UK: Impairment: The Biggest Financial Reporting Challenge For The Sector?

Last Updated: 28 January 2014
Article by Jonathan Pryor

Arguably the main area of contention relates to the new proposals in the SORP on impairment. The current concept of planned internal subsidy on which many RPs have relied has been replaced by an objective measure, EUV-SH, for estimating the fair value of a scheme.

The FRS requires an entity to record an impairment if the recoverable amount of an asset is less than its carrying value. It defines the recoverable amount as the higher of value in use (which the SORP working party consider will be rarely relevant) and fair value less costs to sell.

Consequently, if the EUV-SH is lower than the carrying amount then an impairment will arise. This will be the case both for historic schemes where this is still true and for new schemes. Indeed, the recognition point is likely to be earlier in most cases than completion and could even arise at scheme approval stage.

Assuming the consultation process does not identify any material flaws, it is clear that the consequences of this change could be far reaching. Not surprisingly, there is very considerable concern that the accounting treatment might limit some RPs' future development plans.

Here are some points that may not have been fully appreciated in the sector.

  1. The carrying value includes a deduction for the related amortised grant, provided this is also carried on the balance sheet. Not that much help for future schemes admittedly, but potentially very helpful for historic ones.
  2. EUV-SH is intended to reflect the amounts other RPs would be prepared to pay for the scheme given the continuing restrictions in operation that may be present. The value should therefore include an element to take into account what the sector as a whole is prepared to pay for the social benefit derived from the asset in excess of the cash flows derived from it. So, if the scheme has planned internal subsidy, and the level of this is judged to be broadly in line with the 'RP market level' for such subsidy, then there would ordinarily be no impairment.
  3. If the valuer judges that a bidding RP would take into account potential alternative uses for the properties in their bid for the scheme, they should reflect this in the EUV-SH. Consequently there may be some schemes in high value areas which attract a higher EUV-SH than might otherwise be justified purely from the existing rentals because of a 'hope' value.
  4. Expressly, the valuation should reflect the optimisation of the sale process. In particular, if a higher value could be obtained from dividing the stock up into smaller parcels or lots, then the valuation should be done on that basis. There is objective evidence that this factor alone can increase valuations markedly.
  5. It is also worth noting that, though not the work of the SORP working party, FRS102 is different from FRS11 in that reversals of impairments just due to time are reflected as a credit in the income statement. Consequently, although an impairment may be recognised on some schemes at day one, it is possible that just through inflation on rents, for example, that the impairment will partially reverse each year to counter to some extent the impact of impairment on future development.

So where does this leave us?

It is clear, as indeed it always was, that as many RPs as possible should respond to the exposure draft of the SORP with their thoughts on this issue. Although we recognise that many of these responses are likely to refer to the impact on the particular RP or the sector as a whole, it would be helpful if possible if there were also some comments on the technical aspects of the argument, particularly where people disagree. However, on the basis that the exposure draft is not changed as a result, it is also clear that valuers will be very busy as this process will require more examination of individual schemes and greater levels of analysis by valuers. It will also require higher levels of investigation by auditors.

In the meantime it will be important for many RPs to assess whether the above changes might have a material impact on either the existing financial position or future plans for development. The impact on covenants and business plans is potentially profound.

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. code 13/051 exp: 31/07/14

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