Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Property valuations under FRS 102

17th Jun 2019
Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Steve Collings looks at some of the main issues accountants face when it comes to the accounting aspects of property valuations under FRS 102, and tackles queries raised around fair values and revaluation amounts.

There are two sections in FRS 102 which deal with properties: Section 16 Investment Property and Section 17 Property, Plant and Equipment.

Investment property

The glossary to FRS 102 (March 2018) defines ‘investment property’ as:

‘Property (land or a building, or 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:

  1. use in the production or supply of goods or services or for administrative purposes, or
  2. sale in the ordinary course of business.’

In the basic sense of the definition, if a property earns rentals for the entity it will meet the definition of an investment property and hence must be accounted for as such.

The Financial Reporting Council (FRC) have removed the undue cost or effort exemptions that were in FRS 102 (September 2015) as part of the triennial review amendments, including those which were in Section 16. Therefore, all properties which meet the definition of investment property under FRS 102 (March 2018) are accounted for under Section 16 and must be remeasured to fair value at each balance sheet date with fair value gains and losses going through profit and loss. There is an option available to groups which is discussed later.

Seemingly, some practitioners have continued accounting for investment property under the old UK GAAP accounting treatment (ie taking fair value gains directly to a revaluation reserve).

This is wrong under FRS 102 because the standard applies the fair value accounting rules in the Companies Act 2006 (as opposed to the alternative accounting rules) for investment property gains and losses and hence such gains and losses are reported via the profit and loss account.

Where the practitioner has applied the incorrect accounting treatment and the error is material, then it would need to be corrected by way of a prior year adjustment in accordance with FRS 102, Section 10 Accounting Policies, Estimates and Errors.

Also, don’t forget that deferred tax must be brought into account which is also presented in profit and loss, hence for a fair value gain on an investment property the entries are:

Dr Investment property £X
Cr Fair value adjustments (profit and loss account) £X
Being fair value gain on investment property
Dr Deferred tax (profit and loss account) £X
Cr Deferred tax provision £X
Being deferred tax liability arising on fair value gain

FRS 102, paragraph 29.16 requires deferred tax relating to investment property measured at fair value to be measured using the tax rates and allowances that apply to the sale of the property (there is an exception in paragraph 29.16 relating to investment property which has a limited useful life).

If it is assumed that the client has no plans to sell the asset for the foreseeable future, deferred tax is calculated using the tax rates and laws which have been enacted or substantively enacted by the balance sheet date, hence we can use 17% (indexation allowance may also be available depending on when the asset was purchased) as this will be the corporation tax rate which will apply for the corporation tax year starting 1 April 2020.

Fair value gains on investment property are not distributable because they are unrealised gains (the gain cannot be readily convertible into cash). The gain, net of deferred tax, ends up in retained earnings or they can be presented in a separate component of equity in the balance sheet to ring-fence them from reserves which are distributable. There is nothing in company law which requires such gains to be presented separately in the equity section of the balance sheet, but it is often a good idea to do this to prevent them being inappropriately distributed.

Where fair value gains are presented as a separate component of equity, some professional bodies are advising against calling the reserve a ‘Fair value reserve’ which is what some automated accounts production software systems are referring to the reserve as by default. Instead, they are advising member firms to call it a ‘Non-distributable reserve’ so you may need to rename the reserve accordingly. Regardless of what the reserve itself is called in the financial statements, the crucial point to emphasise to the directors is that the gains are not distributable.

Intra-group investment property

The FRC included an accounting policy choice for investment property which is rented out to another group entity in FRS 102 (March 2018). This is likely to prove to be attractive for groups and formed part of the triennial review amendments.

The triennial review amendments apply mandatorily for accounting periods commencing on or after 1 January 2019 and early application is permissible provided all of the triennial review amendments are applied at the same time.

The only exception to this rule relates to the amendments in respect of directors’ loans and gift aid payment, which can be early applied separately without having to early adopt the rest of the triennial review amendments.

Please note, if you apply the triennial review amendments earlier than the mandatory 'effective from' date you must disclose this fact, although small entities are encouraged to disclose this fact) (FRS 102 (March 2018), para 1.18).

FRS 102 (March 2018), para 16.4A allows an entity which rents investment property to another group entity to account for those properties either at fair value through profit and loss or by transferring them to Section 17 and applying the cost model (cost less depreciation less impairment).

Where this accounting policy choice is adopted, it will require retrospective application as illustrated in the following example:

Example  

Topco Limited has an investment property which it rents out to another group member. The company is preparing its financial statements to 31 March 2019 and wishes to apply the accounting policy to measure the intra-group investment property under the cost model. The group is medium-sized and is required to prepare consolidated financial statements.

A transitional provision is contained in FRS 102, para 1.19(a) which allows the entity to:

  • apply the transitional provision which allows an entity to take the fair value at the date of transition for the triennial review amendments (in this case 1 April 2017, being the start date of the comparative year presented in the financial statements) and use that as deemed cost going forward; or
  • use the historical cost of the property and depreciate/impair the asset as if it had always been carried at cost.

Topco wishes to take the fair value at the date of transition as deemed cost. As a consequence, the investment property is not being carried on a cost basis and is being measured under the alternative accounting rules. Therefore, any fair value uplift existing at the date of transition is transferred to a revaluation reserve from either retained earnings or the non-distributable reserve.

Topco then restates the comparatives and accounts for the intra-group investment property under the cost model in Section 17.

Topco must also make the historical cost comparable disclosures to comply with Schedule 1 to The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410), para 34. In addition, it must also disclose the fact that it has early adopted the triennial review amendments. If it were a small entity, it would be encouraged to disclose that it has early adopted the triennial review amendments.

Revaluation of owner-occupied property

Owner-occupied property is accounted for under FRS 102, Section 17.

Section 17 allows an entity to use the revaluation model for assets, but where the entity does apply the revaluation model to an asset it must revalue all assets within that asset class. The entity cannot just revalue those assets in the class which have increased in value; they must also revalue those which may have decreased in value.

When the revaluation model in FRS 102 Section 17 is applied, the entity is applying the alternative accounting rules in the Companies Act 2006 (not the fair value accounting rules which are applied for investment property). This means the entity must present a revaluation reserve in the balance sheet.

In addition, deferred tax is also brought into account. Hence, for a revaluation gain:

Dr Property, plant and equipment £X
Cr Revaluation reserve £X
Being revaluation gain on freehold building at the year end
Dr Revaluation reserve £X
Cr Deferred tax provision £X
Being deferred tax on revaluation gain

When an asset suffers a revaluation loss, the carrying amount of the asset is reduced and the corresponding debit is taken to the revaluation reserve to the extent of a surplus in respect of that asset. You cannot offset losses of one asset against gains of another and vice versa. Once the surplus in the revaluation reserve in respect of that asset has been used up, any further losses are recognised in profit and loss.

Gains on revaluations are generally recognised in other comprehensive income via the revaluation reserve. The exception to this would be where the gain reverses a previous revaluation decrease in respect of the same asset which has been recognised in profit or loss. In such cases, the gain is taken to profit or loss to the extent of the previously recognised loss with any resulting excess being recognised in the revaluation reserve.

Do not forget to account for the deferred tax consequences as well.

Frequency of revaluations

FRS 102 para 17.15B requires an entity to carry out a revaluation exercise with sufficient regularity such as to ensure that the asset’s carrying amount in the balance sheet does not differ materially from its fair value at the balance sheet date.

There are no specific timeframes referred to in FRS 102 as there was in previous FRS 15 Tangible fixed assets and hence professional judgment must be applied in this respect.

Conclusion

The treatment of properties within the financial statements under FRS 102 does seem to continue to present challenges – particularly investment property.

This article has looked at some of the main issues which practitioners face when it comes to the accounting aspects of property valuations under FRS 102. In addition, the FRC has also produced some helpful factsheets, one of which covers the issue of fair value measurement for property.

Replies (14)

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By johnt27
19th Jun 2019 09:55

"Where fair value gains are presented as a separate component of equity, some professional bodies are advising against calling the reserve a ‘Fair value reserve’ which is what some automated accounts production software systems are referring to the reserve as by default. Instead, they are advising member firms to call it a ‘Non-distributable reserve’..."

I'd love to see a reference to this as I hadn't picked this up from commentary by other experts.

Given the FV adjustment on investment properties is similar to FV movements on other investments I don't see the issue on the naming convention.

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collings
By Steven Collings
19th Jun 2019 14:42

ICAEW Technical Advisory are advising against calling it a Fair Value reserve. They want it called a Non-distributable reserve on the grounds that 'fair value' implies hedging and financial instruments under UK company law.

I'm not sure if ICAEW have put out commentary to this effect to their members but I'd imagine that they have put something out about this.

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By Nigel2810
21st Jun 2019 07:16

Is there any way to claim true and fair override, on the basis that the FRS is stupid.
The cost of implementing this for owner managed businesses massively outweighs the benefit, so they have been able to escape those costs to date.
It also distorts the balance sheet and the ROI as the trading properties are in at cost and the Investment properties will be at current value.
I presume there is no get out and i'm clutching at straws but all this does is increase costs.

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Replying to Nigel2810:
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By johnt27
21st Jun 2019 13:19

T&F doesn't work on this I'm afraid, but you seem to think there is an implicit cost of implementing the FRS, which implies you haven't read it!

There's no requirement to undertake formal valuations of investment properties, so the director(s) can do their own as long as they comply with the requirements of section 11 and the valuation technique, assumptions etc are disclosed. The only issue arises if the company is subject to audit and the technique could be challenged if materially incorrect.

On deferred tax the only difference is this is now recognised rather than disclosed in the accounts (something that was usually missed) so the necessary paperwork and calculations should just be rolled up from previous years and then updated..

On ROI isn't the purpose of an investment property to make a return, whether that be capital, revenue or both? How you decide to measure this is then a choice.

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By ShayaG
02nd Jul 2019 12:15

I don't understand the moral panic around "non distributable reserve". Fixed assets or prepayments aren't readily converted to cash, and nobody has suggested that they be added back from distributable reserves. And I don't think that the balance sheet approach is a particularly appropriate metric of the legality of dividends.

I think a better test would be whether a company can meet its debts *as they fall due* on the basis of cashflow projections. That may be more onerous to evidence, but less onerous in terms of assets.

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Replying to ShayaG:
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By johnt27
03rd Jul 2019 11:05

I think the company's act is quite clear on legality of dividends and directors' responsibilities to ensure companies can continue to meet their debts as they fall due based on reasonable assessments of going concern.

I don't understand the moral panic either but I do understand the legal one. I think it's fair to say that many assets/liabilities may not be readily convertible into the balances shown on the balance sheet, but directors are responsible for ensuring these are true and fair and not materially incorrect.

Prepayments have a value assuming the going concern basis remains appropriate on the basis they will reverse to P&L (reducing distributable reserves), if not, the accounts would be prepared on a break up basis with no prepayments.

Fixed assets are similar to the above - directors are obliged to assess all fixed assets for impairment and adjust as necessary. I think it's a reasonable assumption that many companies, and their advisors, fail to get depreciation and impairment policies that are accurate. Such that many assets are over depreciated and impaired assets tend not to be.

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By ahm
02nd Jul 2019 23:34

Hi
I am new on here, just signed up today !
I understand the deferred tax journals on the first example where you have revalued investment property and taken the gain to PL. You have then provided DT by:
DR Profit/loss Deferred tax
CR DT provision.
This is what I am happy with. However, in the second example the gain is shown within revaluation reserve, which is fine as it cannot go direct to PL. However, the DT journal on this is:
DR revaluation reserve
CR DT provision.
My question is why do we take the DT off the Revaluation reserve credit in this case? Why not do the same journal as in example 1? ie CR revaluation reserve and DR P/l DT expense.

Regards

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Replying to ahm:
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By johnt27
03rd Jul 2019 10:43

Hi there,

The deferred tax charge follows the accounting treatment of the differences in market value (fair value).

In the examples given we have:

an investment property where fair value movements hit P&L, therefore so does the deferred tax movement; and

a revaluation (fair value adjustment) of property, plant and equipment (used in the trade of the business) whereby the fair value movement is required to be accounted for in a revaluation reserve, hence the deferred tax movement is here.

As the investment property is held for this purpose (investment returns), just as say a share or other investment would be expected to, the accounting treatment is to recognise gains and losses in P&L.

As the PPE is used in the trade of the business any valuation gains are incidental to the trade and purpose of owning the assets so these are not recognised in P&L and instead in other comprehensive income resulting in a revaluation reserve. The same can be done for valuation losses, in certain circumstances, but these may also hit P&L if they are deemed to be a permanent impairment (i.e. treat in same way as depreciation).

This change in treatment from old UK GAAP is controversial for some but I think better represents the purposes of holding different types of assets - investments or to facilitate the trade of the business.

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Replying to johnt27:
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By ahm
03rd Jul 2019 11:01

John
Thanks so much for your reply, that now makes sense.

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Replying to johnt27:
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By ahm
03rd Jul 2019 11:14

Hi sorry forgot to say that I completely agree with what you have said. However, in the ICAEW model accounts I have seen a revaluation of investment property go through PL for £30k but the corresponding entry into the other non distributable reserves within equity section is only £25k it is reduced by the amount of deferred tax. In effect they have CR Deferred tax prov and rather than take the DR entry to PL tax charge they have taken the DR to the non dist reserve. This is not consistent with what we had discussed. So I am more confused now !

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Replying to ahm:
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By johnt27
03rd Jul 2019 12:24

Which model accounts are these? Without seeing them it's hard to pass comment but I'll try...

Without trying to make this too confusing - if the net profit after tax is £125k ie £100k trading profit (after CT and DT), £25k FV gain (after DT) then this would go to P&L reserve and non-distributable reserve respectively. Technically it all goes to P&L reserve first and you transfer/ring fence the non-distributable part.

The tax charge/credit in P&L should be made up as follows:
CT on trading profit/loss
DT on timing differences
DT on FV gain/loss through P&L

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Replying to johnt27:
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By ahm
03rd Jul 2019 14:03

Hi
Here is the link to the sample accounts.

https://www.bloomsburyprofessionalonline.com/view/example_financial_stat...

You will see that the revaluation of £30k has gone to the PL as it was an investment property. The entry to reserves is only £24.9k because they have deducted DT of £5.1k from this. Surely they should be doing the following:

DR PL tax with DT £5.1K
CR DT provision £5.1k

CR PL gain on revaluation £30k
DR Investment property b/sheet £30k

The PL gain of £30k gets ring fenced and should be £30k in non dist reserves but they have shown this as £24.9k. This is the bit I am confused with.

Thanks so much

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Replying to ahm:
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By johnt27
03rd Jul 2019 16:09

Those example accounts are correct. As there's no tax note (not requireed in 1A accounts) you're not seeing the DT charge hitting P&L but it will be part of that charge in the P&L, which is correct. The hyperlink to the notes refers to the same.

I wouldn't religiously follow those example accounts as an operating profit note isn't required - it's a bit misleading as there are some exceptional items, which have to be disclosed under 1A included there correctly. Again see the hyperlinks to the notes.

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Replying to johnt27:
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By ahm
03rd Jul 2019 16:25

Thanks so much, that would make sense now. You are an absolute star !

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