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Table 1: Valuation techniques Table 2: Fair value hierarchy and inputs Market approach Uses prices and other relevant information generated by market transactions Level 3 Level 2 Level 1 amount that it approximates its fair value when allocating the fair value of the asset group to the individual assets of the group. HKFRS 13 assumes that the asset is sold consistent with the unit of account (i.e. what is being measured for financial reporting purposes). Management will need to determine whether the unit of account is an individual asset or a group of assets and associated liabilities. This is specified in HKFRS 13, which requires or permits the fair value measurement. The valuation premise and unit of account may differ in some circumstances, for example where a property is part a mixed use development. The unit of account may be an individual property but this property may be grouped with the complementary properties when measuring fair value. Fair value is the price for the individual property as the buyer is assumed to already hold the complementary properties and will not therefore pay more for the property simply because it is sold as part of the group. Valuation techniques Management will need to ensure the valuation technique used is appropriate in the circumstances and sufficient data is available to measure fair value using that technique. HKFRS 13 does not prioritize the use of one valuation technique over another. The valuation technique chosen should maximize the use of observable inputs, including market data from recent property transactions, and minimize the use of unobservable inputs, Income approach Converts future amounts such as cash flows to a single current (i.e. discounted) amount Quoted prices in active markets for identical assets and liabilities Cost approach Reflects the amount that would currently be required to replace the service capacity of the asset Inputs, other than quoted prices within level 1, that are observable for the asset or liability either directly or indirectly Unobservable inputs for the asset or liability including management’s own forecasts and assumptions. It should also be consistent with one of the approaches summarized in table 1. The use of more than one valuation technique will be appropriate where the reliability of the resulting fair value measurement is improved as a result. If the results of the two approaches differ significantly this may indicate the need to reconsider the comparable properties chosen and the adjustments under the market approach or the forecast cash flows and discount rate used under the income approach. Using more than one technique may produce a range of fair value indications. Management will need to assess the reliability of each technique and the inputs it uses in determining the point within the range that is most representative of fair value. Valuation techniques should be applied consistently unless a change in technique or its application results in a measurement that is equally or more representative of fair value. This might be the case where new information becomes available or valuation techniques improve. Fair value hierarchy HKFRS 13 introduces a new three-level fair value hierarchy for nonfinancial assets such as property as summarized in table 2. The valuation technique used must prioritize higher-level inputs over lower-level ones. The inputs used will determine the appropriate classification of the fair value measurement within the hierarchy, which A PLUS will in turn affect the nature and extent of financial statement disclosures required. In some cases multiple inputs will be used, which may fall within different levels of the hierarchy. Classification is then based on the lowest level of input that is significant to the entire measurement. Given that most properties are unique, market prices for identical properties are not likely to be available. Property valuations will therefore commonly be classified within level 2 or level 3 of the hierarchy. A level 2 input for a property valuation might be the price per square foot derived from recent market transactions for similar properties in a similar location. Management will need to assess whether any adjustments to level 2 inputs for differences between the property being valued and the comparable properties are based on unobservable inputs and are significant to the overall fair value measurement. Where this is the case, the valuation is classified as level 3. Some specialized properties may rarely be sold except as part of a continuing business. In the absence of any observable market transactions for such properties, the valuation will also be classified as level 3. Disclosure requirements HKFRS 13 includes significant additional disclosure requirements about the valuation techniques and inputs used to develop fair value measurements. Extensive disclosures must be provided for all level 3 fair value measurements because they are more subjective than those based on market prices. Management will want to ensure valuation reports contain sufficient information to satisfy HKFRS 13’s disclosure requirements. Dialogue with the external valuers on the content of their reports may need to start earlier rather than later. Conclusion HKFRS 13 introduces new valuation requirements that may impact some property valuations used for financial reporting purposes. Management will want to ensure there is clear communication with their external valuers about the techniques and assumptions to be used so that valuations comply with the standard. Gary Stevenson is principal, technical and training, at BDO in Hong Kong. December 2012 47
121 TechWatch The latest standards and technical developments Financial reporting Institute comments on IFRS Foundation constitution consultation The Institute made a submission to the IFRS Foundation on its constitution drafting review about separating the roles of the IASB chair and the executive director. The proposed amendments to the constitution, as set out in the consultative document, were largely in line with those the Institute had supported in a previous comment letter dated 8 April 2011 on the IFRS Foundation Monitoring Board’s consultative report on the review of the foundation’s governance. In that comment letter, the Institute supported separating the role of the IASB chair from the CEO or executive director of the IFRS Foundation where the IASB chair should lead the independent standardsetting process and the executive director manage all other aspects, including administrative affairs, of the IFRS Foundation. The Institute understood that the roles have already been separated in the first quarter of 2012 and the consultative document simply proposed to revise the foundation’s constitution to reflect the reality of such change. Audit and assurance Comments on IAASB consultation documents The Institute made a submission to the IAASB on its invitation to comment on Improving the Auditor’s Report, as part 48 December 2012 of the board’s continuing efforts to clarify the role of auditor and stakeholder expectations. In principle, the Institute supported the proposed improvements to the auditor’s report to provide more information to stakeholders. However, the Institute had concerns as to the extent of information provided under the proposed auditor commentary. The Institute did not believe that the auditor commentary would address the “information gap” without giving rise to implications for auditor liability. The Institute views audit quality as paramount and that any proposed changes to the form of auditor reporting should only be implemented if they do not have a negative effect on audit quality. In proposing changes to the auditor’s report, the Institute believes it is important for the IAASB to promote an understanding of the objective of performing an audit of financial statements and who are the intended users of auditors’ reports. IVSC exposure draft on the role of professional valuers in the audit process The Institute made a submission to the IVSC on its exposure draft of a practical guide on The Role of the Professional Valuer in the Audit Process. In principle, the Institute supported the proposed guide. The Institute considered that the distinction between the roles in acting as an auditor’s expert, and acting for an entity in providing valuations that will be included in financial statements that will be subject to audit, is not clearly explained. As currently drafted, the focus of the guidance appeared to be on the role of valuers acting in the capacity of an auditor’s expert, but guidance was also provided on being the management’s expert. There were further distinctions about whether the professional valuer is an internal or external expert. The Institute considered that these differences are important for a number of matters considered in the guide, for example the ethical and independence requirements and scope of work. The Institute recommended that the “scope of work” section be expanded to include common practices not only with respect to the situation of a valuer undertaking a limited review of the reporting entity’s valuation, but also to whenever the professional valuer is involved in the audit process. Corporate finance Institute submits views on Listing Rule changes As reported in TechWatch 118, Hong Kong Exchanges and Clearing consulted the market on Listing Rule changes to complement the introduction of a statutory obligation to disclose inside information. The Institute supports a review of the Listing Rules relating to price sensitive information disclosure in light of the impending implementation of the statutory regime for disclosure of inside information, under the Securities and Futures (Amendment) Ordinance 2012, and to provide procedures in the Listing Rules to facilitate implementation of the statutory
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