Valuation Guidance for Property, Plant and Equipment, Including Specialised Items in the Health and Education Sectors

Transcription

1 Valuation Guidance for Property, Plant and Equipment, Including Specialised Items in the Health and Education Sectors 2007 First Published 2002 Previously Revised 2003 Prepared by Wareham Cameron & Co Ltd, Rider Levett Bucknall & The Treasury TREASURY: V1

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3 Table of Contents Introduction...1 Background...2 Crown accounting policies...3 Section 1: Financial reporting and valuation standards...5 Section 2: Asset classification and valuation methodology...14 Section 3: Valuations in the health and education sectors specific considerations...27 Section 4: Instructing and liaising with valuers...36 Appendix A: Specific guidance for assessing the replacement cost of health and education buildings...38 Appendix B: Worked example of a depreciated replacement cost calculation...60

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5 Introduction These guidelines have been prepared by Treasury to assist public sector reporting entities and their valuers (and particularly those within the health and education sectors) to comply with the valuation requirements of the New Zealand Equivalent to International Accounting Standard 16: Property Plant and Equipment (NZ IAS 16) and Crown accounting policies in relation to NZ IAS 16. They are also intended to help achieve consistency in such valuations. These guidelines predominantly focus on specialised items of property, plant and equipment (which are the majority of assets in the health and education sectors). These comprise assets that are not regularly bought and sold in the market. The format of these guidelines is as follows: Background Crown accounting policies Section 1: Financial reporting and valuation standards Section 2: Asset classification and valuation methodologies Section 3: Valuations in the health and education sectors Section 4: Instruction and liaising with valuers Outlines the purpose of this guidance. Details Crown accounting policies for the revaluation of items of property, plant and equipment in the health and education sectors. Details the valuation requirements of NZ IAS 16 and the Property Institute of New Zealand s (PINZ) valuation standards as contained in the fifth edition of Professional Practice (which now adopt International Valuation Standards issued by the International Valuation Standards Committee (IVSC)). Overviews asset classification and the valuation methodologies that are appropriate for property, plant and equipment, explaining the depreciated replacement cost approach in detail. This section and Section 1 outline generic (i.e. non-sector specific) requirements and the guidance they contain applies to all items of property, plant and equipment. Considers specific issues and requirements relevant to the health and education sectors, with a focus on specialised property and the application of the depreciated replacement cost approach to valuation. This section also provides indicative parameters for the values/costs and useful lives of items of property, plant and equipment commonly found in the health and education sectors. Provides guidance for engaging and liaising with valuers and identifies audit requirements. Appendices Appendix A Appendix B Provides specific guidance for the assessment of the replacement cost of buildings in the health and education sectors. Provides a worked example of a depreciated replacement cost calculation. Section 1 outlines the requirements of Financial Reporting and Valuation Standards. Financial Reporting Standards are mandatory. Valuation Standards and Applications as set out in PINZ Professional Practice are mandatory for PINZ members. Care has been taken in writing these guidelines to ensure they accurately reflect the requirements of Financial Reporting and Valuation Standards. However, if there is a conflict between these guidelines and the Financial Reporting and Valuation Standards, then the provisions of the standards shall prevail. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 1

6 The application of the Depreciated Replacement Cost methodology discussed in Section 2 is recommended practice. It is acknowledged that there may be variations depending on the judgement of the valuer. The indicative parameters for costs and lives contained in Section 3 (and Appendix A) are considered to be reflective of the market at the time the costing guidelines were prepared (as at 1 May 2007). Indexing may be required to reflect price changes to the applicable valuation date. Furthermore, the parameters represent yard-sticks and specific asset, market and/or owner circumstances may lead to the adoption of assumptions outside of the parameters contained in the guidance. It is the responsibility of the valuer to exercise professional judgement in his/her valuation assessment. The methodology adopted by the valuer together with any material departures from the guidance should be fully reasoned and explained. Health and education asset values are generally inextricably linked to entity operations. Consequently, valuers and the management of these organisations need to work closely in discussing key assumptions for the valuation. Such information exchanges and interaction should occur throughout the valuation process. For public sector reporting entities, further information on these valuation guidelines or the valuation process should be directed in the first instance to your Vote Analyst. Alternatively, enquiries may be directed to Treasury s Accounting Policy Team. Background Public sector entities follow generally accepted accounting practice, which means that, in the first instance, they apply New Zealand financial reporting standards, which from 2007 are predominantly made up of New Zealand International Financial Reporting Standards (NZ IFRS). In the absence of a New Zealand financial reporting standard for a transaction or event, public sector entities should use professional judgement, as guided by NZ IAS 8: Accounting Policies, Changed in Accounting Estimates and Errors (paragraphs 7 to 12), to determine which of the available sources of authoritative support to apply. It is the responsibility of public sector entities to develop appropriate accounting policies for reporting purposes. Guidance on the factors to consider when developing such policies is provided in Treasury Instructions. The Government will comply with the requirements of NZ IAS 16 in its financial statements for the periods beginning or after 1 July All entities preparing financial information for the financial statements of Government from that period onwards will be required to ensure that the information they provide complies with NZ IAS 16 and Crown accounting policies in relation to NZ IAS 16. Treasury considers that there should be consistency in the valuation of specialised items of property, plant and equipment, such as those held by public sector entities in the health and education sectors, and that such consistency, and lower transaction costs, is likely to be achieved if detailed valuation guidance is provided. For those reasons, Treasury has commissioned this guidance on the valuation requirements of NZ IAS 16. This revised 2007 edition updates previous guidance based on FRS-3 Accounting for Property, Plant and Equipment. The original guidelines were produced with stakeholder input to ensure that stakeholders information needs were met and that the guidance produced was fully utilised. 2 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

7 Crown accounting policies Current Crown accounting policies are provided in Treasury Instructions. It is the responsibility of all entities preparing financial information for the Crown financial statements to ensure that they provide such information in accordance with current Crown accounting policies, as detailed in Treasury Instructions. At the time of release of this guidance, Crown accounting policies in relation to items of property, plant and equipment are as per the table below: Class of PPE Land & Buildings Specialist Military Equipment State Highways Aircraft Electricity Distribution Electricity Generation Other PPE Specified cultural and heritage assets Accounting policy Land and buildings are recorded at fair value less impairment losses and, for buildings, less depreciation accumulated since the assets were last revalued. Valuations undertaken in accordance with standards issued by the Property Institute of New Zealand are used where available. Otherwise, valuations conducted in accordance with the Rating Valuation Act 1998 may be used if they have been confirmed as appropriate by an independent valuer. When revaluing buildings, there must be componentisation to the level required to ensure adequate representation of the material components of the buildings. At a minimum, this requires componentisation to three levels - structure, building services and fit-out. Specialist military equipment is recorded at fair value (which is determined using depreciated replacement cost) less depreciation and impairment losses accumulated since the assets were last revalued. Valuations are obtained through specialist assessment by New Zealand Defence Force advisers, and the bases of these valuations are confirmed as appropriate by an independent valuer. State highways are recorded at fair value (which is determined using depreciated replacement cost) less depreciation and impairment losses accumulated since the assets were last revalued. Land associated with the state highways is valued using an opportunity cost based on adjacent use, as an approximation to fair value. Aircraft (excluding Specialised Military Equipment) are recorded at fair value less depreciation and impairment losses accumulated since the assets were last revalued. Electricity distribution network assets are recorded at cost, less accumulated depreciation and accumulated impairment losses. Electricity generation assets are recorded at fair value less depreciation and impairment losses accumulated since the assets were last revalued. Other property, plant and equipment, which include motor vehicles and office equipment, are recorded at cost less accumulated depreciation and accumulated impairment losses. Specified cultural and heritage assets comprise national parks, conservation areas and related recreational facilities, as well as National Archives holdings and the collections of the National Library, Parliamentary Library and Te Papa. Such physical assets are recorded at fair value less subsequent impairment losses and, for non-land assets, less subsequent accumulated depreciation. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 3

8 The Crown accounting policies also require: Classes of property, plant and equipment that are revalued, must be revalued at least every five years or whenever the carrying amount differs materially to fair value. Items of property must be revalued to fair value for the highest and best use of the item on the basis of the market value of the item, or on the basis of market based evidence, such as discounted cash flow calculations. If no market based evidence of fair value exists, fair value must be estimated using a depreciated replacement cost approach. Where an item of property is recorded at its optimised depreciated replacement cost, optimised depreciated replacement cost must be based on the estimated present cost of constructing the existing item of property by the most appropriate method of construction ( modern equivalent asset ), less allowances for physical deterioration and optimisation for obsolescence and relevant surplus capacity. Where an item of property is recorded at its depreciated replacement cost, borrowing costs must be expensed. At the time this guidance was being finalised, an amended NZ IAS 23 was approved by the Accounting Standards Review Board, with applicability for periods beginning on or after 1 January Under this amended NZ IAS 23, borrowing costs that are directly attributable to the acquisition, construction or production of an asset that necessarily takes a substantial period of time to get ready for its intended use or sale, are required to be capitalised as part of the cost of that asset (NZ IAS 23 para 8) and the option to use the previous benchmark treatment to expense borrowing costs will be removed. Accordingly, from 1 January 2009, borrowing costs will also be required to be allowed for in revaluations where a cost based approach (depreciated replacement cost) is adopted. (NZ IAS 16 para 33.14) The Crown will utilise the transitional provisions associated with the 2007 amendment to NZ IAS 23 and continue to expense borrowing costs up to that date, while developing its response to this amendment, given the difficulties in: identifying the relationship between particular borrowings and qualifying assets given that most of the financing activity of the Crown is coordinated centrally determining appropriate interest rates as the Crown uses a range of debt instruments to borrow funds at varying rates of interest, and developing a consistent approach given that the Crown can be expected at various times to move between being a net lender and a net borrower. Due to the requirement for line-by-line consolidation of all state-owned enterprises (SOEs) and Crown entities in the Crown financial statements, these entities are required to provide their financial information to Treasury (for Crown financial statement and forecast purposes) on a basis consistent with Crown accounting policies. 4 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

9 Section 1: Financial reporting and valuation standards This section details the requirements for valuations of property, plant and equipment in accordance with NZ IAS: Property, Plant and Equipment (NZ IAS 16) and relevant Property Institute of New Zealand (PINZ) standards, applications and guidelines. Where additional explanation is required readers are referred to NZ IAS 16 or the relevant PINZ material within Professional Practice. Financial reporting standards: NZ IAS 16: Property, Plant and Equipment NZ IAS 16: Property, Plant and Equipment requires that an item of property, plant and equipment that qualifies for recognition as an asset shall initially be measured at its cost. Cost is deemed to be at fair value where it is acquired at no cost or nominal value (NZ IAS and NZ IAS ). After initial recognition, a reporting entity shall choose either the cost model or the revaluation model as its accounting policy, and shall apply that policy to an entire class of property, plant and equipment. (NZ IAS 16 para. 29) Under the revaluation model, after recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. (NZ IAS 16 para. 31) Valuations shall be conducted either: a by an experienced valuer, or b where the entity employs a person sufficiently experienced to conduct a valuation, by that person, so long as the valuation has been subject to review by an independent valuer. (NZ IAS 16 para ) For plant and equipment, where there is an active market or readily available price indices that establish the item s fair value with reasonable reliability 1, the valuation need not be conducted or reviewed by an independent valuer or experienced employee. (NZ IAS 16 para 35.3) If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs shall be revalued. (NZ IAS 16 para 36) NZ IAS 16 also provides the following definitions and guidance: Fair value Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction. (NZ IAS 16 para 6). The fair value of land and buildings is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. The fair value of items of plant and equipment is usually their market value determined by appraisal. (NZ IAS 16 para 32) 1 Such a valuation is not applicable where depreciated replacement cost is the most appropriate basis for determination of the fair value of an item of plant and equipment INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 5

10 If there is no market-based evidence of fair value because of the specialised nature of the item of property, plant and equipment and the item is rarely sold, except as part of a continuing business, an entity may need to estimate fair value using an income or a depreciated replacement cost approach. (NZ IAS 16 para 33) Depreciated replacement cost Depreciated replacement cost is a method of valuation that is based on an estimate of: a in the case of property: i the fair value of land; plus ii the current gross replacement costs of improvements less allowances for physical deterioration, and optimisation for obsolescence and relevant surplus capacity, b in the case of plant and equipment owned by public benefit entities, the current gross replacement cost less allowances for physical deterioration, and optimisation for obsolescence and relevant surplus capacity. (NZ IAS 16 para.33.1) Revaluation frequency 2 The frequency of revaluations depends upon the changes in fair values of the items of property, plant and equipment being revalued. When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is required. Some items of property, plant and equipment experience significant and volatile changes in fair value, thus necessitating annual revaluation. Such frequent revaluations are unnecessary for items of property, plant and equipment with only insignificant changes in fair value. Instead, it may be necessary to revalue the item only every three or five years. (NZ IAS 16 para 34) Independent valuer The fair value of property, plant and equipment is determined or reviewed by an independent valuer who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the property plant and equipment being valued. (NZ IAS 16 para 35.2). Disclosure is required in respect of each valuation conducted: the name of each valuer a statement in respect of each valuer as to whether they are an employee of the entity or whether they are contracted as an independent valuer the total fair value of property plant and equipment valued by that valuer where the valuation has been conducted by an employee of the entity the name of the independent valuer who reviewed the valuation, and the date(s) of such valuations (NZ IAS 16 para 77.2). 2 Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. 6 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

11 In addition, valuers are referred to IVS 3 Valuation Reporting and IVA 1 Valuation for Financial Reporting within PINZ Professional Practice for a detailed commentary on reporting and disclosure requirements. Where an independent valuer has not been used because there is an active market or readily available price indices that establish the fair value of an item of plant or equipment with reasonable reliability, this fact shall be disclosed. (NZ IAS 16 para 77.3) Componentisation 3 NZ IAS 16 does not prescribe the unit of measure for recognition, i.e. what constitutes an item of property, plant and equipment. Thus, judgement is required in applying the recognition criteria to an entity s specific circumstances (NZ IAS 16.9) However, NZ IAS 16 does require each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item to be depreciated separately. Thus an entity allocates the amount initially recognised in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part. NZ IAS 16 notes for example, that it may be appropriate to depreciate separately the airframe and engines of an aircraft (NZ IAS ). The implication of this is that where the reporting entity does have an item of property, plant and equipment that is accounted for at a component level, any revaluation will need to be valued at a similar component level. Borrowing costs 4 At the time of writing this guidance, an amended NZ IAS 23 is imminent, with applicability for periods beginning on or after 1 January Under this amended NZ IAS 23, borrowing costs that are directly attributable to the acquisition, construction or production of an asset that necessarily takes a substantial period of time to get ready for its intended use or sale, will be capitalised as part of the cost of that asset (NZ IAS 23 para 8) and the current benchmark treatment to expense borrowing costs will be removed. Accordingly, borrowing costs should also be allowed for in revaluations where a cost based approach (depreciated replacement cost) is adopted. (NZ IAS 16 para 33.14) Under the transitional provisions associated with the 2007 amendment to NZ IAS 23, an entity is not required to comply with the requirement to capitalise borrowing costs until periods beginning on or after 1 January 2009, and is permitted to expense all its borrowing costs. The Crown will utilise these transitional provisions (see Crown Accounting Policies) however Crown entities that directly incur borrowing costs may capitalise those relevant borrowing costs earlier. If such an option is taken the information on borrowing costs capitalised, both in the year to date, and incorporated into depreciated replacement cost valuations must be separately disclosed. 3 4 Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 7

12 The Financial Reporting Standards Board (FRSB) has considered the issue as to whether a public sector capital charge is a borrowing cost. As a consequence of these deliberations the FRSB (in its report to the Accounting Standards Review Board on NZ IAS 32 dated Oct 2004): noted that public sector capital charges represent a charge on the net assets employed by public sector entities, and do not relate to any financial instrument, either debt or equity, and that making an interpretation that they did would be inappropriate noted that the capital charge is designed to ensure that the costs of capital are included in the costs of services and to require that they be reported elsewhere would effectively thwart their purpose, and agreed not to include additional guidance for public benefit entities. Accordingly, the capital charge should not be considered a borrowing cost eligible for capitalisation. Optimisation NZ IAS 16 (para s to 33.11) contains specific guidelines regarding the degree of optimisation that should be applied when using the depreciated replacement cost approach. This is further discussed in Section 2 of this guidance. Valuation standards: IVA 1: Valuation for Financial Reporting PINZ Professional Practice has seen a continued move towards International Valuation Standards with the fifth edition (effective 1 March 2007) incorporating all IVSC Standards, Applications and Guidance Notes. IVA 1 and NZVGN 1 provide guidance to valuers when preparing asset valuations for financial reporting purposes for both NZ IAS 16, NZ IAS 40: Investment Property (NZ IAS 40) and NZ IAS 5: Non-current Assets Held for Sale and Discontinued Operations (NZ IFRS 5). IVA 1 and NZVGN 1 apply the principles developed in the IVS s to the requirements of the IAS s/ifrs s. While plant and equipment is revalued in accordance with NZ IAS 16, property may fall under NZ IAS 16 or NZ IAS 40. Property to be accounted for (and revalued) under NZ IAS 16 is generally defined as property held for use in the production or supply of goods or services or for administration purposes or sale in the ordinary course of business. Additional examples of property that fall under the provisions of NZ IAS 16 include property held for the future use as owner-occupied property, property held for the future development and subsequent use as an owner-occupied property, property occupied by employees and property that is being constructed or developed for future use as an investment property. Property to be accounted for (and revalued) under NZ IAS 40 is property held to earn rentals or for capital appreciation or both. (NZ IAS 40 para 5) 8 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

13 In respect of public benefit entities, property may be held to meet service delivery objectives rather than to earn rental or for capital appreciation. In such situations the property will not meet the definition of an investment property and will be accounted for under NZ IAS 16, for example: a property held for strategic purposes. and b property held to provide a social service, including those which generate cash inflows where the rental revenue is incidental to the purpose for holding the property. (NZ IAS 40 para 9.1). Public benefit entities are defined as: reporting entities whose primary objective is to provide goods or services for community or social benefit and where any equity has been provided with a view to supporting that primary objective rather than for a financial return to equity holders. (NZ IAS 16, para NZ 6.1) Some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion that is held for the use in the production or supply of goods or services or for administration purposes. If these proportions can be sold separately, an entity accounts for the proportions separately. If the proportions could not be sold separately, the property is an investment property (i.e. falls under the provisions of NZ IAS 40) only if an insignificant portion is held for use in the production or supply of goods and services or for administration purposes. (NZ IAS 40 para 10) Non-current Assets Held for Sale and Discontinued Operations are assets for which the carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable. The flow chart on the following page provides guidance on the classification of property assets between NZ IAS 16 and NZ IAS 40 for financial reporting and valuation basis purposes. The focus of these guidelines is the revaluation of assets in accordance with NZ IAS 16 and in particular, valuation where reliable market evidence of the value of a property does not exist and valuation using depreciated replacement cost is required. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 9

14 Asset classification framework for valuation purposes Property Asset Yes Is the property surplus to the entity's requirements or held for sale in the ordinary course of business? No Is the property available for immediate sale in its present condition and is the sale highly probable? Yes No No Is a significant portion of the property owner occupied or intended to be used for the production or supply of goods or services or for administration purposes as opposed to being held to earn rentals or for capital appreciation? Yes Public Benefit Entities Is the property held to meet service delivery objectives rather than to earn rental or capital appreciation? Yes No NZ IFRS 5 NZ IAS 40 NZ IAS 16 Fair Value Less Disposal Costs Fair Value Fair Value Market Value less Disposal Costs Market Value Market Value No Is their reliable marketbased evidence of the property being valued? Yes Depreciated Replacement Cost Sales Comparison / Income Approach IVA 1 and NZVGN 1 also provides the following definitions and guidance: Market value The term fair value, used in NZ IAS 16 and NZ IAS 40, is generally synonymous with the term market value as defined in International Valuation Standard 1: Market Value Basis of Valuation (IVS 1) and adopted in IVA 1. 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 para 3.1) 10 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

15 Where the market/fair value 5 of a property, plant and equipment asset is not able to be reliably valued using market-based evidence for the same or a similar asset, depreciated replacement cost is to be used to estimate fair value. Specialised assets / depreciated replacement cost approach Items of property, plant and equipment that are not able to be reliably valued using market-based evidence for the same or a similar asset are referred to as being specialised. Specialised assets are those that are rarely if ever sold on the open market, except by way of a sale of the business of which they are a part, due to their uniqueness, which may arise from the specialised nature and design of the buildings, their configuration, size or location or other factors. Key characteristics of specialised assets are that they: Are useful to a limited number of uses or users Rarely, if ever, sell on the open market, except as part of the business entity Are generally specialised structures, and Earn revenue that has not been derived from an open market and for which market based evidence does not exist. In general, specialised asset are those that, due to some specialised physical or geographical factor, offer very little utility for any purpose other than that for which they were originally designed. Apportionment of value / componentisation In undertaking valuations generally, valuers will frequently be required to undertake an apportionment of reported property values, allocating value separately to the land element (nondepreciable) and the buildings (depreciable). Valuers should, as far as possible, continue to apply market concepts. While it is acknowledged that buildings cannot be separated from the land that they occupy, valuers should recognise that the purpose of carrying out the apportionment is to establish a basis for measuring the consumption in the financial statements. For non-specialised property, the land value should be established and deducted from the total (fair value) to arrive at the depreciable amount for the buildings. In the case of specialised property, the total fair value will be the sum of the land value and the depreciated replacement cost of the improvements (and therefore no separate apportionment to land value is required). The componentisation requirements of NZ IAS 16 will require the valuer to undertake further valuation apportionments of non-land assets where instructed by the reporting entity 6. Valuers may also be requested to explicitly advise on appropriate useful lives over which asset components should be depreciated for accounting purposes. These requirements may require the valuer to seek the professional assistance of specialist valuers (such as plant valuers) or other experts such as engineers or quantity surveyors, where the valuer does not have the necessary expertise. (IVA 1, section and NZVGN 1 para 6.5) 5 6 From here on, the terms fair and market value are used interchangeably, meaning the same thing for the purposes of valuations for financial reporting. Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 11

16 For the purposes of componentisation, the costs attributed to the components should be based on an apportionment of the overall replacement costs (or value) where the latter can be reliably sourced from the market (i.e. a top-down, as opposed to a bottom-up, approach). The reason for this is that the top-down approach will more accurately reflect the market replacement cost/value, as aggregating the replacement costs/values of individual parts from a bottom-up approach will usually produce an inflated overall figure 7. The degree of componentisation for valuation purposes will largely reflect the way the asset is accounted for by the reporting entity. Accordingly, valuers should discuss the required level of componentisation with the reporting entity. Borrowing costs 8 Where the reporting entity adopts the alternative treatment allowed in NZ IAS 23: Borrowing Costs (NZ IAS 23), of capitalising borrowing costs, the amount of borrowing costs that would be embodied in the fair value of the asset is included as a component of DRC. The amount to be included as a component of DRC is determined on the basis of the average debt-to-equity ratio and average cost of debt applicable to entities undertaking the same activities as the entity reporting. (NZ IAS 16 para NZ 33.14) Owner-occupied property Where the primary approach to valuation of owner-occupied properties for financial reporting purposes is capitalisation or discounting of future rental income, the valuer shall assume that a notional lease is in place on market terms and conditions reflecting the current use. This approach assumes that the owner-occupier is using the property for its highest and best use. If it is not, then the property would need to be valued having regard to its highest and best use. (NZVGN 1 para 6.5) Report disclosures IVS 3, section 5.0 stipulates that the valuer s written report shall disclose the following information: Clearly and accurately provide the conclusions of the valuation in a manner that is not misleading Identify the client, intended use of the valuation and relevant dates (i.e. the date at which the valuation estimate applies, the date of the report and the date of inspection) Specify the basis of the valuation, including the type and definition of value Identify and describe the property rights or interests to be valued, physical and legal characteristics of the property and classes of property included in the valuation Describe the scope / extent of the work used to develop the valuation Specify all assumptions and limiting conditions upon which the value conclusion is contingent 7 8 For certain assets, such as infrastructure, where there are no overall replacement costs/values, a bottom-up approach will be the only option. Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. 12 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

17 Identify special, unusual, or extraordinary assumptions and address the probability that such conditions will occur Include a description of the information and data examined, the market analysis performed, the valuation approaches and procedures followed and the reasoning that supports the analysis, opinions and conclusions in the report Contain a clause prohibiting the publication of the report in whole or part, or any reference thereto, or to the valuation figures contained therein, or to the names and professional affiliation of the Valuer s, and Include a Compliance Statement that the valuation has been performed in accordance with IVSs, disclose any departure from the specific requirements of IVSs and provide an explanation for such departure. The Compliance Statement contained in the Valuer s report shall also confirm that: The statements of fact presented in the report are correct to the best of the Valuer s knowledge The analysis and conclusions are limited only by the reported assumptions and conditions The Valuer has no (or if so, a specified) interest in the subject property The Valuer s fee is not contingent upon any aspect of the report The valuation was performed in accordance with an ethical code and performance standards The Valuer has satisfied professional education requirements The Valuer has experience in the location and category of the property being valued The Valuer has (or has not) made a personal inspection of the property, and No one, except those specified in the report has provided professional assistance in preparing the report. For the purposes of valuations prepared in accordance with this document, it is also recommended that the basis of depreciation (in a depreciated replacement cost valuation) be stated. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 13

18 Section 2: Asset classification and valuation methodology This section overviews the asset classification and standard valuation methodologies that are appropriate for property, plant and equipment, and explains the depreciated replacement cost methodology in detail. Asset classification The classification of an asset is central to the selection of the most applicable financial reporting standard to account for that asset for financial reporting purposes (as detailed in Section 1 of this guidance). In turn, the valuation methodology to be adopted is dependent on whether the asset can be valued by reference to market based evidence (i.e. whether the asset is regarded as nonspecialised). Where the value of the asset is not able to be determined using market based evidence, the asset is regarded as specialised. Assets to be accounted for under NZ IAS 40 are those that are held primarily to earn rental or for capital appreciation or both. These assets trade in the market place and accordingly are valued by reference to the active market or to market based evidence. Assets that are to be valued under NZ IAS 16 will usually represent operational assets. These are assets that are: integral to the supply of the entity s output, or being held or developed by an entity to be integral to the supply of the entity s output in the future. The valuer (possibly in conjunction with the reporting entity) will usually determine whether these assets are specialised, non-specialised or a mixture. Valuation methodologies There are three main approaches to determining market value: Sales comparison approach (comparable sales method, direct market comparison) Income (capitalisation) approach (including discounted cashflow analysis), and Cost approach (depreciated replacement cost). The first two approaches apply to non-specialised assets, while the latter applies to specialised assets. In some circumstances a cost approach is also applied to non-specialised properties as a check. There will be circumstances where an asset that is regarded as non-specialised forms part of a larger specialised asset or group of specialised assets. Examples would likely include: Student or staff housing/flats/apartments within a hospital or university campus A university registry or administration building A carpark within the campus of a hospital or tertiary education institution. 14 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

19 In the case of a specialised network or campus comprising numerous assets it is recommended that there is a rebuttable assumption that all the assets are specialised i.e. the campus or network is considered holistically rather than at an individual asset level. The reason for this approach is that in most cases the assets are closely inter-related and their values are directly linked to the operations of the entity. A specialised assumption can be rebutted if there is reliable market evidence for any individual asset, it is legally and physically possible to separate, and separation would not affect the integrity of the network or campus and therefore it could be economically rationale to separate. It will generally be the valuer s judgement as to whether market based techniques (rather than depreciated replacement cost) should be applied to individual assets. This decision should also reflect: The availability of market based evidence that enables the value of the asset to be reliably determined Evidence that there is/would be demand for the asset in its current use in the absence of the specific entity operations (if no such demand would exist, then the asset is inextricably interrelated with the other specialised assets and to value the asset using market based techniques may over-state the value as an individual asset), and The materiality of the particular asset in the context of the overall value of property assets. Cost based valuation methodologies Cost based valuation approaches use the cost of reproducing the asset, or the modern equivalent of the asset, as an estimate of the asset s fair value. The rationale for this is that if the asset: is able to be reproduced provides the utility or service expected of the cost, and is in its highest and best use then potential buyers will pay a cost-related price, which is equivalent to the cost of reproducing the asset themselves. Cost-based valuation approaches include: Reproduction cost, and Depreciated replacement cost. Reproduction cost The reproduction cost of an asset is the cost of reproducing that asset with exactly the same appearance and character, and using the same materials, where available, or where these could be specially manufactured. Reproduction cost is most applicable when valuing assets of a special character that are intended to be retained in their present form (for example, a heritage building). INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 15

20 A property that is described as a heritage asset has some cultural, environmental or historical significance. Heritage assets include historical buildings and monuments, archaeological sites, conservation areas and nature reserves and works of art. Heritage assets often display the following characteristics (although these characteristics are not necessarily limited to heritage assets): Their economic benefit in cultural, educational and historic terms is unlikely to be fully reflected in a financial value purely based on market price 9 Legal and/or statutory obligations may impose prohibitions or severe restrictions on disposal by sale They are often irreplaceable and their economic benefit may increase over time, even if their physical condition deteriorates, and It may be difficult to estimate their useful lives, which in some cases could be several hundred years. In the case of property, where there are prohibitions or severe restrictions on either demolition or alteration of the building, reproduction cost (as opposed to replacement cost, which is detailed in the next section) should be used. Depreciated replacement cost Depreciated replacement cost (DRC) measures the minimum cost of replacing or replicating the service potential embodied in the assets with modern equivalent assets in the most efficient way practicable, given the service requirements, the age and condition of the existing assets and replacement in the normal course of the business. Replacement cost is the cost of replacing an existing asset with a substantially identical new modern equivalent asset. When calculating depreciated replacement cost, NZ IAS 16 requires that physical deterioration be taken into account and that optimisation for obsolescence and relevant surplus capacity occur. The underlying principle is that DRC, through the optimisation process, recognises: that an entity may have more assets than it needs, and/or that some of those assets may be over-engineered or technically obsolescent. The DRC methodology comprises the following broad steps: 1) Develop/review asset registers 2) Develop standard replacement costs (including components, where applicable) 3) Optimise and calculate optimised replacement cost (ORC) 4) Assess useful lives 5) Determine depreciation and calculate DRC 6) Assess land value. 9 Rare and collectible works of art would be an exception. 16 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS

21 Each of these steps is explained in the following sections: 1) Develop / review asset registers The asset register compiled by the reporting entity should itemise all items of property, plant and equipment and provide general data on the entity s assets (especially the material items), including: Land and title/ownership information Age/remaining lives for land improvements and plant and equipment Quantities, size or capacity Construction details Condition and performance information Costing information (original cost and major refurbishment details and costings, where available) Component information (where applicable). The valuer will need to be satisfied as to the accuracy of the data used in the valuation. The extent of data review will be at the judgement of the valuer. Plant and equipment is deemed to include assets owned by the reporting entity that are utilised in the every-day activities of the reporting entity. Generally, these assets are not of a fixed nature and are able to be moved around for operational purposes. Building services assets that may be considered to be plant and equipment, such as lifts and building services, are considered integral (and fixed) and are therefore accounted for as a component of the building. 2) Develop standard replacement costs Under NZ IAS 16, an item of property, plant and equipment shall initially be recognised at its cost, which includes costs directly attributable to bringing the item to working condition for its intended use. (NZ IAS 16 para 16) Similarly, such costs should be allowed for in replacement costs adopted for valuation purposes. Building replacement/construction costs are based on market rates or evidence, which would typically be estimated from: Recent construction cost contracts for new buildings or extensions completed by the reporting entity The valuer s knowledge of construction costs of other buildings considered similar Costing databases/information such as Rawlinsons New Zealand Construction Handbook, and Specialist costing advice from professionals such as quantity surveyors. In addition to construction costs there should be allowances for other site works, professional fees, borrowing costs (where applicable) and resource consent costs. INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS 17

22 As previously mentioned, in the case of heritage property, where there are prohibitions or severe restrictions on either demolition or alteration of the building, reproduction costs should be used. These would be assessed on a case-by-case basis, as uniform rates will typically not apply to heritage buildings. Plant and equipment is to be assessed by reference to available suppliers, agents and manufacturers data, in addition to costing information that is able to be provided from the reporting entity. Specific comments in relation to certain costs are: Borrowing costs: 10 Where the reporting entity has a policy of capitalising borrowing costs under the provisions of NZ IAS 23: - Borrowing Costs (NZ IAS 23), interest costs incurred during the period of construction are to be included in the assessment of replacement (or reproduction) cost. Under NZ IAS 16, the amount to be included as a component of depreciated replacement cost is determined on the basis of the average debt to equity ratio and average cost of debt applicable to entities undertaking the same activities as the entity reporting. (NZ IAS 16 para ). Therefore borrowing costs are calculated at a rate that reflects the standard interest rates obtainable by a notional or hypothetical owner (i.e. an owner of similar assets), not at rates that are specific to the actual owner of the asset. Resource consents: Many specialised properties require initial and ongoing resource consents. These consents often involve considerable time and expense to ensure compliance with the required public consultation processes. Generally, resource consent costs would form part of the fair value of a major specialised asset and, in circumstances where the consents have a finite life, would normally be accounted for as a separate component. Componentisation 11 For the purposes of componentisation, it is considered that buildings should be divided into the following main components: Building structure and external envelope Building services, and Fitout. These are considered to represent the main components of buildings that have different useful lives or provide benefits to the entity in different patterns, thus requiring different depreciation rates/methods. NZ IAS 16 notes that each item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. (NZ IAS 16 para. 43). While it is considered that the three building components identified above should form the basis for component valuations, the actual level of componentisation will need to reflect the specific assets, materiality and the approach adopted/deemed necessary by the reporting entity. This will be a matter to be discussed between the valuer and the reporting entity and may lead to fewer or additional component levels (including sub-components, such as, for example, air-conditioning and lifts within building services). 10 Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. 11 Refer to the Crown accounting policies section of this guidance for details of the policies to be adopted when providing information for inclusion in the Crown s financial statements. 18 INCLUDING SPECIALISED ITEMS IN THE HEALTH AND EDUCATION SECTORS