Fair ValueThe Valuers’ Perspective

Chris Thorne FRICS FCIArbBoard Member IVSC

Stanley Booton MA MRICSChairman: RICS Valuation for Financial Statements Group

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Nature and objectives of IVSC

Valuation for financial reporting:

• Where we are now

• Fair value and Market Value

• Other practical issues

What do valuers need from IASB?

Overview

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Formed in 1981 by various professional bodies involved in real estate valuation

Members are professional bodies. Over 50 countries now represented.

Non Governmental Organisation member of UN

Latest standards (7th edition) published early 2005

IVS now adopted or incorporated into national standards in many developed economies – USA have agreed convergence of USPAP and IVS

Membership and standards now extend beyond real estate to other classes of asset and liability

What is IVSC?

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Members pay a annual fee

Majority of funding comes from sponsorship Current sponsors include:

• larger professional institutes, e.g. RICS and Appraisal Institute (USA).

• Major firms of real estate valuers, e.g. Atisreal, CBRE, Cushman Wakefield, DTZ, Jones Lang LaSalle, King Sturge, Knight Frank,

• Users of real estate valuations, e.g. Verband Deutscher Hypothekenbanken.

Funds committed from some accountancy firms for current business valuation project

IVSC funding

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Current structure considered inappropriate for further development.

Need to:

• broaden scope of markets addressed

• Improve relevance to different applications

• Increase output

All require additional funding

Strategic review underway; future structure may well be modeled on IASCF /IASB

IVSC restructuring

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IVSC’s role is to produce, publish and promote valuation standards:

• It is not a regulatory body

• It has no individual members

• It has no power to enforce or compel compliance with the standards

Compliance with IVS is through the member organisations of IVS.

“Red Book” is RICS regulatory document that requires members to adopt IVS, supported by monitoring and compliance powers.

Role of IVSC

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What are Standards? They ARE statements of:

• recognised principles and concepts• best practice in procurement and reporting• accepted definitions

They do NOT:• Prescribe specific methods of valuation for

different purposes• Teach valuers how to value!

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Valuation for Financial Reporting Accounting Standards were original motivation

for Valuation Standards Although IVS cover valuation generally, principal

“driver” remains IFRS In states such as UK and Australia, long tradition

of valuation in financial statements Also long tradition of valuers liaising with

national accounting standard setters In UK FRS 15 quotes RICS Red Book and vice

versa

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Valuation for Financial Reporting IVSC has had more limited influence on IASB Although IAS /IFRS allowed valuation option, not

widely adopted outside Commonwealth National standards, such as FRS 15, and

equivalents in other countries had clear guidance on valuation bases and assumptions

IAS in contrast just stipulate “fair value”, with only a definition and limited guidance on application

Accordingly existing IVS guidance also vague

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Light at the end of the tunnel? IVSC welcomes both Canadian Measurement and

FASB Fair Value projects Both shine light on some of the issues that have

been troubling valuers and auditors, e.g.:

• What is Fair Value?

• Is Fair Value the same as Market Value?

• Is FV always applied in the same context under different standards?

• How is Fair Value determined?

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Fair Value “the amount for which an asset could be exchanged between

knowledgeable, willing parties in an arm’s length transaction.” (IAS 16 para. 6)

Currently no conceptual framework for application. IAS 16 and 1AS 40 provide some help by stipulating

that normally determined having regard to market evidence or current market conditions, but:

• In general use fair value is price that is fair to the particular parties in the transaction

• It reflects the advantages and disadvantages to them of the transaction – synergistic value is expressly included

• Commonly used in share transfers and business combinations

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Other FV DefinitionsFASB October 05 –

• Fair value is the price that would be received for an asset or paid to transfer a liability in a current transaction between marketplace participants in the reference market for the asset or liability

FASB March 06 –• Fair value is the price that would be received for an

asset or paid to transfer a liability in a transaction between market participants at the measurement date

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Market Value

“Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.” (IVS 1)

Supported by Conceptual Framework in IVS

Definition well tested and now becoming established in regulation international – e.g. EU Directive on Solvency Ratios

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Market Value Conceptual Framework – highlights include:

• “estimated amount” excludes any element of special value – ie synergy gains available from a specific party have to be disregarded.

• a “willing buyer” is motivated but not compelled to buy

• a “willing seller” is neither over eager or forced but motivated to sell at whatever price is available in current market

• “proper marketing” means property has been exposed to market in most appropriate manner

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Definitions of ValueThe Valuers’ View

Market Value

FAIR VALUEmay be represented by

Current Cost (Net) Realisable Value

(price in exchange)

Value in Use to the Entity

Reproduction Cost

Recoverable Amount

(higher of above values)

Replacement Cost

(can be same at NRV)

Deprival Value

(lower of above values)

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Fair v Market Value In many cases price obtainable in the general market for that asset will be a price that is deemed “fair” by both partiesHowever:

• MV disregards any such synergistic value as this could only be realised if a specific party was willing to transact on date of valuation

• MV does not require price to be “fair” to either party – it is simply the price determined by market participants generally

• FV is generally a “broader” concept than MV. For many purposes ignoring synergistic value and whether deal was “right” for the particular entity would be wholly inappropriate

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Fair v Market Value Fair Value and Market Value overlapping

concepts but are NOT synonymous

FASB had proposed in include in its Fair Value definition a direct comparison to a “reference market”.

• Also clear from Canadian paper that entity specific considerations should normally be disregarded.

• Is not obvious solution to stipulate that MV as defined in IVS as appropriate measure for financial reporting?

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Practical Issues Is asset measured under going concern concept?

IAS 1 stipulates that accounts prepared on going concern basis – unless intention is to liquidate

Measurement takes place at asset level not entity level

Assets (or liabilities) can have markedly different market values depending on which assumption made:

• that they are part of a transfer of the whole operation or,

• that they are sold away from the enterprise as a separate item

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Practical Issues Is asset measured under going concern concept? - 2

Potential conflict between IAS 16 and IAS 36

• Is Fair Value under revaluation option supposed to be the same as Fair Value in impairment test?

• Intention of IAS 36 appears to be to establish minimum carrying amount by comparing ViU of holding asset with net proceeds of liquidation (FV less costs)

• Same FV (without costs deduction) might be thought to be carrying amount under IAS 16. However, this figure then used to calculate depreciation under same standard, which assumes asset continuing useful life to entity.

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Practical IssuesReal Estate

Real estate has characteristics that distinguish it from other types of asset and liability:

• It has to be transacted in-situ – if owner occupied the entity has to remove or relocate if not transferred as part of going concern

• Land does not normally depreciate

• Land and buildings may have potential for more valuable uses

• Buildings often adapted to suit particular operation

These pose particular measurement questions…

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If land and buildings declared surplus liabilities for contamination may be triggered – but not if transferred as part of going concern

Land may have higher value for alternative use but this could not be realised without closure or relocation – must be correct that potential is revealed in notes but :

• is it logical that carrying amount reflects a use inconsistent with the going concern assumption?

• If carrying amount does reflect alternative use, how are costs consequential on realising the higher value reflected?

Practical IssuesReal Estate Measurement Questions - 1

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An entity may construct a building that is specialised for its operation – includes buildings that are otherwise conventional but that are of abnormal size or in an abnormal location

• If valued on assumption that transfer of real estate interest is as part of transfer of whole entity the estimated price will reflect need of purchaser for that facility

• If valued without regard to going concern, ie as if surplus, there may be no identifiable purchaser at all, and price will reflect costs of redevelopment or reconfiguration for uses that would be in demand.

Practical IssuesReal Estate Measurement Questions - 2

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Stipulating Fair Value alone will not achieve consistency, transparency and credibility in IFRS

Problems identified are not valuation problems; valuers can provide answers under any of the alternative scenarios

Standards need to clarify the measurement objective for different purposes e.g. initial recognition, subsequent recognition, depreciating accounting or assessing impairment write downs

Valuation standards can then stipulate appropriate assumptions for each purpose

Practical IssuesWhat do valuers need from accounting standards?

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“Canadian Project” recognises some of the issues that can affect the assessment of value.

IVSC generally in agreement with main conclusions, pleased to see that impact of different assumptions (“value-affecting properties”) is acknowledged and discussed

Draft FASB Standard also advances debate. Clarifies that:

• FV for Financial Reports should normally reflect MV

• Discusses affect of “valuation premise” on value

Reasons to be Cheerful Part 1

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IVSC has recently met with both IASB and FASB Boards and Fair Value project teams

Board level commitments to improve understanding of issues and produce suitable guidance

IVSC broadening its scope and in dialogue with other groups interested in valuation of intangibles

Reasons to be Cheerful Part 2

Fair ValueThe Valuers’ Perspective

Chris Thorne FRICS FCIArbBoard Member IVSC

Stanley Booton MA MRICSChairman: RICS Valuation for Financial Statements Group