Technical / Valuations and asset sales – getting to grips with the accounting treatment

The Royal Free London NHS Foundation Trust made the news earlier this year when it struck a deal to sell surplus land, writes Steve Brown. The profit generated by that sale initially boosted the trust’s revenue position for the year, entitling it to a greater share of the incentive element of sustainability and transformation funding.

Auditors later judged that the benefits of the transaction should be accounted for in 2017/18.The sale had been planned for a long time to support funding of a new hospital at the trust’s Chase Farm site (pictured). Regardless of this, reports of the transaction drew some (anonymous) comments about ‘hastily arranged deals’ and ‘accounting wheezes’.

Concerns ranged from the timing of the deal to the fact that the valuation for sale was so far ahead of the value carried in the trust’s accounts (£50m compared with a zero book value, giving a £47m net benefit after £3m provisions were made for site clean-up). 

Without dealing with all the specifics of the case, it is worth examining the process that should be followed in terms of valuations for sale and accounting for any proceeds.

First, it should be said that NHS bodies
are encouraged to dispose of surplus assets – the process for doing so is set out in Health building note 00-08 part B. In general, assets should be sold for the highest price. This generates cash for the selling organisation. These capital receipts can generally be kept by the organisations to finance new capital expenditure. And where there is a profit on disposal, it can increase any operating surplus or reduce a deficit.

A profit equates to the selling price minus the value of the asset as recorded in the body’s statement of financial position (SFP) minus any costs associated with the sale.

However, value – and valuing – is not a straightforward business. The value of property, land and equipment is not simply recorded as the amount paid for it. Instead the valuation of an asset is reassessed over its useful life. 

This ‘revaluation model’ (see paragraphs 29 and 31 to 42 of property, plant and equipment standard IAS 16) requires that assets are held at their ‘fair value’. This is the price that ‘would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’.

The accounting standard is written with the assumption that assets are held to generate income either through their use or by selling them.  Public sector bodies’ assets are held to provide services so, when valuing operational assets, they apply an adaptation to IAS 16 that means they are valued at current value for existing use (see page 32 of the Treasury’s Financial reporting manual). For specialised assets, this is an assessment of the present value of the asset’s remaining service potential. NHS bodies have to use a modern equivalent asset approach to establish this value. This is the cost of an asset built with modern materials to produce the same throughput, perhaps even on a different site. 

An asset can have a completely different value once it is surplus to requirements, and has no restrictions on its disposal, when it could be valued at an open market rate established by professional valuers. 

However, there are special rules for assets that are held for sale. These are defined as assets meeting the criteria of the accounting standard for non-current assets held for sale and discontinued operations (IFRS 5). This basically means the asset is available to sell, there is a commitment to sell and it is being actively marketed.

At this point, the asset is removed from the property, plant and equipment note in the accounts and moved into current assets. Accounting rules dictate that these assets are valued at the lower of their carrying value immediately prior to the change of classification and their fair value (less costs to sell). No depreciation is charged from this point.

If the actual sale price is then above this ‘frozen’ value, the profit is recorded as income in the SOCI, improving the reported financial position, but not changing any underlying position. It might boost an existing underlying surplus – showing a one-off benefit for the year. Or it could improve an underlying deficit position, by enabling the trust to show a surplus despite spending more for that year than it had received in recurrent income.

The cash received from the sale (minus the book value) would be recorded as a current asset in the SFP, matched by an increase in the income and expenditure reserve courtesy of the improved financial position. This would be recorded in the accounting period in which the transaction took place, as long as it was deemed that the transfer of risks and rewards of ownership also took place at the same time.

The further twist in the Royal Free case is that, rather than having to calculate a theoretical modern equivalent value for the old Chase Farm site and facilities, the trust is actually building a modern equivalent on a small corner of the existing site. The residual value of this subsection of the land and the assets built upon it remain in the books, leaving the surplus land for sale at a value of zero.

Now consider the case where the asset had not met criteria for assets held for sale but had no further restrictions on it and was no longer in use. If a valuation had indicated a higher value than that held in the accounts, different treatment would apply. In this case, the asset value would be increased and the asset would continue to be reported as a non-current asset. 

This increased value would be balanced by a corresponding increase in the revaluation reserve. If this asset was then subsequently sold for a sum equal to its revised valuation, the organisation would reduce its non-current assets by the asset value and increase its current assets by the sale value. A sum equal to the difference between the revised asset value and the previously recorded asset value would be transferred from the revaluation reserve to the income and expenditure reserve.

The statement of financial position would look exactly the same as in the ‘assets held for sale’ scenario. The only difference is the impact on the SOCI. The treatment is dictated by the standards and whether the asset meets the relevant criteria for assets held for sale – it is not a choice for the organisation.