Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
knew the number there is no reason to assume that this is the discount rate that
investors actually require as a cost of capital.
As a final note on regulators and costs of capital, we would also point out that
European regulators tend to target a real, pre-tax return on capital. They derive a
real, pre-tax cost of capital by calculating the nominal cost of debt and equity in
the normal way, and then convert this to a real number. As usual, this is an after
corporation tax figure, so it has to be ‘grossed up’ to derive a pre-tax number. But
the marginal rate of tax does not in fact apply to current cost profits. It applies to
taxable profits based on historical cost accounts. And, as we have seen in our
discussions of deferred taxation, the economic tax wedge is usually quite different
(often lower) from the statutory rate of corporation tax. This all means that the
regulators’ calculations of the real cost of capital are highly questionable, even
before we get to the fact that targeting ROCEs is not the same as targeting IRRs.
1.7 IFRS and the utilities industry
The transition to IFRS will have important implications for the regulated utilities
sector. For the first time government based accounting will have to be supplanted
with investor friendly GAAP. We have outlined below some of the areas of
importance:
1.7.1 Asset capitalisation
The assets of a utility may be owned by the government or directly owned by the
utility company for a period of time prior to being returned to the government.
The recognition (or not) of these assets will reflect the detailed substance of the
agreement between the government and the service provider. For example, if the
asset is merely used by the utility company and the key risks rest with the
government then it would appear highly likely that the asset would not be
recognised on the company’s balance sheet. If an asset were to be recognised then
the depreciation period would be a function of the period over which the utility
company is expected to use the asset.
1.7.2 Licences
If a utility corporation purchases the right to use the asset from the government
then it will be recognised as an intangible asset.
1.7.3 Decommissioning costs
One of the key challenges for companies in these industries is to deal with future
‘dismantling’ costs. These costs are difficult to identify and are not required to be
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