Treatment of Land & Buildings

BenEadir

Hi all,

I'm curious about how land & buildings is supposed to be treated in the accounts of small Limited companies. If such a company paid Celtic Tiger prices for land on the edge of town on which they built a shiny new premises is there not an obligation to re-state the balance sheet value of land and buildings to the higher of an estimate of today's market value if the premises were to be disposed of in an orderly manner and the replacement cost i.e. the cost to buy a similar quality plot of land and replicate the facility?

I ask because I recently saw a set of accounts for what appears to be a failing business (revenues down 10-15 % annually year on year for the last 4 years and profits about to turn into losses) which at face value appears to have a healthy balance sheet with net assets of over €1m but this includes land and buildings of €3m and a 20 year loan on these with a balance of almost €2m.

A quick review of the accounts shows that the depreciation policy in relation to land and buildings is blank i.e. no depreciation whatsoever.

The business has been able to service it's loan over the last few years out of cash reserves and profits but with cash depleted and profits about to turn to losses I just don't see how the business can avoid defaulting in the next 6 months without either re-financing the loan and/or getting a fresh injection of capital from the owners and/or a major upturn in trading which is unlikely as it's in a very competitive market sector with tight margins.

It's pretty obvious that land and buildings are wildly overstated and completely distorting the balance sheet but this doesn't seem to be a problem for either the bank or the auditors as far as I can tell.

Given the above is current Irish GAAP being complied with? (Turnover is less than €6m)

Will FRS 101/102 change anything in relation to this?

marizpan

I follow this with interest.
I'm not that knowledgable of Irish GAAP but under ifrs you'd imagine that they should either have a policy of revaluation or carry them at cost and deprec the buildings.
Interesting to see what others think

BenEadir

My main interest is to see if by not revaluing or depreciating land and buildings, especially in light of a huge market correction for such assets with lot's of supporting data to assist with the the write down calculation is Irish GAAP being adhered to and even if it is (because a writedown/revaluation isn't compulsory) can the accounts pass the "true and fair" view test which per the Companies Act is:-

"149.—(1) Every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of its financial year"

BenEadir

105 views of this thread in the Accountancy forum and only one single reply :eek:

Have I hit on a raw nerve with this topic??

marizpan

They don't have to start to deprec the building until it is complete, I assume it is unused and incomplete.
But true & fair overrules the other standards

marizpan

Sounds like balance sheet propping, but I'm not familiar with Irish GAAP

BenEadir

marizpan wrote: »

They don't have to start to deprec the building until it is complete, I assume it is unused and incomplete.

The building is fully complete and has been in daily use for the last 7 years.

marizpan wrote: »

But true & fair overrules the other standards

That's what I thought also but the accounts are signed off by the external firm of accountants just below a statement which includes "In our opinion the financial statements give a true and fair view in accordance with Generally Accepted Accounting Practice"

Anyone who has been awake for five minutes of the last 6-8 years in Ireland knows that an edge of town commercial/retail building which was built/purchased in 2007/08 isn't worth anything close to what it cost then. I'm amazed a blind eye is being turned to something as obvious as this.

marizpan

Doesn't seem right to me!

Do you mind me asking if it is a well known larger firm who audited or a smaller firm

BenEadir

Small local firm with 3 partners and a few associates. I won't name the firm.

I'm interested in what the correct treatment is. I don't want to hang anyone.

marizpan

Maybe someone with experience with Irish GAAP with input.

Have you brought the matter to your senior, assuming you work within the auditing firm?

BenEadir

marizpan wrote: »

Have you brought the matter to your senior, assuming you work within the auditing firm?

I don't work in practice.

superb choice of username

If the client uses the cost model and not the revaluation model, then they would not do an annual revaluation.

Some assets, such as land, can be deemed to have an infinite life span and so do not require depreciating (see paragraph 58 of IAS 16). The buildings should be depreciated for sure which may be a problem. Rest assured though, the value of land and buildings on most sets of accounts are hit and miss, most people don't go for the revaluation model as it requires an annual revaluation, which is an expensive exercise! So, anyone reading the accounts, will know to take the land and buildings figure with a grain of salt and will look at other figures in the accounts for their indicators.

edit: fair enough, in a technically correct world, the directors should look at impairing the assets, but really, it's hard to come to a reliable figure of what to impair it to. IMO, it would very much require the directors approval and would be hard for the auditors to come in and say, 'look, this should be xxx value, and we can back this up with this evidence'.

BenEadir

superb choice of username wrote: »

If the client uses the cost model and not the revaluation model, then they would not do an annual revaluation.

Does their choice of depreciation model not have to ensure the resulting balance sheet represents a "true and fair view" as stipulated in the companies act?

superb choice of username wrote: »

If the client uses the cost model and not the revaluation model, then they would not do an annual revaluation.

Land and buildings have been on the balance sheet at their cost value since 2007 without any write down for depreciation or impairment.

Interestingly the Accounting policy for tangible assets in the years up to and including 2012 is "Tangible assets are stated at cost less accumulated depreciation and accumulated impairment loss" but in 2013 this changed to "Tangible fixed assets are stated at cost or at valuation, less accumulated depreciation"

Although there was an "impairment" policy in place between 2008 and 2012 there was no impairment recorded despite the property market collapse.

I don't understand what the 2013 policy means. What does the term "valuation" mean? Cost or market valuation? If "valuation" means "market valuation" there should be some adjustment to reflect the market value in the recorded value of land and buildings. Correct?

superb choice of username wrote: »

Some assets, such as land, can be deemed to have an infinite life span and so do not require depreciating (see paragraph 58 of IAS 16). The buildings should be depreciated for sure which may be a problem. Rest assured though, the value of land and buildings on most sets of accounts are hit and miss, most people don't go for the revaluation model as it requires an annual revaluation, which is an expensive exercise! So, anyone reading the accounts, will know to take the land and buildings figure with a grain of salt and will look at other figures in the accounts for their indicators.

I have to take issue with you here I'm afraid S.C.OU. The entire purpose of filing accounts with companies house is to enable interested parties (suppliers, financiers etc) obtain a true and fair view of the financial health of the business. Having a nod and a wink attitude to what may be the single biggest and possibly the most overstated asset on the balance sheet is exactly the type of attitude which needs to be rooted out of Irish society in general.

A property re-valuation is neither complex nor expensive. I just undertook an (admittedly amateur and quick) revaluation of the land and buildings using nothing more than publicly available information on Daft.ie and some other property websites. I found 5 properties of similar size and function for sale or to rent in the same town as the subject business and a report of the recent sale of another. Averaging out the asking price per square foot and extrapolating a value from an implied rental yield indicates to me that the property is worth just less than half (at best) of the €3m reported on the balance sheet.

The issue with having a laissez faire attitude to the valuation of tangible assets like this on company balance sheets is that as things are reported the business appears to have net assets of circa €800,0000 whereas if land and buildings were stated at anything even close to market/realisable value the company would be showing a deficit of circa €700,000. A €1.5m impairment isn't a grain of salt to a small company who's balance sheet is dominated by land and buildings. Readers of company accounts are entitled to assume that the company filing the accounts and the external auditors who are paid to certify that the accounts have been prepared correctly are at a minimum implementing the stated policies. How can any auditor in 2012/2013 sign off a set of accounts which have a tangible asset impairment policy stated within them as being in compliance with GAAP and companies act in the full knowledge that no impairment examination was undertaken?

superb choice of username wrote: »

edit: fair enough, in a technically correct world, the directors should look at impairing the assets, but really, it's hard to come to a reliable figure of what to impair it to. IMO, it would very much require the directors approval and would be hard for the auditors to come in and say, 'look, this should be xxx value, and we can back this up with this evidence'.

Seriously? That's a total cop out. It's very straightforward to undertake a market valuation of commercial premises these days as there is a ton of comparable information available. How can anyone argue it's not worth spending money on a professional property valuation every 2-3 years when the asset in question is stated at €3m 4 years after the greatest property crash in the history of the state. €750 to the local estate agent/auctioneer/QS and you'd have a document which would underpin an impairment charge. It's a well established professional practice not rocket science. http://www.rics.org/ie/training-events/e-learning/distance-learning/certificate-in-commercial-property-valuation/online I've no connection to RICS or real estate valuation BTW.

dbran

Hi

If what you are saying is correct the auditors may have a case to answer. The assets should be written down as there may have been a permanent dimuition in value. It would be interesting to see what they have put on their audit file to justify this treatment.

And due to the inherent uncertainty involved in obtaining a proper valuation due to the lack of a functioning property market at the moment, there is an argument that the audit report should qualified on the grounds of fundamental uncertainty and limitation of scope. There is also the issue of whether or not the issue of going concern should also be mentioned.

I think one of the factors involved is the monitoring policy of the accountancy bodies towards their member firms. I understand that the ACA undertakes a risk based approach whereby they only undertake a monitoring visit when you are auditing a higher risk clients. The result is that some forms have never received a monitoring visit in over 20 years of trading, Whereas ACCA have a policy of visiting all audit firms every 6 years irrespective of the make up of their client base.

dbran

BenEadir

dbran wrote: »

Hi

If what you are saying is correct the auditors may have a case to answer. The assets should be written down as there may have been a permanent dimuition in value. It would be interesting to see what they have put on their audit file to justify this treatment.

And due to the inherent uncertainty involved in obtaining a proper valuation due to the lack of a functioning property market at the moment, there is an argument that the audit report should qualified on the grounds of fundamental uncertainty and limitation of scope. There is also the issue of whether or not the issue of going concern should also be mentioned.

I think one of the factors involved is the monitoring policy of the accountancy bodies towards their member firms. I understand that the ACA undertakes a risk based approach whereby they only undertake a monitoring visit when you are auditing a higher risk clients. The result is that some forms have never received a monitoring visit in over 20 years of trading, Whereas ACCA have a policy of visiting all audit firms every 6 years irrespective of the make up of their client base.

dbran

What you say makes a lot of sense dbran except for the comment "due to the lack of a functioning property market". What is the definition of same? If there were no relevant comparable transactions happening I think a case could be made that there isn't sufficiently reliable market data to base a valuation on and that may well have been the case in 2008/2009 as everyone froze and hoped the crash was a short term issue but since then transactions have been occurring so there has been (in my opinion) a functioning market for at least the last 3-4 years. It may not be a "normal" market but it is functioning.

dbran

Maybe a "normal" market is what I meant. In any case it would be a brave auditor who would sign off on a set of accounts with a hugely overvalued property on the balance sheet without some form of qualification. They are leaving themselves open to being sued if the company defaults on the loan or goes into liquidation.

BenEadir

dbran wrote: »

Maybe a "normal" market is what I meant.

The problem with saying assets only have to be revalued if the market is acting in a "normal" manner (however that would be defined) is that it would give companies the option to pretend they are still adhering to collateral covenants they may have given when borrowing against the asset when the reality is at the date the balance sheet is being reported the disposable value of the asset is nowhere near the value being reported. That would equate to a sanctioned misleading of lenders and other parties who have an interest in the financial status of the business. "True and Fair" has to trump all other interests regardless of whether the market is acting "normally" or not. In fact I would argue and I believe history would support the view that sudden market corrections like a property bubble bursting followed by price crashes and/or poor lending resulting in banking defaults and a severe tightening of credit etc are completely normal outcomes of a functioning market correcting itself. Pretending anything else is akin to a young child putting his hands over his eyes and believing no one can see him or weather forecasters not reporting the weather when winds get over 100km an hour as it's not "normal"

dbran wrote: »

In any case it would be a brave auditor who would sign off on a set of accounts with a hugely overvalued property on the balance sheet without some form of qualification. They are leaving themselves open to being sued if the company defaults on the loan or goes into liquidation.

And it looks like a default on the loan or a liquidation of the company is what's likely to happen in the next 6-12 months.