1.4 Asset revaluations

Local government: Results of the 2004-05 audits.

During the year, both local authorities and our auditors had to consider if there had been a material effect on the valuations of local authority asset infrastructure as a result of increasing prices, particularly construction prices, in the sector.

Entities need to ensure that property, plant, and equipment that is recognised at “fair value” is done so in accordance with paragraph 7.1 of Financial Reporting Standard No. 3: Accounting for Property, Plant and Equipment (FRS-3). This stipulates that property, plant, and equipment must be revalued with enough regularity so that no item is included at a carrying value that is materially different from its fair value. At a minimum, revaluations must be carried out at least every 5 years.

The 5-year minimum is one circumstance that would require revaluation of property, plant, and equipment that is recognised at fair value. For example, if a valuation was carried out for a particular item or class of property, plant, and equipment as at 31 March 2001, then the latest date by which the next valuation would need to be carried out is 31 March 2006.

A similar circumstance is where a shorter revaluation cycle is part of an accounting policy for revaluing property, plant, and equipment. A typical shorter revaluation cycle is 3 years. The latest date by which a valuation would need to be carried out is 3 years after the previous revaluation.

However, both of the above circumstances are secondary to the core principle concerning revaluation of an item or class of property, plant, and equipment. This core principle is that, if the fair value of property, plant, and equipment differs materially from its carrying value, then it should be revalued. The crucial determination is whether or not there are sufficiently reliable indicators of a material movement between carrying value and fair value. We recognise this is not straightforward, because it is a matter of professional judgement whether there is likely to have been a material movement in value either up or down.

During the 2004-05 financial year, the construction sector was experiencing a tightening in supply and this led to higher contract prices – in some cases, up to 30% higher – than in previous years. These increased contract prices were expected to have a significant effect on the fair value assessment of local authority infrastructure and, in the absence of any other relevant matter, require revaluation of the assets regardless of their anticipated revaluation cycle.

Where the effect of price changes is quite high (known as “material”), an entity will probably need to revalue assets before the date normally scheduled in their revaluation cycle. This principle is outlined in paragraph 7.5 of FRS-3.

In local authorities, as with other entities, the value of infrastructure is an important factor in determining the depreciation provision. It also provides some of the base information for many asset management plans. Reliable, up-to-date information is important to ensure compliance with generally accepted accounting practice and to provide a sound basis for strategic planning.

The possibility of more frequent revaluations to reflect fair asset values in advance of normal revaluation cycles is also within the new New Zealand equivalent to International Accounting Standard 16: Property, Plant and Equipment.

Most local authorities are indicating that they will revalue during the 2005-06 financial year – even if only because many are at the end of the revaluation cycle. However, should the events of late 2004-05 repeat themselves in the future, local authorities will need to consider revaluation of property, plant, and equipment in advance of the completion of their next cycle.

It is recognised that the revaluations resulting from upwards price changes have the potential to affect the level of rating set by a local authority. An upwards revaluation will impact on a local authority’s total expenditure (through increasing the depreciation charge). In this situation, councils need to consider if they have sufficient resources available to undertake the level of renewals needed to maintain the integrity of their infrastructure asset base.

While revaluations in line with a local authority’s revaluation cycle will have this effect, there is the possibility of a more regular effect on rating levels if “off -cycle” revaluations are required due to circumstances similar to those that arose late in 2004-05.

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