VALUE ALLOCATION – CONTRIBUTION AND RISK TO THE RELIABILITY OF FINANCIAL REPORTING

Our study argues in favor of the reliability of fair value estimates for correct decision making by the stakeholders of the fi nancial reporting market. The analysis is singularized to emergent contexts, as the Romanian market is the case study, and it is focused on the process of value allocation between the components of a group of assets. Having an application on fi xed assets, the paper shows how fair value estimation is critical and implies risks on such an atypical market. The process of value allocation may bring a high level of arbitrariness to fair value accounting, this being crucial to apply correctly the valuation methodology in relation to the nature of the asset and market information available, and the selection of the allocation keys. The empirics of our study show a consistent expertise of Romanian valuators, as the most frequently used method for value allocation is the deduction of the value of those assets that was estimated based on the market approach, and not the values that were estimated based on the cost or income approach. Other fi ndings show the frequent use of replacement cost, gross or net, to the detriment of book value, a very important aspect for an emergent market, even more so as revaluation in Romania does not guarantee that dedicated valuation methodology was used. These results are all the more important as land and buildings were the majority of fi xed assets valuated, with the highest values as a result of the real estate bubble prior to the fi nancial crisis, and with an essential role in the activity of the companies

FROM ACCOUNTING REGULATIONS TO VALUATION PRACTICE - THE APPRAISER’S ROLE IN TANGIBLE ASSETS’ REVALUATION

Tangible assets revaluation has an impact over equity, profit and the financial indicators of the company, several being relevant for the decision making process of investor’s and company management. The revaluation process is usually done by valuation experts who have to start their mission departing from the accounting information regarding the revalued assets. A sound understanding of accounting rules and of the necessities of the revaluation process is essential for a reliable revaluation. Lack of specific accounting knowledge on the valuer’s side can lead to distorted representations of the valued assets which will affect faithful representation, have accounting and fiscal impacts and can also raise problems when auditing the company. The quality and valuation expertise of the called-in appraiser are also relevant for the outcome of the revaluation process, especially if market values evidence is scarce or the revaluated assets are highly specialised. We present the actions that the valuer and the entity have to pursue in order to ensure a reliable revaluation process, contributing thus to a better understanding of the practical approach to assets revaluation and its specific requirements

CAN ASSET REVALUATION BE MANIPULATIVE? - A CASE STUDY

Asset revaluation can trigger different signals to investors depending upon company type, asset intensity and category and investors’ expectations. In the same time, motivations behind asset revaluation decisions are diverse, being influenced by management incentives, credit covenants, faithful representation and various other reasons. In many cases the revaluation decision is imposed upon the company by auditors or the need to reduce information asymmetry. In Romania, one of the main decision drivers is the Fiscal Code, due to buildings taxation provisions. For companies that revaluate their fixed assets for taxation purposes only (which is the case for most small companies in Romania), the primary concern is to reduce the fiscal impact – the preferred scenario in this case is most likely to be the one that reduces tax expenses. Our research aims to provide a full picture of the motivations behind the revaluation decision and point to the manipulation instruments made available to companies by the allowed alternatives in what regards (1) which assets to be revalued and (2) how to recalculate book values. By means of a case study we identify the options available to a revaluating company and show how each one can impact the financial statements and financial ratios, thus influencing financial statement users’ perception. Our analysis is limited to fixed assets revaluation, as these are the ones revaluated by most Romanian companies. The comparative analysis shows that the decision to not revaluate certain assets categories can lead to serious distortions of the faithful image. Financial ratios can be significantly impacted by the type of assets revalued, depending upon the revaluation direction (upward or downward) and the revaluation differences. In upward revaluation leverage ratios and solvency can improve, leading to a better position in relation to credit covenants. Equity is also positively affected. Alternatively, a decrease of assets’ value will be reflected in a negative manner upon these indicators, which might be a serious reason for a company to not revaluate, thus not preserving the true and fair value of assets in the financial statements. Companies can choose between two alternatives of recalculating book values and depreciation. The option taken can also influence the company’s financial position. Our study shows that impact over profitability is lower and that profit tax is not affected in a significant manner even if an influence can be identified

Value allocation: contribution and risk to the reliability of financial reporting

Our study argues in favor of the reliability of fair value estimates for correct decision making by the stakeholders of the financial reporting market. The analysis is singularized to emergent contexts, as the Romanian market is the case study, and it is focused on the process of value allocation between the components of a group of assets. Having an application on fixed assets, the paper shows how fair value estimation is critical and implies risks on such an atypical market. The process of value allocation may bring a high level of arbitrariness to fair value accounting, this being crucial to apply correctly the valuation methodology in relation to the nature of the asset and market information available, and the selection of the allocation keys. The empirics of our study show a consistent expertise of Romanian valuators, as the most frequently used method for value allocation is the deduction of the value of those assets that was estimated based on the market approach, and not the values that were estimated based on the cost or income approach. Other findings show the frequent use of replacement cost, gross or net, to the detriment of book value, a very important aspect for an emergent market, even more so as revaluation in Romania does not guarantee that dedicated valuation methodology was used. These results are all the more important as land and buildings were the majority of fixed assets valuated, with the highest values as a result of the real estate bubble prior to the financial crisis, and with an essential role in the activity of the companies