Valuation and Depreciation of Road Infrastructure

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Fair Value

in Accordance with the

Australian Accounting Standards

David Edgerton FCPA

Director

Quality + Expertise +

Flexibility + Innovation =

Confidence & Real Value www.apv.net

Agenda

• Background

• AASB13 refresher

• Issues discussed at AASB

• CPA Australia guide

• Auditing of Valuations www.apv.net

Background

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Legislative (Public Sector)

• All assets to be at Fair Value

– Land

– Buildings

– Infrastructure

– Parks

– Plant

• Disclosure consistent with Special Schedule 7 www.apv.net

Fair Value Definition

“the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

(Exit Price) www.apv.net

Accounting Standards

• AASBs (13, 116, 136, 5)

• Australian Interpretations (1030, 1050)

• IFRIC 1, 4

• IFRIC 12 / IPSAS 32

Service Concession Arrangements www.apv.net

Auditing Standards

• Auditor required to express an opinion

• Compliance with the Australian Auditing

Standards

• (cover later in presentation) www.apv.net

Materiality and Risk

• Most material figures

• Highly subjective

• Non-compliant or overly simplistic approaches

• Significant impact on KPIs & Sustainability

Measures www.apv.net

Remember

• This is not an engineering exercise !

• Nor is it a ‘market valuation’ exercise

• It is –

– Valuation

– Based on Accounting Standards

Essential to have right expertise with right experience www.apv.net

Biggest Risk

• Using overly simplistic approaches

• Based on poor in incorrect assumptions

• That do not reflect asset management reality

• Resulting in materially incorrect results www.apv.net

When this happens (typically)

• Fair Value significantly under-stated

• Depreciation Expense (following years) significantly overstated

• KPIs make asset position and asset management performance look worse than actual www.apv.net

Simplistic v Reality

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Overview of Accounting Standards

• AASB13 about the valuation

• AASB116 & others about specific asset types

• Fair Value and depreciation concepts are critical

• Disclosure –

– Now critical

– Major part of the output www.apv.net

Many standards +

IFRICs to consider

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AASB116 Property Plant and

Equipment www.apv.net

Three techniques

• Market

• Income

• Cost

– Typically used for road & infrastructure

– Note differences between Cost (AASB13/116) and

Depreciated Replacement Cost (AASB136) www.apv.net

AASB116 Process

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Specific requirements AASB116

6 "Depreciable amount“ is the cost of an asset, or other amount substituted for cost, less its residual value.

43 Each part .... shall be depreciated separately.

50 Allocated on a systematic basis over its useful life.

51 The residual value and the useful life of an asset shall be reviewed at least at the end of each annual reporting period

60 The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity.

61 The depreciation method applied to an asset shall be reviewed at least at the end of each annual reporting period and...... the method shall be changed to reflect the changed pattern. www.apv.net

Concepts in simple terms

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Concepts for cyclical maintenance assets

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Critical Methodology Issues

• Future Economic Benefit

– What does the asset provide?

– drivers of consumption?

• Replacement Cost (existing v proposed)

• Depreciable Amount

– Residual Value and Useful Life

• Pattern of Consumption

• Accumulated Depreciation (% RSP) www.apv.net

What is WDV &

Depreciation Expense ?

GCRC = $100,000

Actual Age = 40 years

Original assumptions

Assume

Pattern of Consumption is constant

Useful Life = 45 years

Residual Value = nil

Current condition assessment

RUL = 30 years www.apv.net

What if you also knew ?

• Asset was renewed 10 years ago ?

• Expect to renew asset back to as new in 5 years time at cost of $50,000 ?

• After the renewal in year 30 the level of RSP was assessed as = 80% www.apv.net

Possible outcomes…. But only one is correct!

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Actual Data

Depreciation = 10,000 / 5 years = 2,000 p.a

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Example: Common Mistakes

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Miscellaneous Issues

• Segmentation

• Componentisation www.apv.net

AASB13 Fair Value Measurement www.apv.net

What is IFRS/AASB13 about?

• GFC and Sovereign Debt Crisis

• Valuation = Subjectivity

• Need for greater information

• Greater Risk = Greater Disclosures

Enables users to identify

‘dodgy, risky or non-compliant’ valuations www.apv.net

AASB13 Process

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Recurrent v Non-Recurrent

• Recurrent: required to be done on regular basis (e.g. infrastructure)

• Non-Recurrent: Only done is special circumstances (e.g. asset held for sale) www.apv.net

Valuation Premise

• Highest and Best use

• From the perspective of other market participants

Not entity specific

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Valuation Hierarchy / Level of

Valuation Input

• Three levels

• Need to maximise level of input

• May use multiple levels for each asset

– Level 1 (Quoted price)

– Level 2 (Observable market evidence)

– Level 3 (Non-observable market evidence) www.apv.net

Inputs & Valuation Hierarchy

Valuation Hierarchy based on –

• Lowest level of input

• Unless input is insignificant

Need to –

• Identify ALL significant inputs

• Classify as level 1, 2 or 3

• Technique DOES NOT determine hierarchy www.apv.net

What are the inputs?

(observable or unobservable)

• Asset design, location and specification

• Condition (and Scoring methodology)

• Componentisation / Segmentation

• Replacement Cost (Unit Cost)

– what level?

– How developed?

• Component level details (NOT at asset level)

– Residual Value

– Pattern of Consumption

– Useful Life

• Future Use / Obsolescence?

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Component Assumptions

• AASBs mandate that depreciation be applied at component level

• AASB13 requires these disclosures at component level

• Whole of asset depreciation assumptions are

‘inappropriate’ www.apv.net

Asset Classes

• Probably the biggest issue

• Totally missed by many !

• All disclosures by ‘Asset Class’

• ‘Asset Class’ defined by paragraph 94 www.apv.net

Asset Classes

94 An entity shall determine appropriate classes of assets and liabilities on the basis of the following:

(a) the nature, characteristics and risks of the asset or liability; and

(b) the level of the fair value hierarchy within which the fair value measurement is categorised.

The number of classes may need to be greater for fair value

measurements categorised within Level 3 of the fair value hierarchy because those measurements have a greater degree of uncertainty and subjectivity.

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In layman’s terms

• If you have used a different valuation process then this would be a different ‘asset class’

• Idea is to provide the ‘reader’ with all the information about each different valuation

• Indicators include different –

– Technique

– Level of Valuation Hierarchy

– Approach / Algorithms

– Inputs / Assumptions

– Level of risk or uncertainty www.apv.net

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Disclosures

• General Disclosures (policies and reconciliations)

• For each ‘Asset Class’

– Valuation Techniques and Inputs

– If level 3

• For each level 2 input (no disclosures)

• For each level 3 input

– Where did it come from

– How was it evaluated

– Quantitative info (eg. min and max)

– How reliable is it (sensitivity +/- %)

– Impact ($) on Fair Value Measurement www.apv.net

Techniques and Inputs

(for each asset class)

• Market / Income/Cost (or combination!)

• High level overview of process

– Segmentation

– Componentisation

– Condition scoring process

• Identify and disclose ALL inputs

• Classify each input as level 1, 2 or 3 www.apv.net

The Future of Valuation

• Increasingly more complex and specialised

• More changes ahead in accounting standards

– IFRIC4 & 12 / AASB15 (control and service concessions)

– Conceptual Framework (definition of asset)

– AASB review of disclosure requirements

– IPSASB conceptual framework

• CPA Australia Guide (AASB standards) www.apv.net

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AASB Issues (Sept 2014)

• AASB13 Disclosures for Public Sector

• Residual Value

• Difference between Replacement Cost

(AASB13) and Value in Use (Depreciated

Replacement Cost – AASB136) www.apv.net

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CPA Australia’s eGuide

• CPA Australia’s Guide to asset valuation and depreciation for not-for-profit and public sector physical assets under accrual based accounting standards

• Download from CPA website

• 18 month public consultation

• Peer Review Peter Batten (former member AASB)

• Covers high level, technical and practical issues

• AASB version under development www.apv.net

Auditing of Valuations

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Auditing Standards

• Key outcome is that auditors need to ensure valuation and methodology –

– Is sound and makes sense

– Complies with all relevant accounting standards

– Undertaken by expert with relevant knowledge and expertise

– Can be supported by sufficient and appropriate audit evidence

– Supported by appropriate report and disclosures www.apv.net

Key Considerations

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Audit Risk - Context

• Valuations dominate Balance

Sheets

• Depreciation usually highly material

• Maintenance v Capital: Impact highly material

• Significant impact on long term financial viability

Consequence

Low Moderate Major Qualification

Certain Mod

Likely Low

Possible Low

Unlikely Low

High

Mod

Low

Low

Extreme Extreme

High

Mod

Low

Extreme

High

Mod www.apv.net

Audit Risk – Identification &

Analysis

• Assets may not exist

• Asset Register not complete or accurate

• Valuation or depreciation methodology might be flawed

• Critical assumptions may be wrong

• No evidence to support assumptions

• Poor previous Audit History

Consequence

Low Moderate Major

Certain Mod

Likely Low

Possible Low

Unlikely Low

High

Mod

Low

Low

Extreme

High

Mod

Low

Qualification

Extreme

Extreme

High

Mod

Audit Risk = HIGH to EXTREME www.apv.net

Appropriateness , expertise and experience of the valuer

• Cannot just assume that they have the right background

• I’m an accountant who specialises in asset valuation and depreciation

– Would you let me do tax returns?

– How about giving financial planning advice?

• Understand the requirements and assess how much reliance you can place on the ‘expert’

• Adjust testing appropriately www.apv.net

Completeness

• What has the entity done to ensure the list provided to the valuer lists all assets?

• Do they understand concept of ‘control’?

• What has the valuer done to address this issue?

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Accuracy

• How have the underlying inputs been validated?

– Full inspection?

– Sample test?

– Just Assumed?

• What have you done to test?

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Existence

• What controls are in place to ensure –

– Only assets controlled are in books

– There is no duplication

– Erroneous assumptions have not been made about the existence of components www.apv.net

Valuation

• Risk is not whether additions and deletions have been recorded

• Nor whether or not the system correctly recalculates depreciation

• Real risk is whether methodology makes sense and fully complies with all aspects of the standards www.apv.net

For example

• Right technique

• Segmentation / Componentisation

• Assessment at component level

– Useful life

– Residual Value’

– Pattern of Consumption

• Appropriateness of Factors used

• Sufficient and appropriate evidence to support critical assumptions www.apv.net

Consider

• Do the results make sense?

• Is WDV as % of Gross reasonable given general condition?

• Are assets unreasonably written down to Nil or very low values?

• Has valuation used ‘condition’ or ‘age’ ?

• Have values been based on overly simplistic or unsupported assumptions ?

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IVSC v AASB

• Note that IVSC is not consistent with

IFRS/AASB

• Different definition

• Some approaches inconsistent

• IVSC focuses on ‘value to entity’ whereas Fair

Value is ‘ highest and best use that market participants would pay’

• Not well understood by ‘valuers’ www.apv.net

Final Thoughts

• Understand you professional obligations

• Tailor audit program to the greatest risks

• Doing Fair Value requires much more than some calculations (calc is only 25% of work)

• Easy to get key concepts wrong

– Understate value

– Overstate Depreciation Expense

• Check off disclosures against AASB13 (don’t rely on model statements) www.apv.net

Valuation Timeframe

Council gets data and prepares Aug - Sept

Council goes to market

Valuer to prepare proposal

Council to assess proposal and awarded contract

Oct

Oct

Nov

Valuer appointed and work scheduled

Council to provide asset listing and other data

Dec

Dec - Feb

Confirmation of assumptions

Inspections and valuation preparation

Mar

Mar / Apr

Draft valuation report

Council quality assurance review

May

Jun

Final Valuation Report Jun

Audit review of valuation

Finalise accounts

Final Audit review and Sign Off

Aug

Sept

Oct www.apv.net

Questions

David Edgerton FCPA

Email: David@apv.net

Web: www.apv.net

Mob: 0412 033 845

Work: (07) 3221 3499 www.apv.net

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