To mark this momentous year for UK GAAP, I'm embarking on a mission to work my way through FRS 102, reading a portion on each working day of 2015 and writing a short blog entry on my thoughts and musings (be they few or many).
Day 62 (11 Jun)
Oh dear. For any avid readers (I'm fantasising, maybe) who've wondered in dismay why the blog has dried up since 3 June, I'm afraid I've had a recurring spot of ill health which is proving a little too persistent. Happily I am on the mend and back for more thoughts on the thorny topic of investment property valuation.
In my last post, I began to explore the 'undue cost or effort' opt-out in section 16 of FRS 102. I suggested its inclusion is primarily due to the lack of established valuation professions in some countries applying the IFRSSME (on which FRS 102 is based), and while this circumstance is not broadly true in the UK, the FRS has retained the opt-out for 'oddball' properties that prove difficult and costly to value.
But we've not really got to grips with how the FRS itself interprets the phrase. So today's post will turn to this.
Firstly, there's no point searching through the FRS itself for any expansion on the term 'undue cost or effort'. It's not defined in the glossary (the clue, of course, is that it doesn't appear in bold type). In fact the only hint of guidance appears in the advice accompanying the FRS from its authors, the Accounting Council, to the issuing body (the Financial Reporting Council). The advice is appended to the FRS and, on the topic of undue cost or effort, states the following in paragraph 118:
The Accounting Council considered whether to provide guidance for the term 'undue cost or effort' where respondents had sought clarification. The Accounting Council noted that Section 2 Concepts and Pervasive Principles discussed the balance between benefit and cost and that no further clarification was required.
In that case, let's turn to section 2 where the relevant paragraphs (2.13 and 2.14) are as follows:
Balance between benefit and cost
The benefits derived from information should exceed the cost of providing it. The evaluation of benefits and costs is substantially a judgemental process. Furthermore, the costs are not necessarily borne by those users who enjoy the benefits, and often the benefits of the information are enjoyed by a broad range of external users (2.13).
Financial reporting information helps capital providers make better decisions, which results in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole. Individual entities also enjoy benefits, including improved access to capital markets, favourable effect on public relations, and perhaps lower costs of capital. The benefits may also include better management decisions because financial information used internally is often based at least partly on information prepared for general purpose financial reporting purposes (2.14).
So to summarise: accounts preparers bear the cost; users enjoy the benefits (such as obtaining loans, management decision-making etc). Users and preparers are not necessarily the same people and there may be a broad range of users. But comparing cost and benefit always involves judgement (as the full extent of users may not be known - how can one quantify the number of people downloading the entity's filed accounts, for instance?)
Now I am very happy to agree that in many cases there are either (a) a number of users of the accounts who would benefit from obtaining property fair values - notably the bank! - or (b) even in the case that the only user of the accounts is the sole owner-manager, that the fair values are still beneficial for decision-making. But I contend that, in the latter case where the only identifiable user of the accounts is the proprietor, we should allow this person to judge whether or not they wish to pay for a valuation on the basis of benefit to them. I have had conversations with one or two such individuals who state candidly that, although it might be vaguelyinteresting to know the value of the properties they rent out, it isn't of any real use as they have no intention of ever selling the properties (they are a family inheritance), are not indebted or seeking to borrow against the properties, and only care about whether the tenants behave themselves and whether the rent can be increased each year.
NB If the entity is audited, then of course the auditor would need to examine such a client's rationale for claiming that revaluation incurs undue cost or effort. This will include considering the users of the accounts and their needs, the likely cost of revaluation, and an assessment of whether the underlying motive for this approach is consistent with true and fair accounting (or is it designed to mislead and distort the accounts?)
To conclude: while it's likely that the undue cost or effort opt-out will be a minority approach, we shouldn't rule it out, but need to apply critical judgement based on the guidance in section 2. More tomorrow on how gains and losses should be dealt with...
P.S. If you missed the last instalment click here