17 May 2023
So, you are preparing financial statements for a Tier 3 charity – or auditing them – and the board have come up with the bright idea that they will use a revalued amount for land and buildings. The financial position will look better, so funders and members will feel that the entity is secure. What could possibly go wrong?
Quite a bit, actually. I’ve been asked to review a few of these lately and there are a number of potential pitfalls to explore. If you are auditing these kinds of statements, I hope this is a helpful guide to what to look out for.
Tier 3 – the basic rules of engagement
Table 3 of PBE SFR-A (NFP) (the Tier 3 reporting standard) states that Property, Plant and Equipment are to be recorded when purchased or donated, at cost if purchased or at current value if donated. Impairment is to be recognised if the market price of the asset falls below its carrying (book) value, or when the value of the asset to the entity is less than its carrying value if the asset is to be retained.
It is anticipated that depreciation will be charged to spread the cost of the asset – we’re talking buildings – over its useful life. Land is not to be depreciated.
There is a common misconception that buildings are not required to be depreciated – probably a carry-over from tax accounting. But Charities don’t fall under tax rules. PBE SFR-A (NFP) assumes depreciation will be charged on buildings.
Tier 3 – what to do with revaluations
PBE SFR-A (NFP) Paragraph A113 says that ‘an entity may elect to revalue a class of property, plant and equipment.’ It suggests that this will be the case where there is the likelihood of increases in value over the asset’s life – i.e. for land and buildings. If this is to be done, PBE SFR-A (NFP) tells us that we must apply the relevant requirements of PBE IPSAS 17 Property, Plant and Equipment.
What is PBE IPSAS 17? It is an international standard that applies, in New Zealand, to Tier 1 and 2 entities. So we’re playing with the big boys now. We going to have to read a ‘proper’ accounting standard. The only slight exception from the full PBE allowed under PBE SFR-A (NFP) is that the entity may use the current rateable or government valuation rather than ‘fair value’ as required by PBE IPSAS 17 when revaluing.
What are the implications? Firstly that disclosure must be made that PBE IPSAS 17 has been adopted for land and buildings. There should also be a change in accounting policy note when first adopted. Auditors should also note in their report that the Performance Report is prepared using PBE SFR-A (NFP) with PBE IPSAS 17 applied to the revaluation of land and buildings.
PBE IPSAS 17 – what’s required?
Paragraph 44 tells us that the carrying value of a revalued asset shall be its revalued amount, less any subsequent depreciation and impairment losses. Revaluations are to be made ‘with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the reporting date.’
As we have said, many Tier 3 charities will use current rateable or government valuation. This is fine. If not the standard allows market-based appraisals to be used. In some cases depreciated replacement cost may be appropriate – say where there is a building on leasehold land. Some additional points to note:
- If an item of property is revalued, the entire class of property to which that asset belongs shall be revalued. (para 51)
- Land is one class, and Buildings are another class. (para 52)
- This means that you can’t just value one bit of land or one building – you have to revalue all land holdings or all buildings at the same time. (para 53)
- The increase from the revaluation must be recognised in ‘other comprehensive revenue and expense’ and accumulated in ‘net assets/equity’ under the heading of revaluation surplus. (para 54)
Remember that land is not to be depreciated, but buildings are – including depreciating the revaluation of buildings. So you will need to identify which part of the revaluation relates to land and which part to buildings.
The accounting treatment of the revaluation
A couple of problems arise here for Tier 3 entities. One is that they do not have an ‘other comprehensive revenue and expense’ category. The other relates to revaluation reserves.
PBE SFR-A (NFP) A143 states that there are two kinds of reserves; ‘Restricted reserves’ which may be used only for a particular purpose such as terms agreed with a donor, and ‘Discretionary reserves’ created by a transfer from accumulated funds to set aside resources for a particular purpose. Neither of these could pass as revaluation reserves.
There are two options. One is to bury the revaluation in accumulated funds. The second is to assume that if we are applying PBE IPSAS 17 it’s okay for us to break the letter of the Tier 3 law and make a revaluation reserve. I think this is the most sensible option, and the proposed changes to the Tier 3 standard obviously recognise the problem and assume the use of a revaluation reserve.
What about whether to record the revaluation through the Statement of Financial Performance or put it directly to Equity? Again I think that we are justified in adding to our Tier 3 rules by including an additional section in our Statement of Financial Performance – below the operating surplus or deficit – for the revaluation gain. Charities Services encourage this treatment. However, the updates to Tier 3 will allow the transfer of the surplus directly to reserves. So for now it is probably more correct to put through the Statement of Financial Performance – but ‘below the line.’
To revalue or not?
For entities who decide to use valuations for land and buildings, there will be some extra complexity and disclosure required. Extra notes will be needed, including details of the valuer, their qualifications, the date of valuation and the revaluation cycle. Depreciation will need to be calculated from the date of revaluation on the amount attributed to buildings. And auditors will need to assess all these things.
Note that there are proposed changes to the Tier 3 standard that do allow for revaluation to be done without having to move to PBE IPSAS 17. These are not far away.* See our commentary here. So if you are preparing financial statements for a Tier 3 entity you might want to consider waiting a while before revaluing, and just disclose the latest valuation by way of note.
*The new Tier 3 (NFP) Standard sets out the requirements that Tier 3 NFP entities are required to follow when preparing their annual performance reports. This Standard is required to be applied for accounting periods that begin on or after 1 April 2024. Earlier application is permitted for accounting periods that end after the Standard takes effect on 15 June 2023.