.0 7,823.9Operating properties- 428.9 5574Other tangible assets 45.3 41.5Investment in joint venture, net 188.8 106.88,501.9 8,566.3

Current assets 365.6 441.4Creditors fall ing due within one year (690.9) (594.9)Net current liabilities (325.3) (153.5)Creditors falling due after more than one year (2,010.1) (2,670.7)Provision for liabilities and charges (129.9) (179.0)Total assets less total liabilities 6,036.6 5,563.1 "Capital and reserves

Called-up share capital- 76.9 . .524.3Share premium account 13.3Revaluation reserve 3,376.9 3,038.9Other reserves- 901.3 0.1Profit and loss account (retained earnings) 1,234.1 2,433.9

Total equity 6,036.6 5,563.1

a. Operating properties are those managed by LandSecuritiesunder contract aspart of its "total property outsourcing"strategy. Theseassetsdo not satisfy the definition of investment properties and thus must be reported at depreciated cost.b. LandSecuritiesengaged in a capital restructuring in July2002 that included a substantial dividend payment to shareholders.Thisrestructuring effectively exchanged one type of common stock sharesfor another and accountsfor the reduction of both"called-up share capital" and "other reserves," aswell asmuch of the increasein "profit and lossaccount."Source: LandSecuritiesGroup, 2002 and 2003 annual reports.


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N TOOLSD VALVATIO111 PART 2 BUSINESS ANALYSIS AN e statements ( millions)

2002-2003 meomEXHIBIT2 a s uri ties Group, d'ng Fortheyearertd'Lan ee for the year en ~ March 31. 2oo~rt9March 31. 200 ~- 519.7

658.361.5

1,025.6 1.239.5(164.4)(124.5) (399.4)(249.9) (57.1)(50.6) (41.9)(21.0) (26.5)(62.8) (508.8) (689.3)

516.8 550.213.4 41.7

(166.7) (272.3)319.663.5

(99.9) (89.7)229.963.6

(178.4) (167.4)85.2 62.S

RevenueRental income/other

Total property outsourcingljoint ventureOther incomeTotal revenue

ExpensesRentalsDirect property or cont ra c t e xpendi tu r esIndirect p ro pe rty o r c on tr ac t e xp en ditu re sDepreciation/amortizationOtherT ot al e xp en s es

Operating profitProfit on sa le of investment propertiesInte re st a nd s im ila r ch arge s

Profit on ordinary activities before taxationTaxat ionProfit on ordinary activities after taxationDividendsRetained profit

Source: Land Securities G ro up. 2 002 a nd 2 003 annual reports.


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~ ~i~t"4 \OICf i. ' , . . . , ' ,.. .:CHArTER 3 OVERVIEW Of ACCOllNTING ANALYSIS 113

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I"

I114 PART2 BUSINESS ANALYSIS AND VALUATION TOOLS

dinary activitiesEX HI BIT 4 Land Securities Group, 1990-2003 profit on or(miJIions)1,250,- --------------11,000t-------------------------------I750+------ --------------~500t----------------------------------------------~250t~~~~-~-~--.-~----~--~-~~~r=~~~-~-~--~-.~~-~~~A - - - - ~ - - - - A - - - - ~ - - - - ~ - - - - A - - - - ~ - - - - 4 r - - - - A - - - - ~ - - -

Noo " "oo< : : > ; : ; ; N m'" ~ '" '" r-, 00 en(250) '" '" '" '" '" 0'1 '" en en~ '" '" 0'1 0'1 '" '" ~(500)(750)

(1,000)

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--..t.--- Profit on ordinary activities (revaluation model)

Sources:Compiled by casewriter f ..rom LandSecuritiesGroup, 1990-2003 annual reports.

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116 PART 2 BUSINESS ANALYSIS AND VALUATION TOOLS

EXHIBIT 6 U.K.office property values, 1983-2002350300 1983 = 100


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CHArTER 3 OVERVIEW OF ACCOUNTING ANALYSIS 1 1 7

EXHIBIT 8 Summary of accounting models (as applied in the U.K. for investmentproperties)Forpurposesof evaluating how thesethree modelsareapplied to investment properties in the U.K., the term"fair value" is usedsynonymouslywith the U.K. termHopenmarket value."Cost modelThe cost model lists investment properties on thebalance sheet at cost less accumulated depreciationand an y impairment losses.Depreciation ischarged tothe income statement in the period in which thebenefit occurs. Fair values must be disclosed in thefootnotes. Any impairment (i.e., evidence that fairvalue is lessthan stated cost) requires a reduction inthe cost of the investment property to its fair value,with the reduction reflected asan impairment chargeon the income statement. In addition, under certainconditions, impairment charges may be reversedunder lAS.

Revaluation modelThe revaluation model lists investment properties onthe balancesheet at their fair value. Under this model,depreciation isnot recorded. Increasesin fair value arerecorded directly to a revaluation reserve that fallsunder the equity section of the balance sheet.Decreasesin fair value are charged directly against anyrelated revaluation reserve.However, if the decrease infair value exhauststhe related revaluation reserve, anyremaining decrease is recorded as an impairmentcharge and included in the income statement.Fair value modelThe fair value model lists investment properties on thebalance sheet at their fair value, similar to the revalu-ation model. However, any changes in fair value arerecorded directly to the income statement. No revalu-ation reserve is used, nor is depreciation recorded.Source:Compiledby casewriter.

EXH I BIT 9 Comments on the exposure draft for lAS 40, In ve stm en t P ro p erlyBelow are excerpts from comment letters received bythe IASBon the exposure draft for lAS 40, InvestmentProperty. The excerpts are responses to the followingquestion: "Do you agree that changes in the fair valueof investment properties should be recognized in netprofit or loss for the period?"

Investment property industryLand S e cu ri ti es (U .K . )In our view, mixing rental income with unrealizedholding gains (or losses)would be confusing and suchaccounting treatment would be a retrograde step andmisleading to investors.

Ho ngko ng Land Ho ld ings (Ho ng K ong)To reflect fair value changes in the income statementas an operating item increases the volatility of incomewhile not necessarily reflect ing the performance of thebusiness. Investment property is a long term business

and the year-on-year change in asset value is not agood yardstick to reflect performance.

Large accounting firmsE rnst and Yo ungIn our view, there are relatively few circumstances ... inwhich the application of a fair value model with subse-quent changes in fair value being recorded in theincome statement is appropriate ... we believe thatinvestment properties should be accounted for ateither amortized cost or at fair value through equity.

Pr ic e Wa t e rhouseCoop er sIncluding changes in value in profit (but only forinvestment properties) creates a curious 1/ mixedmodel" for the reporting of performance.Source: Compiled by casewriter from comment letters inC omm en t L ette rs to E xp os ure D ra ft E 64 , In ve stm e nt P ro pe rty ,InternationalAccounting StandardsCommittee, January2000.


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. . . . '118 VALUATION TOOLSPART 2 BUSINESS ANALYSIS AND

t and income statementsEXHIBIT 10 Condensed balance shee se r 31 2003 $ mil l ions)Cost model: Vornado Realty Trust (Decemb , r Income statement

1,503Balance sheetland 1,504Buildings 6,244Accumulated deprec iat ion (870)Othe ra sse t s 2,641Total assets 9,519

4 520 In terestLiabilit ies(principallydebt) ,4 999 Other~~~ '. eTotal liabilities/Equity 9,519 Operating mcom

tation deprec iat ion is p ro vi de d on aFootnote excerpt: Rea lestate is c arr ie d at co st, n et o f a ccumula te d de pre ci ...s t ra igh t -l ine bas isove r the asse ts 'estimated use fu l l i ve s f rom 7 to 40 years .

RevenueExpenses:Operat ingDeprecia tion .Genera land admin is t ra tion

(584)(215)(122)(230)(67)285

Revaluation model: Land Securities Group (March 31,2003; mil l ions)Balance sheet Income statementInvestment propert ies 7,824 Revenue 1,240

Ot he r a s s e ts 1,184 Expenses:Total assets 9,008 Operat ing (621)

Liabi l i t ies (pr incipal ly debt) 3,445 Depreciat ion (42)Revaluat ion Reserve 3,039 In terest (272)Equity 2,524 Other (75)

Tota' liabilities/Equity 9,008 Operating income 23 0Footnote excerpt: In ve s tm e nt p ro pe rtie s a re c ar rie d a t o pe n ma rk et v alu es , b as e d o n th e la te s t p ro fe s sio na l v alu -at ions. Unrealized c ap ita l s ur plu se s a nd d efi cits , in clu di ng th os e a ri sin g o n th e p er io di c r ev alu atio n o f p ro pe rtie s ,a re taken t o t he r e va lu a ti on reserve.

Fair value model: Hongkong Land Holdings (Decembe r 31 ,2003 ; $ mil l ions)Balance sheetI n ve s tmen t p rope r ti e s

Othe r assetsTotal assets

l ia b i li ti e s (p ri n ci p al ly debt)Equity

Totalliabilities/Equity

Income statement5,5071,0836,5902,9503,6406,590

RevenueExpenses:

D ecre as e in fa ir va lue o fi nv e stmen t p ro pe r ti es

InterestC o st o f s a le s /O t he r

Operating lossF o ot no te e xc er pt : Inve stm ent pro pe rtie s a re ca rrie d in th e ba la nce s he et a t f . .value determined annually by ind ep end en t va lue rs C h an ge s f' I a ir va lue , repre senting ope n m arke tand l o s s account. . In a ir va ue a re re co rde d in the co ns olida te d profit

Source : Compiled by casewri te r f rom respec ti ve2003 annua l r epo r ts .

384

(824)(65)(63)

(568)

,

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