Question

10 years ago your organisation bought a block of land on the Perth foreshore for $500 000. Over the next two years an apartment block was constructed on the site at a cost of $5 000 000. The apartments are currently owned by your organisation and sublet to tenants on a variety of leases not longer than five years. You want to establish the fair value of the property using AASB 13/IFRS 13. You have ascertained the following information for your assessment:

I. Two separate expert valuations have been received. One valuer said the property was worth around $9 000 000 ($1 000 000 for the land and $8 000 000 for the building). The other valuer said it was worth $6 000 000 ($750 000 land value and $5 250 000 building value). Both valuers acknowledge that valuing the building in the current economic climate is difficult as there have been few sales of comparable buildings recently. They have used their experience of prior markets to estimate the values.

II. The current cost of replacing the building has been established as

$7 500 000, determined based on the current design with today’s construction costs, including labour, materials and overhead.

III. Present value of future cash flows:

Average net cash inflows over next 20 years is estimated to be $650 000 per year, based on projected cash flows from rent, tax savings and expenditures. It is assumed after 20 years the building will need to be replaced, and the land will be worth $1 000 000. The current borrowing rate for the entity is 12%.

IV. Depreciation is currently being charged on a straight-line basis using the same assumptions presented in part III.

(a) Discuss each of the above four values as a basis for establishing fair value. In accordance with AASB 13/IFRS 13 which methodology do you believe is most appropriate? What additional information would you like to obtain to make a better estimate?

Answer 1

Before we analyse, find below the information summarised:

Paritculars	Cost Price	Valuation 1	Valuation 2	Cost of replacement
Land	500,000	1,000,000	750,000	No information
Apartment	5,000,000	8,000,000	5,250,000	7,500,000
	5,500,000	9,000,000	6,000,000	7,500,000

Average net cash flows	650,000
Land value in 20 years	1,000,000
Borrowing rate	12%

Analysis

As per IFRS 13, there are three methods namely given below:

The income approach: amount dervied using DCF

The market approach: using prices from market transactions of similar assets are used to determine fair value

The cost approach: The amount that would be required to replace the asset.

Also the inputs used for valuation is classificed as given below:

1. Level 1 inputs : unadjusted quoted prices in active markets for items identical to the asset being measured.

2. Level 2 inputs are inputs other than quoted prices in active markets included within Level 1 that are directly or indirectly observable.

3. Level 3 inputs are unobservable inputs that are usually determined based on management’s assumptions.

1. Expert Valuation : As per the IFRS, the best input to be considered is the fair value of identical / similar asset in an active market. However the valuation received has acknowledgment that there are less transactions in the market and prior market information has been considered. No adjustment is made to these values to reflect the current economic situation also. This may be required to obtain more reliable information on the valuation. However depending upon the adjustments, the inputs may fall under under Level 3.

2. Current Cost of Replacement: Cost of replacement for the building is available. However the land value is not available. Also it is mentioned that replacement cost considers current design cost. However adjustment needs to be made for any costs which are not relevant to the end user who may use the property if bought. This method could have lesser adjustments than value provided in Expert Valuation.

3. Present Value of Future Cash Flows : The value derived using the DCF method will fall under level 3 as management estimates are being considered for the valuation. The lease rental assumption has to be validated by comparsion with similar assets.

As per the standard, market approach or income approach is preferred over and above the cost approach. However the value reliable will be the one with lesser unobservable inputs. Hence depending upon the additional information required as mentioned above and additional adjustments made, the best method needs to be considered.