Scope
For the purpose of the analysis of Property, Plant and equipment
(PPE), AP Eagers Limited and the group (hereinafter referred as Company) general
purpose financial statements for the financial year 2016 has been selected. The
financial reporting practice of PPE is critically analysed with reference to
the AASB 116 Property, Plant and Equipment, AASB 13 Fair Value Measurement,
Framework for the Preparation and Presentation of Financial Statements
(hereinafter referred to as Framework) and drawn inferences from the extant
literature.
Background
The
core business of the Company is retailing of branded automotive in Australia
through ownership and dealership. These dealerships are strategically clustered
and operated in the properties owned and leased by the Company throughout the
country. The property accounts for 84% of total PPE and 17% of total assets,
and therefore could be considered as a material account balance for the
financial statement.
PPE Measurement
Land
and building (property) are valued at fair value and other PPE are assessed at
cost. The Company policy is to state property at fair value as per the
assessment by directors which is supported by independent valuer’s periodic
valuation. For the year 2016, the property valuation was made by the directors
based on their assessment on market conditions and the knowledge of the Company
on market and its activities. According to the general principle of AASB 13 on
Fair Value para 67, the entity shall use observable inputs and minimise the use
of unobservable inputs. However, the Company has used unobservable inputs where
it falls under level 3 in the fair value hierarchy. Level 3 inputs are
subjective and biased, thus renders higher risk. To address this risk AASB 13 requires more
disclosure than other 2 levels (Edgerton, 2016) .
Relevance and faithful
representation
The
relevance and faithful representation are the fundamental characteristics of
financial information[1].
It is however questionable whether the PPE of the Company could be compared
with other retail listed companies in ASX as most of the entities use
historical cost in their valuation (Edgerton, 2016) . Notwithstanding to the fact that the Company
measures property under revaluation model, it could enhance the relevance of
the information published in the general purpose financial statements, the
reliability qualitative characteristic has been compromised due to the estimates
and the biasness in the revaluation model. On the other hand the Company
reports its other assets, such as leasehold improvements, plant and equipment
and motor vehicles, under cost model, which enhance the reliability
characteristics and undermine the quality of relevance.
According to Framework
faithful representation has 3 fundamental sub-qualitative characteristics as
completeness, neutrality and free from error. When the Company elect to follow
the revelation model for property, the valuation is subject to biasness. As per
the Framework suggests that if an unobservable price is used (like fair value
of Property reported at level 3 in this case) the amount should be explained
precisely as being an estimate, the nature and limitations of the estimating
process should also be stated for the information to be faithful (AASB, 2016) . We noted that there
is less information being presented on how the directors obtained the Key
information inputs.
The
Australian economy is still experiencing the property boom. In this context, the
option of recording land at fair value will undoubtable result in revaluation
gain. Further, reporting land at fair value will not impact on the profit or
loss as land is not a depreciable asset. Therefore, it is questionable whether
the attempt to revalue only property, which is subject to constant rise in price,
and recording the other assets at cost, which in otherwise could have resulted in
revaluation loss under fair value model, lead to faithful representation of
information. It could be perceived as an attempt to inflate the balance sheet.
Many critiques argue that the fair value accounting led the financial crisis by
increasing the pro-cyclicality[2] of
the financial system (Palea, 2014; Menicucci
& Paolucci, 2016; Majercakova & Skoda, 2015).
The previous literature
suggests that corporate relying on high debt tend to follow fair value model
for PPE (Barlev, Fried, Haddad, & Livnat,
2007; Cotter & Zimmer, 1995; Barać & Šodan, 2011; Iatridis &
Kilirgiotis, 2011; Brown, Izan, & Loh, 1992), especially for land (Guo, 1995) . Having the same
conviction, it could be argued that the Company has a higher propensity to
revalue property as it experience a high total debt to equity ratio[3] of
1.01. Thus, it is questionable whether the motive of revaluation is to enhance
the faithful representation of the of the Company’s affairs or to show an image
that the management purported depict.
Conclusion
It
could be concluded that the by electing to follow the revaluation model for
property the relevance of the information could be enhanced at the expense of
compromising the reliability. On the other hand the motive of the management
for revaluing only property could be questioned in the context of rising
property prices and not having a depreciation impact on the balance sheet. This
could lead to impair the faithful representation of financial information.
References
AASB. (2016). Framework for the
Preparation and Presentation of Financial Statements. Victoria: The
Australian Accounting Standards Board (AASB).
AASB.
(2015). Fair Value Measurement. Victoria: The Australian Accounting Standards Board
(AASB).
AASB Australian Accounting
Standards Board [Australian Government], (2009); [page 72] “Property, Plant and Equipment”; Australian
Accounting Standards Board: Melbourne, Victoria.
AASB. (2014). Propoerty, plant
and Equipment. Victoria: The Australian Accounting Standards Board (AASB).
Aboody, D., Barth, M., &
Kasznik, R. (1999). Revaluations of Þxed assets and future Þrm
performance:Evidence from the UK. Journal of Accounting and Economics,
149-178.
2016 Annual
Report. (2017). Brisbaine: A P Eagers Limited.
Barth, M.
E., Clinch, G., 1996. International accounting differences and their relation
to share prices, Evidence from U.K., Australian, and Canadian firms.
Contemporary Accounting Research 13(1), 135-170.
Barać, Ž. A., & Šodan, S.
(2011). Motives for asset revaluation policy choice in Croatia. Croatian
Operational Research Review, 2.
Barlev, B., Fried, D., Haddad, J.
R., & Livnat, J. (2007). Reevaluation of Revaluations: A Cross-Country
Examination of the Motives and Effects on Future Performance. Journal of
Business Finance & Accounting, 1025–1050.
Brown, P., Izan, H., & Loh, A.
(1992). Fixed Asset Revaluations and Managerial Incentives. ABACUS, 28(1),
36-57.
Cotter, J., & Zimmer, I. (1995).
Asset revaluations and assessment of borrowing capacity. ABACUS, 31(2),
136-151.
David Edgerton FCPA, (2016);[page
12] “Guide to valuation and depreciation
for public and not for profit sectors under AASB accounting standards” ; Australia:
CPA institute.
David Aboody, Mary E. Barth and
Ron Kasnik, (1998);[page 13] “Revaluations
of fixed assets and future firm performance” ; USA: University of
California.
Edgerton, D. (2016). Guide to
valuation and depreciation. Southbank: CPA Australia.
Frank Missioner Pieria, (2011);[page
124] “Motives for Fixed asset
revaluation; and empirical analysis with Swiss data” ; France: ESSEC
Business School.
Guo, M. (1995). The Economic
Incentives and Consequences of Land Write-Ups. Journal of International
Financial Management and Accounting, 6(2), 115-129.
Henderson, S., & Goodwin, J.
(1992). The case against asset revaluations. ABACUS, 75 -87.
Iatridis, G. E., & Kilirgiotis,
G. (2011). Incentives for fixed asset revaluations: the UK evidence. Journal
of Applied Accounting Research, 13(1), 5-20.
Lopes,
A. B. and Walker, M., (2012) “Asset revaluations, future firm performance and
firm-level corporate governance arrangements: New evidence from Brazil”, The
British Accounting Review, No. 44, pp. 5367
Lin,
Y.C. and Peasnell, K.V., (2000), “Fixed Asset Revaluation and Equity Depletion
in the UK”, Journal of Business Finance and Accounting, No. 27 (3) & (4),
pp. 359-394
Majercakova, D., & Skoda, M.
(2015). Fair value in financial statements after financial crisis. Journal
of Applied Accounting Research, 16(3), 312-332.
Menicucci, E., & Paolucci, G.
(2016). Fair value accounting and the financial crisis: a literature-based
analysis. Journal of Financial Reporting and Accounting, 14(1), 49-71.
Missonier-Piera, F. (2007). Motives
for Fixed Asset Revaluation: An Empirical Analysis with Swiss Data. The
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Financial Reporting and Accounting, 12(2), 102-116.
[1] According to
Framework, for “financial information is to be useful, it must be relevant and
faithfully represent what it purports to represent. The usefulness of
financial information is enhanced if it is comparable, verifiable, timely and
understandable.” (AASB,
2016, p. 36) .
In this regard comparability is qualitative
characteristics of usefulness.
[2] Pro-cyclicality refers to the ability to
exaggerate financial or economic fluctuations (Majercakova & Skoda, 2015)
[3] The total debt to equity ratio is
calculated by dividing borrowings from total equity. Other liabilities have
been disregarded in the calculation. The total liabilities to total equity
ratio is 1.3
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