statutory auditor, Audit Partner at RSM Poland
Not so long ago I wrote about a certain wrong approach to the valuation of fixed assets (revaluation model). Frequently, in the "revaluation" model, companies measure fixed assets at the fair value and cease to depreciate. Thus, the rules are confused with those that have been established for the valuation of investment properties. This is precisely according to IAS 40 that an entity may measure its investment properties at the fair value and does not need to depreciate. But first things first...
Secondly, pursuant to sec. 30 of IAS 40, an entity may select a valuation model for a subsequent measurement according to the fair value or a "cost" model. It is important that the selected approach should be applied to all investment properties.
You can find some information on the cost model in sec. 56 of IAS 40, including a reference to the principles of valuation of fixed assets according to IAS 16 (Property, plant and equipment), but also IFRS 5 (Assets held for sale) or IFRS 16 (Leases), though I will not focus on this approach later in this article.
While focusing on the approach based on the subsequent measurement at fair value, I would like to draw your attention to several issues which, unfortunately, frequently result in incorrect valuation and/or presentation in the financial statements:
- entities applying IFRS are encouraged to have the valuation at fair value prepared by an independent expert (IAS 40, sec. 32);
- profits/losses from changes in fair value must be recognised in the profit and loss account (sec. 35);
- the valuation based on fair value should be applied (unless there are circumstances preventing the valuation at fair value), inter alia, until the disposal of the property or its reclassification into fixed assets;
- double disclosure of assets in the balance sheet should be avoided - e.g. fixed assets recently commissioned or improved frequently constitute a part of the investment property and are included in the measurement at fair value of the investment property (they increase its value); therefore, special attention should be paid to work in progress which may be included in the valuation of the investment property; another example may be fixed assets affecting the valuation of the investment property, while they are elements of the financial lease of another asset, presented separately from the investment property;
- a number of disclosures in the financial statements is necessary - e.g. attention should be paid to demonstrate the effects of changes in the fair value separately from the effects of exchange rate differences in case of the valuation of investment property in a currency other than the presentation currency applied in the statements - see the example below.
An investment property as at 31 December 2015 was measured at the fair value of EUR 1,000, and the recognition in the entity's statements according to functional currency was at the exchange rate of PLN 4 per EUR, i.e. in the amount of PLN 4,000. At the end of 2016, the value of investment property was determined as PLN 4,400, mainly due to the depreciation of PLN against EUR (exchange rate of PLN 4.5 per EUR). The company recognised profits under the item "revaluation of investment properties" in the profit and loss account in the amount of PLN 400. However, as you might guess, there was a decline in the value of property calculated in EUR from the level of EUR 1,000 to about EUR 977.9. How then should we present these changes in the valuation in the statements/profit and loss account?
In my opinion, a following approach could be applied, which consists in determining:
- "what would happen if" the old value denominated in EUR was converted at the new exchange rate
- the change in the fair value in the valuation currency (EUR) according to the new exchange rate.
- the change resulting from the PLN depreciation amounts to: EUR 1,000 EUR x (4.5 – 4.0) = +PLN 500
- the change resulting from the decline in the fair value amounts to: EUR 22.1 x 4.5 = - PLN 100 (approximately).
Thus, ultimately, the entity should have demonstrated in the profit and loss account a loss on the change in the fair value in the amount of PLN 100 and profits resulting from exchange rate differences in the amount of PLN 500.
I invite you to visit our blog where you can find another portion of practical information related to IFRS erroneously presented in the Polish literature or in reports of the companies applying IFRS: www.rsmpoland.pl/en/blog.