Accounting measurement of real estate. Adjustment for inflation and recoverable values
What precautions should be taken when carrying out the accounting measurement of the properties that make up the item “Property, plant and equipment” (PP&E), within the framework of the restatement by the application of the adjustment for inflation, in order to avoid an overvaluation of the assets?
In determining the carrying values adopted by the PP&E elements of financial institutions, it should be taken into account that, regardless of the primary measurement criterion used (cost model or revaluation model), and including the restatement that is practiced by application of IAS 29 if applicable, it must always be verified that the values of the assets do not exceed their recoverable value (reference: paragraph 19 of IAS 29). To this end, attention should be paid to IAS 36, which states that the value of an asset is impaired when its carrying amount exceeds its recoverable amount, which is the greater of its fair value less disposal costs and its value in use.
In general, IAS 36 does not require a formal estimate of recoverable value every year (except for goodwill and intangible assets with an indefinite useful life), but it must be performed to the extent that there are indicators of impairment. Some of the important indicators to highlight would be:
External:
• During the period, significant changes have taken place, or will take place in the immediate future, with an adverse impact on the entity, referring to the legal, economic, technological or market environment in which it operates, or in the market for which the asset is intended.
• During the period, market interest rates, or other market rates of return on investments, have increased that are likely to affect the discount rate used to calculate the value in use of the asset, such as to decrease the recoverable amount of the asset significantly.
Internal:
• Actual net cash flows, or results, derived from the operation of the asset, which are significantly worse than budgeted.
• A significant decrease in net cash flows or budgeted operating profit, or a significant increase in originally budgeted losses from the asset.
• Operating losses or negative net cash flows for the asset, when the current period figures are added to those budgeted for the future.
Similarly, paragraph 23 of IAS 36 provides that “In some cases, for the determination of the fair value of the asset less costs to sell or value in use, estimates, averages and other simplifications in the calculation may provide a reasonable approximation to the figures that would be derived from more detailed calculations such as those illustrated in this Standard.”
In this sense, and with respect to the fair value to be considered of the property, external evidence should be taken into account, such as the dissemination of prices by area and activity carried out by the real estate sector, prioritizing -when possible- data from similar operations carried out.
Rules involved:
IAS 29 – Financial Reporting in Hyperinflationary Economies
IAS 36 – Impairment on Assets