Property is often the most significant figure within a set of financial statements, so it is vital to get the numbers and disclosures correct. The most important, or significant, part of that is the valuation of the property itself.
The accounting treatment for property can differ depending on the financial reporting standards applicable to the entity (company) in question. If you are not sure which financial reporting standards apply to your business, it is important to get professional advice to make sure you are working to the correct standards.
The majority of small businesses, under the definition provided by the Companies Act 2006, need to meet the reporting requirements under FRS (Financial Reporting Standard) 102, although there are some exceptions – again, seek advice from a professional if you’re in any doubt.
Before any valuation work begins, you need to decide what category the property falls into as this will affect how the assets are recorded and how they are dealt with for tax purposes.
Freehold properties are interests in land or buildings which are intended to be used on a continuing basis for the company’s activities.
Initially recorded at cost, these assets must be depreciated in accordance with the Companies Act and applicable reporting standards. You can choose whether to revalue the land or buildings later, but it is still necessary to calculate depreciation and adjust for it if material.
If you decide to adopt a policy of revaluation, this must be applied to all assets within that class of assets and the valuations must be kept up to date. You cannot just revalue those assets in the class which have increased in value; you must also revalue those which may have decreased in value.
At the same time, FRS 102 paragraph 17.15B states that you need to carry out a revaluation exercise with sufficient regularity such as to ensure that the value of the asset on the balance sheet does not differ materially from its fair value (equivalent to open market value) at the balance sheet date.
There are no specific timeframes referred to in FRS 102 as there was in the previous FRS 15 reporting standard, and so professional judgment must be applied.
Any changes in the value of a property due to normal market movements should be taken to a revaluation reserve displayed separately on the balance sheet. Annual movements should be disclosed in a statement of changes in equity.
Investment properties can be defined as land and/or buildings held for its investment potential or capital appreciation, with rental income at arm’s length. This generally excludes property owned and occupied by a company for its own purposes and property that is let to, and occupied by, a related group company.
This type of property should be included in the balance sheet at its open market value and should not be depreciated. Investment properties should be revalued each year to fair value (equivalent to open market value) with any value changes taken to the profit or loss account.
Fair value gains on investment property are not distributable because they are unrealised gains (the gain cannot readily be converted into cash). The gain, net of deferred tax, ends up in retained earnings. These gains can, however, be presented in a separate component of equity on the balance sheet to ring-fence them from reserves which are distributable. It is not essential to separate these gains on the balance sheet, but it is often a good idea to do this to prevent them being inappropriately distributed.
Some professional bodies are advising against calling the reserve a ‘fair value reserve’ and are advising companies to call it a ‘non-distributable reserve’. Regardless of what the reserve itself is called in the financial statements, the crucial point to emphasise to the directors is that the gains are not distributable.
The financial statements should clearly display the carrying value of investment properties. The notes to the financial statements should disclose the names of the persons making the valuation, the bases of the valuation and whether they are an officer or employee of the company.
Formal valuations performed by qualified valuers may not be essential under financial reporting requirements, however, it is generally advisable for the directors of a business to seek a formal valuation on a periodic basis, particularly where it is suspected that a valuation has increased.
With increased property valuations, the business will benefit from an improved net asset / balance sheet position, thereby improving the overall valuation of the business, financing potential and eventual shareholder / investor returns.
Whether the land or buildings are freehold or investment, and whether their value has increased or decreased, getting an accountant involved will make sure that these assets are categorised properly, and valued and reported on in the correct way.
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This post was written by Liz Graney