Investment Properties
Part 1: Investment Properties
The preference for a particular approach (historical cost, UK method, market value) by a manager, shareholder or analyst will be influenced by each stakeholders economic incentives, and therefore, by gauging the impact the approaches have on:
The Fixed Assets in the Balance Sheet
The Profit & Loss Statement
Furthermore, depending upon the interest of each stakeholder, the desired approach can also be influenced by the economic environment of the industry. For the purpose of this assignment, we will be assuming an optimistic outlook for the future of the industry.
Manager Perspective
A manager has a number of incentives to choose one method of valuation over another depending upon his goals. For example, a manager focussed on performance ratios might prefer to use the historical cost method when there is a wide discrepancy between the original cost and the higher market value. A low asset value in this case will increase asset ratios such as Return on Assets (ROA), a positive indication of performance by the firm and its management. However, we think that the most useful overall methodology for a firm invested in investment properties is the method of market valuation under IAS 40.
While this method accurately displays the market value of the assets, the Profit & Loss statement will have to reflect gains from an upward valuation, and losses in the event of devaluation. As the outlook for the future is optimistic, we will assume an appreciation in the value of the investment properties. As per IAS 40 it is required to recognize the unrealized gain in the income statement immediately, which suits the management objective of boosting profitability. This method also does not require a depreciation of investment properties in the income statement which will thereby increase profitability as compared to the historical cost method. Furthermore, an increase in the total asset value of the firm in the balance sheet reflects well on management investment decisions and has the added benefit of helping the firm raise financing for further investments.
Analyst/ Shareholder Perspective
A shareholders preference for a particular approach is largely defined by his short term or long term interest in the firm. We will assume a long term outlook in which case the market value approach under IAS 40 suits a shareholder best. This approach will give him a true and fair picture of the investments of the firm allowing him to make an informed decision for the future. Furthermore, the effects of revaluation on the income statement also directly benefits the shareholder, as realizing gains from periodic valuations as they occur will increase profitability and earnings per share (EPS).