1. Assume there are three separate real estate companies US Realty (which uses the cost model), UK Realty (which uses the revaluation model, and International Realty (which uses the fair value model). Assume that on December 31, 2003, each company pays ? 1,000 cash to obtain investment property comprising of land with negligible value and an office building worth ? 1,000. The building has a 10 year useful life, has no residual value, and is expected to provide a constant stream of economic benefits over time.
What is the accounting entry for each company for the following four scenarios: a. On December 31, 2003 acquisition b. On December 31, 2004 assuming the investment property fair value is ? 1,300 c. On December 31, 2005 assuming the investment property fair value is ? 1,100 d. On December 31, 2006, assuming the investment property fair value is ? 500. US Realty (cost model): 1000, 900, 800, 700 UK Realty (revalution model): 1000, 1300, 1100, 500
International Realty (Fair value): 1000, 1000+300(unrealized gain), 1300-200(unrealized loss), 1100-600(unrealized loss) Using Exhibit 10 as reference, what financial analysis challenges arise as a result of these differing accounting models? 2. Which model (cost, revaluation, or fair value) provides the most relevant information? Which model provides the most reliable information? Fair value is the most relevant and the cost is the most reliable. 3. How does each model affect Land Securities’ balance sheet? Income statement?
Can the firm assess the impact of adopting the fair value model on previous years’ key performance metrics, such as “profit on ordinary activities”? 4. Which model, cost or fair value, would you recommend Land Securities adopt? Why? Although cost method provides more reliable evaluations, I recommend Land Securities adopt the fair value method which gives more relevant information in the company’s financial statements. Firstly, when we are looking at the background of the company, Land Securities was an investment property firm located in the U. K. hich adopted IFRS in 2005. Investment property firms invest in property to generate rental income and/or long-term capital appreciation. This distinguished from property used in production or for administrative purposes, as well as from holding property for sale in the ordinary course of business. Both rental price and long-term capital appreciation are related to the current fair value of the properties, because the rate of any rental property is influenced by its fair value of this property and long-term capital appreciation is determined by fair market value.
In addition, as an UK company, revaluation model was adopted before 2005 which is quite similar with fair value model. Lots of high qualified independent appraisers can work on evaluation under fair market value model intermediately. Secondly, fair value model offers more accurate balance sheet and income statement. The fair value model lists investment properties on the balance sheet at their fair value. Any changes in fair value are recorded directly to the income statement as other gains or losses.
Therefore, under fair value model, investors can obtain more relevant and accurate information. 5. The FASB and IASB are actively seeking to eliminate differences between US and international accounting standards. However, investment properties are reported under the cost model in the US, while IFRS allows either the cost or fair value model. Should FASB also allow the fair value model? In my viewpoint, the FASB should allow the fair value model to reconcile the differences between US and international accounting standards, but not right now.
As we all know, fair value model can provide at least more relevant and also reliable information in a good fair value model system. However, more professional and fair appraisers will be needed to evaluate and update the information frequently. If most U. S. companies cannot afford the cost of appraising, they will still use cost model which is also allowed in international accounting standard. In this situation, in order to improve comparability, the companies which begin to adopt fair market model may have to disclose financial information under both models.
