BRIAN GILSON provides clarification for members where clients request valuations that must comply with the International Financial Reporting Standards.
For valuers being asked to provide valuations for year-end company accounts, the valuer must use the fair value measurement approach under International Financial Reporting Standards (IFRS) – IFRS 13 – for reporting periods on or after January 1, 2013. IFRS 13 is mandatory and universal for those companies that operate under IFRS. It is essential that the valuer is familiar with the IFRS 13 requirements and the additional reporting requirements necessary.
There are two recognised definitions of fair value and the valuer must explicitly state in their Terms of Engagement the correct definition under IFRS 13. The two definitions are:
- The definition adopted by the International Accounting Standards Board (IASB) in IFRS 13: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. For most practical purposes, this definition of fair value is consistent with the concept of market value. But, in order to comply with IFRS 13, it would be appropriate to report the basis of valuation as fair value rather than market value.
- The second fair value definition in a non-IFRS context (as adopted by IFRS): “the estimated price for the transfer of an asset or liability between identified, knowledgeable and willing parties that reflects the respective interests of those parties”.
An example of this application might be for an off-market transaction, the most important element here being that it involves identified parties. The valuation figure may not necessarily accord with that which would result from exposure of the relevant property or interest to the market at large, i.e., it may not necessarily represent market value.
From the valuer’s perspective, IFRS 13 imposes two clear responsibilities. The first is to assess whether an appraisal complies with IFRS 13, and the second places an obligation on the valuer to apply a fair value hierarchy of evidence to any valuation appraisal. The valuer must be satisfied that any valuation carried out is an appropriate measurement of fair value for financial reporting (that is, the appraisal has been performed in accordance with the principles of IFRS 13). Such an assessment would include, but is not limited to, assessing whether:
- the principle or most advantageous market has been appropriately considered;
- appropriate market participants have been identified and the assumptions that market participants would utilise in pricing the asset have been used;
- all appropriate valuation approaches and techniques have been used; if different valuation techniques are used the merits of each technique in underlining assumptions must be assessed and considered and highlighted to the client; and,
- the highest and best use has been assessed.
The second obligation on the valuer is to apply the fair value hierarchy of evidence described in Table 1.
Due to the non-homogenous nature of most property, it would be rare for real estate to be classified in Level 1 of the fair value hierarchy. In market conditions where real estate is actively purchased and sold, the fair value measurement would normally be classified in Level 2. In this regard, IFRS 13 provides a real estate-specific example, stating that: “Level 2 input would be the price per square metre for the property interest derived from observable market data, e.g., multiples derived from similar prices in transactions involving comparable property interest in similar locations”. In other words, in active and transparent markets, real estate valuations would be classified as Level 2.
In inactive or less transparent real estate markets it is generally unlikely that real estate would be classified in Level 2, but would rather be classified as Level 3.
While the above concepts are not new, fair value creates extra reporting responsibility when accepting instructions from clients for the purposes of their company accounts. It is most likely that the client has now adopted IFRS 13 and the required basis of valuation is not market value but fair value, and this needs to be explicitly highlighted in the valuer’s terms of engagement to their clients.
The valuer is required to disclose the fair value hierarchy in assessing any real estate appraisals for a company for accounts purposes. The above categorisation is something new and has not been a requirement for valuations in the past under market value, which was most likely used for figures reported in company accounts up to year ended December 31, 2012. As such, it is important not to confuse the reporting standards that were used in annual valuations in 2012.
Considerable judgement may be required on applying the fair value measurement concepts such as determining what is the highest and best use, value and alternative use, determining the valuation premise and applying the fair value hierarchy. It is important that both the valuer and their client enters into a meaningful dialogue at the outset of any instruction, and that both have a good knowledge of the concepts for making judgements relating to fair value measurements.