Research Korner: Valuation Methods

MANAGEMENT ACCOUNTING

1. Assume that Abbey had decided to divest its ANTS and ANL divisions prior to any purchase discussions with Santander in early 2004. What is the likely range of values for those divisions based on the information available in the two cases? As the case does not include all the information to calculate this valuation, show what additional information you would need to have, make a reasonable assumption about any information not provided by the case, and provide the basis for your valuation. Consider the seller's and buyer's perspectives and assume a friendly (not hostile) transaction process. Answer:             Accordingly, valuation is an appraisal of what specific thing is worth. This is not the same as the context of price. Valuation is something which will actually paid for in an industrial transaction like merging and acquisition. If Abbey would decide to divest its ANTS and ANL divisions to any agreement with Santander in early 2004 the likely range of values that can be considered is the values of growth of the two divisions prior to the years when ANTS and ANL divisions are facing financial trouble. Base on the case, the financial situation of ANTS and ANL are given and this information is useful to calculate valuation. However, there are some other information which is considerable in calculating valuation of ANTS and ANL. The following are the assumed valuation that should be considered in computation: ·         The statement of the financial assets of ANTS and ANL can be noted as a good valuation in considering the purchase of these two activities by Santander. As a base for calculating valuation, the management or accountant of Santander and Abbey may look at the Net Tangible assets of the companies. Net Tangible assets is the summation of assets that can be seen in the balance sheet minus the intangible items and total liabilities. The calculated valuation for this is the physical assets managed by the both Santander and Abbey. However, this information may be affected by the accounting treatments of assets which include depreciation policies and others. ·         The current situation of Santander in the UK market, at is has been recognised to be one of the most competitive financial industry within UK. In order to calculate the valuation of the decision of selling ANTS and ANL activities of Abbey to Santander includes all assets which will come under the management of Abbey within the current financial year. This is also needed in order to calculate valuation for the perceived acquisition. ·         The major information that can also be given emphasis as part of acquisition valuation also includes value of the enterprise. Such valuation may be based on a primary allocation of assets that should be published by Abbey in accordance to the purchase of Santander with ANTS and ANL which can be attributed with the intangibles. Santander may examine the value of ANTS and ANL using the stand-alone basis of the cash flows of these activities.  The use of this information can be essential for several attributes. First, such information can provide a good view of what ANTS and ANL is capable of achieving when these two activities stand on its own. Such information may help create a floor with respect to value for transaction purposes. Secondly, the information that can be derived on a stand-alone basis of valuation can be compared to the targeted market value. Such information can be usable in valuating whether the target is over or under valued within the market environment. The information may allow the management of Abbey to calibrate model assumptions to Santander.  By assessing the key assumptions related to this essential information, Santander’s management can gain confidence that the calculated valuation will give a reasonable guide in analysing the acquisition situation. The calculation of valuation must include company value to determine how saleable or marketable ANTS and ANL is even after the financial problems and issues encountered. ·         Presents value of cash flow of ANTS and ANL activities, as well as the present value of cash flow for Santander can also be used to calculate valuation of the subject of acquisition. For this transaction, Santander and Abbey (for ANTS and ANL) can use discounted cash flow (DCF) method. This approach can be used to determine the value of ANTS and ANL activities by computing the present value of cash flows over the life of Abbey. In this regard, other information includes the forecasted life-span of Abbey and the terminal value of Abbey. In the first context, clear forecast of free cash flow should be established which composed of the economic costs and benefits of the said acquisition and transaction. Preferably, this forecasted time must be equated with the interval over which the company (like Abbey) enjoys a competitive position in the marketplace i.e., the condition where the expected profit exceeds required profits. For the transaction of Santander and Abbey, a forecast period of 5-10 years may be used.  On the other hand, the value of Abbey or Santander derived from free cash follows which happens after the forecasted time is considered is captured by a terminal value. This information is derived in the last year of the forecasted time and capitalizes the present value of all upcoming cash flows which happens beyond the forecasted time. Such information is needed in order to calculate valuation and to determine whether both companies will be benefited from the acquisition of Santander with ANTS and ANL activities of Abbey.   Sample DCF Computation for Santander Acquisition with Abbey             DCF will be computed using the following formula:                 Future Years 1 2 3 Forecast Net Income 100,000 120,000 144,000 Cash Flow Adjustment (B23) 75% 75% 75% Forecast Cash Flow 75,000 90,000 108,000 Present Value Factor (Mid-year Assumption) 0.9017 0.7331 0.5960 Present Value of Cash Flow (Row 8 * Row 9) 67,625 65,976 64,367 Total Cash Flow:  Years 1-3 197,968     Forecast Cash Flow Year 4 (D8 * (1 +B25) 113,400     Gordon Multiple 6.1614     Present Value of Cash Flow Year 4-Infinity 375,472     100% Marketable Minority (Total PV of CF) (B11+B14) 573,440     Discount for Lack of Marketability-% 16%     Discount for Lack of Marketability-$ 89,457     100% Illiquid Minority Interest 483,983     Control Premium-% (See Table of Control Adjustments) 25%     Control Premium-$ 120,996     100% Illiquid Control Interest 604,979     Assumptions       Payout Ratio 75.0%     Discount Rate 23%     Long-Term Cash Flow Growth Rate 5.0%             Table of Control Adjustments to Marketable Minority Values Controlling Interests 25.0%     Private Minority Interest -20.0%             21% -2.0% 0.0%   75,000 23% 25%   100,000 22% 24%   300,000 21% 23%   900,000 20% 22%   3,000,000 19% 21%   10,000,000 18% 20%   30,000,000 17% 19%   85,000,000 16% 18%   258,000,000 15% 17%           Discount Rate Calculation FMV-100% Marketable Minority Interest (=B15) 573,440     Ln FMV 13.25940841     Multiply By X-Coefficient -0.008788     Subtotal -0.116523681     Regression Constant 0.3452     Unadjusted Discount Rate 22.9%     Adjustment for Fama French Research -2.0%     Discount Rate 20.9%     Discount Rate-Rounded 21%       All in all, with the valuations or assumptions given above, the situation of Abbey and Santander will dictate which of the information is really essential to calculate valuation of ANTS and ANL activities. The information should be relevant to the financial condition and current market situation of ANTS and ANL activities to make sure that Santander will not encounter drawbacks because of its purchased of Abbey’s ANTS and ANL. Acquisition transactions don’t usually go through smoothly. A lot of information should be needed in order to make sure that the acquisition process will benefit both companies. The calculation of valuation is helpful in determining whether acquisition transaction will benefit both the company or not.   2. As a senior manager in one of Abbey's back-office groups, how would you prepare your division for the post-merger integration? Answer: Merger has been recognised to be one of the strategic ways in business operation growth and expansion.  In line with the strategy of Abbey it can be said that the used of merging may be able to provide the company a more comprehensive, efficient and effective ways to have a sustainable company growth. Mergers allow the company to grow both internally and externally because through mergers the family of the company has increased, not only in its local operation but also in global environment. According to  (2002) merger and acquisition will immediately impact the company with changes in ownership, in ideology, and eventually in practice.  In order to have a more successful expansion, the company should provide some post-merger integration strategy.  As a manager, it is my responsibility to ensure that both companies (Abbey and Santander) will be benefited from the transaction or agreement. In this regard, I will prepare my division for the post-merger integration by conducting a training and seminar program which will allow the staff to understand why the merging has been done. The Post-merger Integration approach will be considered so as to make sure that the organisational goal will be achieved. As a manager, I will design a post merger Integration management plan. In this plan, the use of an effective communication will be considered. Figure 1 Post-Merger Integration Management Plan               The first part of this plan is the merger design, in this regard, being the manager of Abbey, I will focus on the structure of the transaction, its strategic vision the business model used by Santander. As a manager, I will create a merger principle and integration context including the organisational design of the new merged company to make sure that the staff will be knowledgeable about the new company. In order to prepare the division with the merger, a meeting will be conducted with the agenda of disseminating the information about the purpose and objective of the merger. In order to disseminate the information properly, an effective organisational communication will be used. In organizations, it is well-known that communication certainly affects business functions and operations.  The ability to communicate of the persons involved in a particular business transaction will, by at large, determine the outcomes or results. Effective communications is a ‘life-skill’ upon which sound relationships are established.  Communication serves a number of functions for preparing a specific division for the post-merger integration (, 2001).  Consequently, communication serves as the pathway through which post-merger integration are discussed.  (1994) suggested that communication serves four primary operations within a specific groups. These include control or management, motivation, emotional aspects, and information dissemination.  For example, I will use an effective communication approach to tell the employees about the merging activities.  On the other hand, communication is linked to motivation by clarifying to staffs what is to be accomplished, how well they do their tasks, and what should be done to prepare themselves on a possible impact of the post-merger integration.  Lastly, the final function of communication is related to its role in facilitating decision making.  It provides the information that individuals and groups need to make decision by transmitting the data to identify and evaluate alternative choices.  In order to prepare the staff or employees regarding the merging activities, both internal and external communication must be included. Being the manager, I should be able to disseminate this information effectively internally and externally.  In this manner, I can disseminate these merging in the following approach.  First, I should be able to make the employees and staff aware of the said merging activities. Herein the I can conduct a meeting to tell their plan to the employees. In addition, I should also provide the employees and key stakeholders about the purpose and objective of the said merger activities to avoid conflicts and problems.  I can also make a memorandum which indicates the reasons why the company must merge with other company system.  This integration management process is important so that every member of the organisation will be aware of the said merging activities As mentioned, merging process is complex and that the assurance of having a successful outcome is to have an effective communication within the division.  Hence, I must insure that there are open channels for staffs of the division s to communicate new solutions, problems, input and feedback relevant with the process of merging ( &  1994). Furthermore, it is important that preparation for these activity through meeting and the information dissemination provided is clear and consistent within the departments of the organisation. By and large, it can be said that in order to prepare the division of a company to a post-merger integration, effective communication is needed. It has been stressed out that to have a successful merging, the management that implements the changes must be committed to the importance of communication, and that they match actions and words.  There should also be commitment to two-way communication process, more emphasis on face-to-face communication, shared responsibility for employee communication, immediate discussion when organizational controversies and problems arise, accurate transmission of information, and moreover, every member of the organization should treat communication as an ongoing process. In the problems in terms of cultural differences, the management that initiate the process must insure that there provide the employees the chance to express their feelings and assessments. This process will make sure that the division will be prepared in any challenges that will bring about by the merging activities.   Reference

MANAGEMENT ACCOUNTING

1. Assume that Abbey had decided to divest its ANTS and ANL divisions prior to any purchase discussions with Santander in early 2004. Wha...

VALUATION METHODS

This paper analyses the feasibility of a takeover bid of the commercial aviation company Ryanair Holdings PLC by a North American airlines firm through determination of the appropriate method of valuation which the latter can adopt to verify the practicability of bidding for the takeover of Ryanair Holdings. Financial factors need to be taken into consideration when deciding for any decision to bid for takeover. Generally, the target company’s financial statements, such as the balance sheet and profit and loss statement are the basis for such financial analysis. There are non-financial issues that must be carefully weighed as well. These issues are those that need to be sorted out in order to come up with a decision which will lead to either taking the takeover bid forward or not. The valuation methods available for utilisation may produce different results as they are based on a variety of variables. The approach deemed most fit for the situation of Ryanair is the earnings-based model which assumes that the value of an entity is equal to the present value of future earnings that will be generated by the business. This approach is applicable to the Ryanair case, as the company’s financial documents offer the year when they have observed a decline in net profit, it will be most useful to use this type of approach to company valuation. INTRODUCTION             With a North American airline’s plan to takeover Ryan air PLC, it is imperative that the latter be valued either formally or informally. Owing to asymmetry in terms of the underlying financial incentives, it is fundamentally important for the purchaser to understand the principles of business valuation so as to anticipate and, more importantly, to interpret the other's offer. Valuation, as a science, deals with, among other things, the following: (1) adherence of general accounting principles for the organization and presentation of the financial data of the business; (2) chronicalization of the facts associated with the historical growth of the business; (3) extrapolation of financial data into future time periods; and (4) calculation of various valuation ratios and statistical formulae (Boger & Link 1999). These are, without question, critical dimensions to a business valuation, but they are not the only dimensions of a business valuation that are important. All too often, for a variety of reasons, individuals may fall into the trap of believing that business valuation is little more than a formulistic exercise.             There are, in line with the above, non-financial factors affecting business valuation. It deals with, among other things, the following concepts: (1) understanding the economically efficient life of productive assets, compared to the general accounting practice defined depreciable life of productive assets; (2) understanding the economically relevant industry in which the business being valued operates; (3) understanding the appropriateness of one valuation method or one statistical method over another; (4) understanding the limitations of financial information from comparable businesses; and (5) understanding the economic environment into which financial data are being extrapolated, and the appropriateness of such an extrapolation. As such, there is the need for the detailed analysis of Ryanair Holdings PLC in terms of the financial and non-financial factors affecting the planned takeover of the North American Airline in order to arrive at a recommendation either a bid should be made for the takeover or not. FINANCIAL FACTORS AFFECTING THE TAKEOVER BID             In general, the data needed to provide a valuation of Ryanair are: projected and historical financial data, ownership records, information on products and services, sales and marketing data, and supplementary information on banking, legal and contractual relationships (Mastracchio Jr. & Zunitch 2002). Before work could be started, company data that is needed include financial statements and tax returns for three to five years; an accounting of all outstanding payables, and receivables, if there are any; the actual value of inventories; identification of key customers and the percentage of business tied to the relationship; equipment, including its age; industry, geographic and market comparisons; sales and other projections; resumes of key personnel; the most recent business plan; published corporate literature and press articles; and the percentage of revenues dependent on each product line or service. There is also the need to gather information from other sources, including industry and geographic comparisons, as well as a survey of sales of comparable businesses.             The preparation of financial statements should be foremost in mind in the preparation of a corporate valuation in order to come up with a recommendation if the takeover bid is going to push through or not. It is through peruse of these documents that the valuator will most accurately provide a recommendation for the North American airline client. Another issue relevant to any valuation is whether the valuation should be conducted on a pre-tax or an after-tax basis. The valuation profession differs with regard to this issue, and there is no definite right or wrong answer. What is important is for all parties to understand the underlying assumptions being brought to the valuation and for all parties to verify that the data used in the valuation process are consistent. Valuations are generally conducted on a pre-tax basis. Some who frequently argue that valuations should be done on a pre-tax basis often point to the fact that courts have argued that future tax liabilities are too uncertain to be included in a valuation. In other words, while all valuators rely on assumptions regarding the future and attempt to predict future financial situations (e.g., profitability), predicting the tax rates that might be applicable to those future financial situations adds another level of judgment and an entirely new set of assumptions. Although this is true, future tax liabilities are no more uncertain than other elements in a valuation, such as the economic conditions that will surround the business in the future. Some who frequently argue that future tax liabilities should be included do so by making the rather obvious observation that taxes are a reality of doing business. These points aside, the justification for conducting business valuations on a pre-tax basis comes from a more pragmatic perspective. It is generally the case that the valuation is done as if there were a reasonable and fully informed buyer, when in most cases there is no buyer at all. As such, there is no a priori way to know the tax liabilities that will pertain to such a hypothetical, and it would be speculative to assume that the potential buyer's tax structure will be the same as that of the seller. As a general rule, the smaller in size and the more limited the scope of activities of the business being valued, the less likely there will be a set of publicly traded companies that are comparable, or even a single comparable publicly traded company. Publicly traded companies are for the most part large, measured in terms of revenues or assets, and they are diversified across product lines. This diversification implies that reported revenues are from various lines of business, not all of which are relevant for comparison purposes. Also, diversification reduces the operating risk of the company, and to the extent that this reduced risk is reflected in the company's realized earnings and in the publicly reported price, the comparison may be less than accurate. Most small closely held companies are not diversified, and this characteristic alone makes financial comparisons difficult. There are many sources for information on publicly traded companies including information provided by Value Line and Standard and Poor. Internet access to traded securities research services is the more common means to acquire the needed information.             In particular to Ryanair Holdings PLC, their sales, operating profit, and net income have recorded an increase since the company went public prior to the financial setback in 2004. Regardless of the poor financial performance of the company during the said year, they still continued to acquire assets while managing to keep down their flight fares through internal efforts on the part of the Ryanair management and employees to lower costs of providing their commercial aviation services to the public. And although they posted a decrease in net profits in 2004, they still managed to have the highest return on equity percentage among fifteen flight passenger carriers that the company was compared with. To discuss further, published research on the application of marketability discounts when valuing a business on the basis of information from publicly traded companies follows two lines. One line of research is based on reviews of court cases and the marketability discount that the court has allowed. The conclusions from this line of research are interesting, but not generally applicable to a particular business valuation. First, there is selectivity bias in the sense that only those valuations that are litigated and appealed are available for such study. Second, the court's decision reflects the opinion of a judge or small group of judges, as swayed by the rhetoric of attorneys, many of whom may have less expertise in valuation than the valuator. The other line of research is based on comparisons in the price of initial public offerings of stocks to actual transaction sales, where the initial public offering is viewed as a reliable observation of fair market value in the absence of market demand. Again, there is no reason to assume that the companies involved in the initial public offerings are comparable to the particular businesses being valued. NON-FINANCIAL FACTORS AFFECTING THE TAKEOVER BID             Apart from the financial considerations, there are non-financial factors that would affect the decision to bid for the takeover of Ryanair Holdings PLC as well. For instance, the business model of the particular company that is under analysis would have to matter. The fundamental business structure of Ryanair is the proven Southwest model, where low fares are combined with high frequencies and excellent punctuality, while giving emphasis to on-time performance, baggage handling and customer satisfaction. Their smaller market share leaves ample room for growth, which is why room for expansion is likewise considered in takeover bids. Britain is saturated, but there is plenty of room in Spain, Low Countries, Germany, Italy, Scandinavia for Ryanair to explore and penetrate. For long-term markets, there is the need to look into regions yet untapped, in particular Eastern Europe. Also, keeping an eye on Singapore/Asia ventures, as it is still enormously untapped markets, will prove helpful in making the decision whether to bid for the takeover of Ryanair or not. As it appears that Ryanair is well-poised to take advantage of new opportunities in the emerging markets of the next decade, it is one point towards a positive reaction to taking the takeover bid. However, there are also certain considerations to look out for, for example, the Charleroi case, because if Ryanair loses, as they are appealing to EU Supreme Court in Luxembourg, the company will lose all revenue from that airport, numbering to an estimated 2 million passengers. This is a huge hit, if ever the case fails, though it may be made up in growth in other airports, so it is another dimension to look into. Long term, analysts say it may lead to more transparency, shorter leases with publicly-owned airports. This can elevate costs and hurt the bottom line, thus affect everyone in the company equally. It might be wise to wait for the Charleroi decision to settle before entering a position. If it decides against Ryanair, it is expected that headline influence will drag prices down further than fundamentals, which leads to a better entry. If it decides for Ryanair, then it is a very good decision to enter based on its long-term potential. There is the wide belief that EU will not side with Ryanair due to lobbying/protectionist pressure. After all, they saw what happened to UAL/AMR in the time span of a single year. Additionally, politics must also be considered. Ryanair claims that the EU decisions are heavily lobbied by its traditional competitors like the British Airways and Air France. A similar battle played out in U.S. courtrooms with Southwest and American Airlines over Dallas is observed. It could just be a matter of time in Europe, as well, because in the end, the customers – the public – are on Ryanair’s side due to the low flight fares that they are offering. On a deeper inspection, even British Airways and Air France could not be considered a competitor of Ryanair, as the said companies have a notably higher rate of air fare if compared with the commercial aviation firm under analysis. Thus it can be said that they operate with a different market profile than where Ryanair is currently operating. Deregulation and strong growth is also seen in Europe, as an accompanying depreciation in the dollar makes the European company more attractive. The consensus is that the dollar will depreciate further in 2004 as the deficit soars, so the company is a very lucrative venture to become involve with. VALUATION METHODS There are six general types of valuation: (1) earnings valuation; (2) revenues valuation; (3) cash flow valuation; (4) equity valuation; (5) yield valuations; and (6) member valuations. The type of valuation that the North American airline company should adopt would depend on what reliable information they have at hand in order to pose for easier company valuation and arrive at a decision to bid or not to bid at the earliest time possible. The choice of a valuation method requires thought and contemplation. The valuator should first learn about the business and then select the one valuation method that is the ‘most appropriate’ based on the relationship between the circumstances for understanding the valuation and the assumptions that underlie each of the valuation methods. The valuator should not, in Boger and Link’s (1999) opinion, define ‘most appropriate’ based on the results that follow from the application of several methods. There should be an a priori reason for selecting one valuation method over another. Income-based valuation methods use the businesses or a comparable business's income statement as the starting point for the analysis. Doing a corporate valuation is not a mysterious process that is open only to the few (Copeland, Koller & Murrin 2000). It does require, however, a different perspective from that taken by many managers. It requires focus on long-run cash flow returns, not quarter-to-quarter changes in earnings per share. It also requires a willingness to adopt a dispassionate, value-oriented view of corporate activities that recognises businesses for what they are – investments in new productive capacity that either earn a return above their opportunity cost of capital or do not. There are many areas in valuation where there is room for disagreement, according to Damodaran (2002). This includes how to estimate true value and how long it will take for prices to adjust to true value. But there is one point which there can be no disagreement: asset prices cannot be justified by merely using the argument that there will be other investors around willing to pay a higher price in the future. Similarly, asset-based methods use the business's balance sheet at the starting point. However, even when conducting an income-based analysis, the valuator should carefully study the balance sheet, and vice versa. Income statements and balance sheets describe aspects of the financial condition of the business, and hence, both should be examined. In fact, all financial information should be considered in detail. A fundamental and extremely important assumption that underlies all business valuations is that the financial health of the business is accurately characterized by its financial statements. If the financial statements are incorrectly prepared, or if they overstate or understate the true financial picture of the going concern for some accounting reason, then it follows logically that the valuation will be imprecise. Analysts use a wide range of models in practice, ranging from the simple to the sophisticated. The models enumerated previously belong to the general category. These models often make very different assumptions, but they do share some common characteristics and can be classified in broader terms, which makes it easier to understand where individual models fit into the big picture, why they provide different results, and when they have fundamental errors in logic. Following is the recommended valuation model that fits the need of the North American airline company to aid in its decision whether or not to take a bid for takeover. RECOMMENDATION             It is deemed that the earnings valuation method is the best model to use for valuing Ryanair. It is, first and foremost, the most common way to valuation. It is an approach to valuing a company by capitalising its earnings, which generally involves multiplying one or another income statement earnings figure by some multiple (Luecke 2002). The earnings-based valuations assume that the value of an entity is equal to the present value of future earnings that will be generated by the business. Further, this method is based on two elements, the price/earnings ratio and the post-tax earnings per share of a business, which, when combined, give the market price per share (Ogilvie 2006). There maybe a different (higher or lower) future earnings estimate based on efficiencies arising from new management (higher earnings) or restructuring costs (lower earnings) that will gave an impact on price negotiations.             Particularly, the Normalised or Average Earnings should be used. This approach, which is similar to that used for cyclical firms, uses an average average-based valuation upon a period when the earnings were healthier as the base-year earnings for analysis (Damodaran 2002). The assumption is that the firm will revert back to health in the near future. As the company’s financial documents offer the year when they have observed a decline in net profit, it will be most useful to use this type of approach to company valuation. When there are difficult choices to make between relevant treatment of accounting items on the balance sheet or income statement, the income statement tends to win out. The earnings-based formulation has intuitive appeal. It implies that if a firm can earn only a normal rate of return on its book value, then investors should be willing to pay no more than the book value for the stock. Investors should pay more or less than book value if earnings are above or below this normal level. Thus the deviation of a firm’s market value from book value depends on its ability to generate ‘abnormal earnings’ (Damodaran 2002). The formulation also implies that a firm’s stock value reflects the cost of its existing net assets (that is, its book equity) plus the net present value of future growth options (represented by cumulative abnormal earnings). To further strengthen the argument, the AICPA’s Management Advisors Services Practice Aid, Valuation of Closely Held Businesses indicates that the Internal Revenue Service strongly recommends the use of earnings-based valuation models for valuing businesses (as noted by Sipes 2005).             But, as with any other model, the output of an earnings-based valuation model will only be as good as its inputs. To help improve the quality of accounting inputs in the valuation process, earnings should be properly classified according to their components. To further assist in seeing through the potential biases inherent in financial data provided by Ryanair management, it is important to understand the discretion involved in making accounting classifications. As asserted by Hirst & Hopkins (2000), being armed with better knowledge about how accounting data are generated puts analysts in a better position to use the information effectively.

VALUATION METHODS

This paper analyses the feasibility of a takeover bid of the commercial aviation company Ryanair Holdings PLC by a North Amer...

Accounting Theory

HSBC             The method of valuation of investment properties is disclosed which justifies the increase of their net book value and crediting to income statement.  However, there is no explicit terminology (e.g. sum-of-years, double-declining balance) to described the depreciation method being applied as well the asset’s useful lives and depreciation rates.  Computations on carrying amount and accumulated depreciation are shown with current and previous year comparisons.  Carrying amounts at the beginning through the end of the period are adjusted by considering additions, disposals, and exchange differences among others.                                Bearing in mind that PPE of HSBC are land and buildings, other disclosure involves their nature as finance lease contracts, expenditure and commitments but there are no third party compensation clause.  In the revaluation of its investment properties, HSBC disclosed the effective date of revaluation (e.g. every 31 December), involvement of independent professional valuers (e.g. DTZ Debenham Ltd), use of open market basis and recognition of contractual obligations on investment properties.  However, there is no presentation on alternative cost model.  There are no disposed non-current assets that HSBC has executed.  As there is no specific depreciation method used, it is undeterminable to comment about its semblance with pattern of asset’s economic benefits and consumption.                         In valuing intangible assets, HSBC seemingly is not within the scope of IAS 38 because it included goodwill arising from issuance contracts which is beyond the scope of the standard.  However, the analysis will be focused on certain contents which coincide with the provisions of IAS 38.  For example, HSBC created a classification of intangible assets under “other” account which make it impossible to assess its ground for recognition.  There are also figures concerning present value of in-force long-term insurance benefits.  Further, adjustments for PPE and intangible assets have the same accounts (e.g. additions, exchange differences, etc.).  However, the lack of text explanations for the notes to goodwill and intangible asset presentations inflicted the validity of internally-generated software which accounts for the biggest intangible property.          The strength of HSBC especially pertaining to current assets is that it revalues its non-assets regularly to avoid huge discrepancy of the previous period to the succeeding ones.  This is aided by presenting comparative revaluation results year-on-year.  As investment properties are only the ones that are revalued, HSBC also rescinded in revaluing non-current assets under finance lease contracts (FLCs).  This move is according to IAS guide on revaluation model.  In addition, investment properties are also imputed with the same adjustments and comparative presentations like non-current assets under FLCs.  As both accounting year 2006 and 2005 have revaluation surplus, it should be recorded in equity but HSBC opted to reflect it on notes under “non cash items included in profit and tax” and ultimately in income statement (IS).               One advantage of HSBC’s approach to non-current assets is that it applies a comprehensive valuation of PPEs even though the company does not gain most of its income from non-current assets such land and building.  This reflects managerial evaluation due to inability of available depreciation methods to suffice representation needs.  However, this strategy can also minimize the “true and fair” impression on its BS because of excessive non-objective application of valuation techniques.  In contrast, HSBC is able to redeem some spots of unbiased stance by regularly evaluating its techniques, inclusion of outside valuer and stating non-current asset restrictions.  However, the inability to reflect the revaluation surplus in equity account rather on IS makes the increase less useful to shareholders.               For the low-educated type of people, the BS of the company will be appreciated because it maximized managerial evaluation in determining the “true and fair” value of non-current assets for the purpose of information.  However, on the part of credit rating agencies (e.g. Standard & Poor), the opposite impression will result.  The same adjustment elements for non-current assets that are evaluated are also helpful in establishing ease of analysis from low-educated people.  In the contrary, agencies would prefer more complex numerical data to suffice the claim like the movement in PVIF shown in adjusting the values of intangible assets.  For both users, HSBC could infuse more textual explanations to the arrived figures especially in valuating goodwill and intangible assets because fewer details would mean confusion and speculations. Hang Seng Bank             Same as HSBC, Hang Seng uses open market value, independent professional valuer and annual assessment method for its investment properties.  However, unlike HSBC, Hang Seng explicitly classifies their investment properties as operating leases.  The requirement disclosure of IAS 16 is not accounted as Hang Seng does not present a detailed surplus revaluation rather the note that supposedly explains the carrying amount and adjustments is inexistent.  Although the basis for valuing PPE is stated, the depreciation method used or the same problem on HSBC is not explicitly disclosed.  Useful lives of the PPEs are also not reflected.  On the other hand, reconciliation of investment properties and PPEs are included while the restrictions on assets are stated when presenting investment properties.                Alternative presentation for the cost model is excluded like the HSBC and also changes in economic benefits and consumption pattern of PPEs and investment properties are not discussed.  Possibly, this is the result when external valuers have found no significant valuation change for Hang Seng which is the present case.  Provisions on disposals are eminent in both PPEs and investment properties which requires the abolition of such assets in the BS.  In addition, a situation that Hang Seng would defer payment of certain properties to apply market interest is not determinable because there is no disclosure about purchase or lease transactions.  But Hang Seng included direct operating expenses as expenditures for investment properties which contribute to the increase of revaluation of investment properties.  In contrast, it is observable that no impairment looses that are recognized.  Also, there are no recorded amortizations that concretized the fact that the Hang Seng fully-paid such assets.               When it comes in intangible asset, Hang Seng method of valuation purely shows computations without textual explanation to justify the provisions of IAS 38.  Another, like HSBC, Hang Seng also included long-term insurance as intangible assets which are beyond the scope of the standard.  Disclosures are also lacking and this is aggravated by the lack of textual explanations and explanatory notes.  There are no indications of the useful life of the intangible assets, amortization method used and impairment looses.  The focus of the presentation is to show the developments Hang Seng initiated to improve intangible assets but not the impairment looses due to the use of the asset.               Further, intangible assets that Hang Seng presented are unable to justify themselves as under this class since there is no elaboration on who controls the asset and future economic benefits of the asset (e.g. internally developed software).  If any, acquired software should the one that has relatively highest merit of being in the intangible group due to the assumption of IAS 38 for business combinations.  However, it is necessary to reflect the details of the acquisition in order to assess the value of the acquired intangible asset.  It is also observable that Hang Seng amortized its internally generated software but the method used is not indicated.             The “true and fair” valuation of the BS of Hang Seng based on its method is not eminent because the users of such information are left in the middle of nowhere.  The presentations are merely numerical in nature and there is no chance of knowing their validity according to IAS 16 and IAS 38.  The lack of textual explanations which is earlier pointed as weakness of HSBC is also the undermining factor in the BS of Hang Seng.  In the contrary, Hang Seng admonition that it considers its investment assets as operating leases makes the analysis from external users easy unlike HSBC approach of consolidating lands and buildings related cash flows.  One core disadvantage is the inability of Hang Seng to fully discuss the characteristics of the intangible asset to clearly show its compliance to the recognition provisions of IAS 38.                For the low-educated people, the non-current assets of Hang Seng will impede understanding of the true nature of its value because of they are purely quantitative.  Although this presentation would be agreeable to experts, laymen would want a more detailed valuation to use IAS guidelines in determining on what extent does the company is being true and fair.  Computations can be analyzed by experts with their profound experience in financial statements but low-educated people may view them as unrealistic given that explanations of their existence and positions are unknown.  On the other hand, low-educated people can appreciate the external auditors that are involved in revaluating investment assets.  On the part of experts, this cannot be easily accepted as collusion between the client and service provider is probable. Wing Lung Bank             The accumulated depreciation for the investment properties of Wing Lung is zero which can mean that improvements of such asset can impede the decline in the loss of its value due to usage.  The non-compliance issue is eminent especially when it is known that Wing Lung had revalued its investment properties and ultimately gains surplus revaluation but depreciation is not applied.  According to IAS 16, the cost model on depreciation applies on revalued assets.  In addition, the surplus revaluation reflected under fixed assets has no notes that can indicate that the surplus is included in the equity section of the BS.  It is also observed that all the non-current assets of Wing Lung had increased in value since 2004 from premises, investment properties and furniture/ equipments.               Additions, disposals, reclassifications and other adjusting elements for revaluation are limited to numbers which make it hard to determine their compliance with the respective provisions.  This can lead to ambiguity which can undermine the “true and fair” valuation of its non-current assets.  For example, there are additions in every non-current account where only amounts are indicated.  Therefore, initial measurement provided by IAS 16 cannot be enforced like the recording of “other cost necessary to bring an asset to working condition” because the features and improvements of certain assets are not disclosed.  In this foregoing, deferred payment applied to acquire these assets are also hindered in the eyes of the users.             The valuation of investment properties is also not done in regular manner.  In fact, the 2005 revaluation is done by Wing Lung for the first time although the valuers are independent and open market value basis is applied.  Most of the investment properties in 2004 are reclassified as premises but such action is not covered in IAS 16, therefore, this is no basis to analyze this strategy.  However, it is noteworthy to mention that since 1995 through 2005, investment properties are increasing in value although in decreasing rate.  There are also no disclosure on restrictions in title, expenditures, commitments and compensation to third parties which means that the assets of Wing Lung really owned and benefited by them.  However, the same situation can lead to speculation that Wing Lung has erred in valuing its non-current assets.                The advantage of the valuation method of Wing Lung is that there are no provisions for intangible assets.  Therefore, users of BS can only consider the real non-current assets of the company with less regard to the complicated nature of intangible assets when it comes in evaluation.  It can be said that it is advantages for laymen to view the true and fair valuation of corporate assets because of its simplicity and absence of technicalities (e.g. PVIF).  The disadvantage is on the undermining of the intangible assets of Wing Lung that unlike HSBC and Hang Seng maximized.  Therefore, the company can be undervalued but this undervaluation can be redeemed when users of BS can attribute truth and fairness in the presentation.  However, the absence of in-depth presentation remains the weakness of all three banks. Conclusion             Banks can be considered as one of the industry that most likely consistent to IAS guidelines as they are monitored by government authorities as well as private associations.  They also partake in financial statement analysis from corporations which makes its safe preparation and appearance.  However, our analysis of the well-known and biggest banks listed in Kong Stock Exchange proved that they are also private entities with profit-orientation.  Due to this, notes to their respective BS are limited to numerical presentations without reference to the provisions of IAS 16 and 38 for the sake of readership on both expert and layman levels.  In this manner, only experts can extract the needed information from these BS.                Shown in table 1 are the different valuation methods that one of the banks used in assessing the value of its non-current assets.  As there are several methods that can be used or even combination of these, it is vital for these banks to ensure that they can state the valuation method being applied by their independent valuers in order for users to have an easy grasp on the framework being applied.  When users would know the specific valuation method, they can be aware of its strengths and limitations and can initially have a birds-eye-view on what to expect on the BS and succeeding notes.  However, even banks have their way to minimize the error that can arise once the framework used is limited in their own ways.  Therefore, flexible valuation method is vital infused with managerial judgment in estimation for optimal non-current asset values. Table 1: Comparison of Valuation Methods Method Primary Activities Unique Feature Practical Use Direct Comparison - comparison of the property with similar transactions  - can be straight or analytical comparison  - most frequent used method especially in residential property and vacant land Summation - comparison of vacant and developed sites - the added value of improvements is added to the result of the primary activity - helpful in rating and taxation valuation Capitalization - net passing rental is capitalized or multiplied in perpetuity  - uses a certain percentage called yield that has a formula of net rent/ sale price - used in commercial, investment and hospitality premises whose operations are on a going concern Hypothetical Development - pre-supposes a development proposal on a certain property - scenario planning for future property improvements - applied in assessing the feasibility of a project, development option and value of the proposed development Depreciated Replacement Cost - methodology of summation with regards to depreciated replacement cost - uses cost estimates and allowances for depreciation to account for property and improvement obsolesce - evaluation of specialized assets for financial reporting purposes Discounted Cash Flow Analysis - use the stream of future cash flows of the property  - necessitate computation of net present value (NPV) - use to value substantial commercial premises subject to long-term lease agreements, and also, valuing subdivisions

Accounting Theory

HSBC The method of valuation of investment properties is disclosed which justifies the increase of their net book value and...