This is a question I hear quite a bit in the local authority asset valuation community – from both accountants and property valuers. Given that we have been measuring our property assets on current value, rather than historical cost, for over 28 years, it seems to me quite amazing that this question still comes up. What is the point of asset valuations?
Given the 2022 emergency Code consultation by the CIPFA LASAAC Board, and the current consultation by HM Treasury on the future of non-investment asset valuations in the public sector, it is timely to perhaps remind ourselves why capital accountants and property asset valuers all across the UK, do what they do.
The HM Treasury consultation follows a thematic review which examined the valuation methodology of non-investment properties for financial reporting purposes. What we see from this consultation, is a movement to cease the valuation of specialised assets (currently valued using Depreciated Replacement Cost), so that they are not carried at Current Value, and instead carried on the balance sheet at historical cost.
In recent years there have seen significant delays in signing off the audits on English local authority accounts. At the September 2022 deadline, only 12% had been signed off, according to the National Audit Office (up from 9% in 2021). There is no question that this statistic has influenced the form of the current HM Treasury consultation. There appears to be a feeling that reducing the number of asset valuations for local government balance sheets will favourably impact this statistic. Personally, I doubt it would make any difference whatsoever, and there are a number of unintended consequences that I am not sure HM Treasury have considered fully. We are in danger of throwing the baby out with the bath water.
One problem we have, is that the valuation programme is seen by some as a chore to be carried out at the least cost. Wider benefits and opportunities represented by the valuation programme, which can be substantial, are often ignored. There is sometimes little cross referencing to things like financial planning, capital strategy and strategic asset management. The benefits and opportunities of the use of current value are not appreciated or used by many public sector bodies that should.
The worrying development for me, is that HM Treasury, who should be supporting the strategic need for up to date and relevant asset valuations, are now seemingly looking to take the public sector back to the pre-1994 days where significant numbers of property assets are held in the balance sheet at historical cost. In my view that would be a backward step.
The case for current value
I set out below four cases for the asset valuation programme. The first two of these are touched on in a CIPFA publication from 1997 – produced three years into the current value approach being adopted. For those that might remember the document, or indeed still have a copy (like me) it was called Valuations for Accounting Purposes: A Guide for Public Services.
Case 1: A system of accounting for assets, often acquired over several decades, on the basis of the cost prevailing at the time of their acquisition precludes comparability, both between different assets owned by the same organisation and between different organisations at any given time.
As all property valuers will know, market prices vary considerably around the UK, sometimes with huge variations even within a small geographic area. For that reason, I am not certain that the second part of this case (comparison between organisations) is as significant as the first part (internal comparison).
Both parts do though go to the heart of transparency in public finance, and accountability for the use of resources over time. We all know that very few people actually paw over local authority financial statements.
But that’s not the point. The point is that some do look at them, and even we have never looked at them ourselves, we and others have the right and ability to do so. And if we do (or anyone else does) then they should be entitled to see relevant and up to date financial information about that organisation.
Case 2: Current values are intrinsically more relevant than historical costs for measuring the current financial position of an organisation and the current economic cost of using fixed assets in the provision of services.
The public are entitled to know how an organisation that is accountable to them, makes use of its financial resources. This for me includes property assets used in and by the organisation. The balance sheet is an important part of that, and having a balance sheet populated with historical cost data for assets doesn’t really tell you anything.
A balance sheet that contains historical cost information rather than current value, simply tells you nothing more than what the organisation spent to acquire the assets in the first place, plus what capital they have spent on it since acquisition, less any accumulated depreciation.
But this is not just about the general public. The organisation itself should know what those assets are now valued at. A balance sheet based on historical cost tells you what capital has been spent not what capital is currently tied up into those assets. This information can inform strategic decision making through internal comparison of relative values and economic costs of not only different services, but different assets within the same service. Sadly, too few grasp this opportunity.
Case 3: Depreciation of historical cost tells you nothing about how much should be set aside to replace property assets, when they reach the end of their economic life.
Depreciation calculations provide indicators of the value decline in fixed assets, assets that at some point will need to be replaced. Depreciation charges that relate to historical cost are next to useless, and become less and less valuable over time.
Whilst in some sectors, such as local government, depreciation charges are ‘below the line’ and do not affect the cash available to the organisation, the depreciation charges provide the same value as if the depreciation charges are real, in providing information about the state and life of fixed assets.
Arguably, too few organisations pay enough regard to their depreciation figures, but that does not make them less valuable. Too few capital strategies draw upon depreciation data, which often results in weak capital planning.
The valuation process itself can generate data that is valuable to the organisation, especially in DRC valuations which can often form the bulk of the asset valuation programme. The DRC methodology requires the valuer to assess condition and where the asset is in its life. As GRC and DRC figures diverge over time, it is an early indicator of the asset travelling along its economic life, to the point where it will cease to provide economic value without capital intervention.
Case 4: If we revert to historical cost as the valuation basis, data quality around our property assets will deteriorate, as will investment in data systems, impacting on our ability to manage those assets strategically.
It is undoubtedly the case that the move to accruals accounting in 1994 was a game changer in terms of the amount and depth of information that had to be collected to support the annual valuation process. This information has been invaluable in the strategic management of property portfolios. Much of the data organisations now hold, might never have been collected if not for current values being needed for balance sheet purposes.
The incentive to retain data will reduce if balance sheets move to historical cost, and this will impact on the quality of the property portfolio in many organisations. This can have a detrimental effect on public sector customers and the quality of services delivered.
As someone that joined local government in 1978, my experience is that data collection, quality and availability on local government property estates has improved massively, and mostly down to moving to the revaluation model in 1994.
I believe there is a strong case for retaining current value, in preference to historical cost, as a basis for measurement of property assets on local authority balance sheets. You may or may not agree with my point of view of course.
I should say that IFRS does allow organisations to choose either the cost model or the revaluation (current value) model, and that remains the case. If HM Treasury were to decide to ditch current value in favour of historical cost they are perfectly entitled to do so without risking non-compliance with accounting standards.
If the HM Treasury review was to conclude on a reversal of the decision that adopted current value in 1994 it would, in my view, be a retrograde step. Yes, local authorities would save a great deal of money and release a great deal of officer time if they adopted the cost model. In my view the sector would potentially lose more than it would gain.