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November 9, 2021 at 10:22 pm #640327Anonymous
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Q- Included within the non-current assets of Fiskerton is a property in Halam which has been leased to Edingley under a 40-year lease. The property was acquired for $20 million on 1 October 20X7 and was immediately leased to Edingley.
The asset was expected to have a useful life of 40 years at the date of acquisition and have a minimal residual value. Fiskerton has classified the building as an investment property and has adopted the fair value model.
The property was initially revalued to $22 million on 31 March 20X8. Interim financial statements had indicated that gearing was 51% prior to this revaluation. The managing director was made aware of this breach of covenant and so instructed that the property should be revalued. The property is now carried at a value of $28 million which was determined by the sale of a similar sized property on 30 September 20X8. This property was located in a much more prosperous area and built with a higher grade of material. An independent professional valuer has estimated the value to be no more than $22 million. The managing director has argued that fair values should be referenced to an active market and is refusing to adjust the financial statements, even though he knows it is contrary to international accounting standards.
Solution: The Halam property should not have been classified as an investment property because it is a finance lease as the lease term is equal to the useful life and its residual value is deemed to be minimal. Edingley should record a right to use asset and Fiskerton should derecognise the property. Fiskerton should instead record a lease receivable equal to the net investment in the lease. The property needs to be removed from investment properties and the fair value gains of $8 million reversed. In any case, the fair value gains were incorrectly calculated since adjustments should have been made for the differences between the Halam building and the one sold due to the different location and quality of the materials between the two buildings. It would appear that $22 million would have been a more accurate reflection of fair value.
My Query: What does this line mean that “the fair value gains were incorrectly calculated since adjustments should have been made for the differences between the Halam building and the one sold due to the different location and quality of the materials between the two buildings”?
Thanks!November 10, 2021 at 8:42 am #640342mrjonbainModerator
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The managing director is attempting to support his valuation of building with reference to building that is not comparable due to different location and quality of materials used. The independent professional valuer assessed building to be valued six million lower than managing director. In other words the managing director’s comparison is not valid. Location and quality of materials have impact on likely market price. Consider example where building in central London is likely worth more than comparable sized building on outskirts. Also other things being equal, a double glazed building bis likely worth more than a single glazed building of same size in similar location. Hope this helps.
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