Fair value of investment property and independent appraisers: the experience in the UK and Japan.
The fair value of investment property has become an important topic since the international advancement of fair value accounting. This article looks at the role of appraisers in fair market accounting. It elucidates the status of the fair value of investment property of companies in the United Kingdom, which pioneered it. The article also provides an analysis of the fair value of investment property of companies in Japan following the recent adoption of accounting standards for disclosure of the fair value. The analysis reveals that directors of companies use the valuations of outside appraisers to determine fair value when the unrealized value of the investment property is large, and investors recognize the usefulness of appraisers' valuations.
The International Financial Reporting Standards (IFRS) have been adopted in many countries, and the assessment of the fair value of investment property in accounting practice has become more important than ever. Although IFRS has not been adopted in the United States, the Financial Accounting Standards Board (FASB) has actively pursued convergence of those standards with the US generally accepted accounting principles (GAAP). (1) The opportunities for appraisers to be engaged in the valuation of investment properties are expected to increase, even in the United States.
Japan also has not yet adopted IFRS. However, since 2010 Japanese accounting standards have mandated disclosure of the fair value of investment property in the notes to financial statements. (2) The amount of investment property held by Japanese companies is extremely large--larger than that held by European companies--but before the mandated disclosure it had been difficult for investors to assess the fair value of investment property of Japanese companies. As the fair value of investment property is now disclosed, information asymmetry on investment property in the securities market is expected to lessen.
In an economic transaction, information asymmetry occurs when all the necessary information is not disseminated to all the individuals involved in the transaction; instead, information is unevenly distributed to the parties involved. Akerlof explains the effect of information asymmetry by giving an example of the used car market. (3) He points out that when a customer cannot acquire correct information on the quality of a used car, the customer cannot confirm its quality even if the quality of the car is high. Consequently, the customer tends to hesitate in making a purchase. As high-quality cars cannot be distinguished from low-quality ones, there is no incentive for sellers to put high-quality cars on sale. As a result, the used-car market is saturated with low-quality cars. This can cause a negative chain reaction and lead to the collapse of the used-car market. To avoid this, sellers endeavor to provide correct and detailed information for customers to ease information asymmetry.
Similar uncertainty exists when companies possess investment property. In conventional financial statements, the value of investment property is based on its acquisition cost. Therefore, only a small number of individuals know the actual current value of the investment property. In other words, information asymmetry exists in investment property. If many investors know the actual value of the investment property due to the disclosure under fair value accounting, many problems caused by information asymmetry can be resolved, and the securities market can be stabilized.
As fair value accounting of investment property has been adopted in many countries, the importance of accurate valuation of investment property has increased. The fair value of investment property may be based on a director's valuation, which is performed by a director of the company, or may be based on an appraiser's valuation, which is performed by an outside specialist (independent appraiser). (4) When an appraiser's valuation is adopted, companies must bear the cost of the valuation in the form of an annual valuation fee. When a director's valuation is used to measure the fair value of investment property, the results may be skewed in favor of the companies. By discretionarily estimating the value of investment property, the profit on investment property can be adjusted freely. In the worst cases, the quality of financial statements decreases, and the significance of the accounting system becomes questionable.
The aim of the present study is to elucidate the actual status of the fair value of investment property of companies in the United Kingdom (UK), which has already adopted the IFRS, and to analyze Japanese companies that provided fair value information as well as the behavior of investors who used the information on the disclosed value of investment property held by Japanese companies. The study also examines the preferred method to measure the fair value of investment property and assesses the future role of appraisers internationally in fair value accounting. If appraisers' involvement in fair value accounting systems is recognized as contributing to the stabilization of the securities market, appraisers can expand their professional services in this field and increase their status in the business economics sphere.
What Is Investment Property Accounting?
Investment property accounting is part of the fair value accounting system. IFRS 13, "Fair Value Measurement," defines fair value as follows:
Fair Value 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. (5)
Fair value accounting became popular in the second half of the 1980s. During that period, a new financial product called derivative transactions entered the financial market Since then, the principal objective of business management has gradually shifted toward risk management. The prediction of future cash flow has become more important than ever, resulting in the increase in the usefulness of fair value accounting for investment property. The incorporation of fair value accounting has continued to reform accounting systems in general. Similar to accounting for financial instruments, investment property accounting plays an important role in the fair value accounting system.
The investment property accounting system originated with Statement of Standard Accounting Practice 19, "Accounting for Investment Properties," issued in the United Kingdom. (6) During the 1990s, the accounting system was internationalized, and in 2000, International Accounting Standard (IAS) 40, "Investment Property," was published. IAS 40 calls for the value of investment property to be remeasured using (1) a fair value model, (7) in which all changes in the fair value of an investment property are shown in a statement of profit and loss; or (2) a cost model, (8) in which the acquisition cost of the investment property after depreciation is measured, and the fair value is disclosed in notes to financial statements. (9)
When the fair value model is used, the changes in the fair value of the investment property influence the business's profit and greatly affect corporate management. Under current accounting standards, companies can arbitrarily select either an appraiser's valuation or a director's valuation as the method to measure the fair value of investment property. Under IAS 40.32, valuation by independent appraisers who have a professional qualification is recommended but not mandatory. The valuation method of investment property can be classified as a valuation by an independent appraiser who is a qualified professional (referred to as an appraiser's valuation in this article) or as a valuation by a company director (referred to as a director's valuation in this article). Therefore, the method used to measure the fair value of investment property must be scrutinized.
Regarding the valuation of investment property, the relationship between fair value and market value is questionable in many cases. However, the International Valuation Standards (IVS) state that fair value in IFRS is generally consistent with market value:
The IVSB considers that the definitions of fair value in IFRS are generally consistent with market value. (10)
The IVS defines market value as
the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion. (11)
Several accounting research studies have looked at the market value of real estate and revalued tangible fixed assets in the United Kingdom and in Australia. Studies also have investigated the reliability and the usefulness of appraisers' valuations and the motivation of directors of companies to select appraisers' valuations. These studies have found that the benefits of appraisers' valuations include the accuracy of the appraised value and the ability of the appraiser's valuation to ease information asymmetry in the securities market.
Dietrich, Harris, and Muller (12) study the reliability of appraisers' valuations of the fair value of investment property. In their study, the appraised value of real estate in financial statements that had been revalued was compared with the actual sale prices of investment property when it was sold. The accuracy of the valuations was measured based on the difference between the appraised value and the sale price. The results show the following:
* The reliability of the appraiser's valuation was greater than that of the director's valuation.
* In the case of a director's valuation, the accuracy of the appraised value was recognized when it was audited by six major audit corporations.
* The accuracy of an appraiser's valuation of investment property not audited by the six major audit corporations was higher than a director's valuation of the investment property audited by these corporations.
Thus, the reliability of the appraiser's valuation was high, with six major audit corporations contributing to the reliability of the asset valuation to some extent.
Muller and Riedl (13) also examine the usefulness of appraisers' valuations. They divide investment properties held by a company into those based on a director's valuation and those based on an appraiser's valuation and then analyze the bid-ask spread between the two valuations. In this study, the bid-ask spread is larger in the case of a director's valuation than in the case of an appraiser's valuation. This suggests that information asymmetry is greater in directors' valuations than in appraisers' valuations, and that the information provided by appraisers is more useful for investors than the information provided by directors. A study by Muller, Riedl, and Sellhorn (14) also verified the usefulness of appraisers' valuations in investment property accounting.
Brown, Izan, and Loh, (15) and Cotter and Zimmer (16) study the motivation for selecting appraisers' valuations. These studies focus on the revaluation of tangible fixed assets in Australia. Their analytical results reveal that appraisers' valuations are used when reporting the tangible fixed assets of financial institutions. Cotter and Richardson (17) use more recent data and conclude that the concept of corporate governance, rather than the fulfillment of accountability to financial institutions, influences the selection of appraisers' valuations.
Yamamoto (18) studies the role and the behavior of appraisers in asset-impairment accounting in Japan. This study reveals that use of an appraiser's valuation as a valuation method controls the discretionary earnings of company directors and increases the reliability of financial statements. Company directors are able to assess the impairment loss by arbitrarily valuing tangible fixed assets. As a result, they can adjust their profits. However, the valuation of investment property by outside appraisers prevents such arbitrary valuations by company directors. Although the aforementioned studies generally support the reliability and the usefulness of appraisers' valuations, the number of studies is insufficient for broad conclusions and further studies are needed.
Investment Property Accounting in UK Companies
This section examines the status of appraisers and their participation in ascertaining the fair value of investment property in the United Kingdom. The discussion here focuses on companies that have already adopted investment property accounting standard IAS 40. In the United Kingdom, appraisers are commonly involved in determining the fair value of investment property. Financial Times Stock Exchange 350 (FTSE 350) companies listed on the London Stock Exchange (as of February 1, 2011) are investigated here, based on accounting figures in the latest annual reports as of that date. Table 1 summarizes the data for general business companies, and Table 2 summaries data for financial institutions.
General Business Companies
Table la shows the adoption of the IAS 40 by 246 general business companies in the FTSE 350, excluding financial institutions. Of the 246 companies, 20 companies (8.1%) have adopted the IAS 40. The adoption rate of IAS 40 by companies in the real estate industry is high (75.0%), followed by commerce (24.1%). Other than these industries, few others have adopted IAS 40. The average value of the "investment property/total assets" of the companies in the real estate industry is high (72.2%). However, the values of the companies in other industries are about 1% or smaller. Thus, the possession of investment property by general business companies is extremely rare in the United Kingdom.
Table 1b shows the valuation models employed by the 20 companies that have adopted IAS 40. Of these, 12 companies have employed the fair value model and 8 use the cost model. Table 1c shows the valuation methods of the 12 companies that have adopted the fair value model; of the 12 companies, 7 employ an appraiser's valuation while 5 use a director's valuation.
Financial Institutions in FTSE 350
Financial institutions in the FTSE 350 were divided into four categories: real estate investment trust (REIT), life insurance, nonlife insurance, and others. Table 2a shows the IAS 40 adoption status of financial institutions in each of these four categories. In the REIT and life insurance categories, 100% of the companies have adopted IAS 40. This indicates that financial institutions in these two categories have close links with owned investment property. Table 2a also shows that for financial institutions, except for in the REIT category, the value of the investment property compared to total assets was low (1%-3%).
Table 2b shows the valuation models employed by the financial institutions that have adopted IAS 40.
As shown in this table, 28 of 29 financial institutions relied on the fair value model--a tendency that differed from that of the general business companies. Table 2c shows the valuation methods of the fair value model used by the 28 financial institutions. Unlike the general business companies, the majority of the financial institutions (22) employ an appraiser's valuation.
As mentioned, the adoption rate of the IAS 40 investment property provisions is higher among UR financial institutions than general business companies. The fair value model is the valuation model used by most financial institutions, with an appraiser's valuation as the most commonly used valuation method. Companies whose main business is the possession of investment property are likely have a strong motivation to disclose the real market value of investment property and to ensure the reliability of the fair value. In the United Kingdom, appraisers' valuations play an important role in the investment property accounting system, and therefore, the quality of financial statements.
Investment Property Accounting in Japanese Companies
As mentioned, several past studies have confirmed the reliability and the usefulness of appraisers' valuations. The previous section described the adoption of the IAS 40 by UR companies and the role of the appraiser's valuation in the investment property accounting system there. Based on the findings, the advantage of using outside appraisers to value investment property appears to be the reliability of the valuation of the property's fair value. This reliability appeals to outsiders. The use of outside appraisers may also decrease the valuation responsibility of company directors.
Large corporations with long histories often possess a wide variety of investment properties with unrealized profits. (19) The number of investors' requests to ensure the reliability of the fair value of investment properties increases as the unrealized profit of the investment property increases. To inform investors of the true value of an investment property, directors of companies use outside appraisers. As the unrealized value of investment property increases, the difference between the book value and the fair value of the investment property increases (i.e., the information asymmetry becomes greater). Therefore, directors of companies have a 19 strong motivation to ease information asymmetry. If the directors of a company provide high-quality information on the fair value of investment property, information asymmetry can be eased to some extent, and financial risks can be reduced. Consequently, the value of the company will increase.
In general, the fair value of investment property is measured through multiple steps, and the number of steps is larger for investment property than for vacant lots. Investment property tends to be arbitrarily measured--in the case of a director's valuation in particular, director's discretionary behavior is a concern. Unlike vacant lots, the fair value of investment property must include building values and profitability. Therefore, a high degree of valuation expertise is needed. Investors acknowledge this and are aware of the usefulness of an appraiser's valuation.
This section presents two hypotheses relating to Japan's investment property accounting. The hypotheses relate to the disclosure of the value of investment property.
* Hypothesis 1: Directors of companies with investment properties with large unrealized profits tend to select an appraiser's valuation.
* Hypothesis 2: Investors recognize the usefulness of an appraiser's valuation.
The validity of Hypothesis 1 (HI) and Hypothesis 2 (H2) correspond to the behavior of directors and the perspectives of investors, respectively. The following section discusses the findings of a study examining each hypothesis.
Disclosure of Fair Value in Japan--Type of Company
A total of 613 companies were extracted from companies listed on the first section of the Tokyo Stock Exchange (TSE). To investigate companies with long-term real estate accumulation, all of the 613 companies were typical large companies in Japan and satisfied the following conditions.
* They were continuously listed on the TSE between fiscal years 1984 and 2011.
* The settlement day was March 31.
* They were not financial institutions.
* They have adopted the Japanese accounting standards.
Table 3 summarizes data on companies in Japan that have adopted the "Accounting Standard for Disclosures about Fair Value of Investment and Rental Property" (ASBJ Statement 20). (20) Of the 613 sample companies, 216 (35.2%) disclosed annotation information in 2010. In Table 3, the investment property (cost)/total assets index indicates the quantity of investment property. Although the average of this index for the 216 companies was 10.6%, the average was 57.5% for companies in the real estate industry. This extremely high value is likely due to the characteristics of this industry, which possesses a large amount of investment property.
An index for investment property unrealized profit and loss/total assets is used to indicate the scale of unrealized profit and loss of the investment property. Although the average of this index for the 216 companies is 6.9%, it is 26.7% for companies in the real estate industry. Again, this extremely high value is probably due to the nature of this industry. There was no significant difference in the average of the investment property unrealized profit and loss/total assets between fiscal years 2010 and 2011. However, in fiscal year 2011 the number of companies possessing investment property, the index for investment property (cost)/total assets (total average), and the index for investment property unrealized profit and loss/total assets (total average) are all slightly smaller than in fiscal year 2010. This was probably due to some companies selling investment property and a long-term decrease in land values.
Table 4 shows the summary of basic statistics for the rental profit and loss/investment property (cost) index for companies with investment property, according to the type of industry. The values of this index indicate the qualitative aspects of investment property. The average values for TSE-listed companies in the manufacturing, and transportation and warehousing industries are above 4.0% and below 5.0%--higher than in any of the other industries. This is probably because many of the investment properties owned in these industries are located in industrial districts with low land values. Consequently, the denominator of this index is relatively small. The minimums of this index for companies in the manufacturing industry and commerce are mainly negative. Thus, some companies appear to have problems with the effective use of investment property. The high standard deviation, particularly in commerce, is noteworthy; it indicates large variations among companies in their effective use of investment property. In contrast, a low standard deviation is observed in the construction, real estate, and transportation and warehousing industries. Therefore, investment property appears to be used effectively in these industries.
Use of Appraisers' Valuations
This section analyzes the use of outside appraisers in the first year of disclosing the market price of investment property. In this analysis logit regression analysis is used. Logit regression analysis is similar to multiple regression analysis, which is often used for factors on real estate value. The difference between these two analyses is that in multiple regression analysis, quantitative data (such as actual property prices) are assigned to variables, but in logit regression analysis, qualitative data (such as 0 and 1) are assigned to variables. (21) Logit regression analysis has many uses, and it has been employed in various fields. For example, in the field of business management, logit regression analysis is used for corporate bankruptcy prediction models. Namely, 1 is assigned to bankrupt companies and 0 is assigned to nonbankrupt companies. In this way, factors peculiar to bankrupt companies can be specified.
In this study, logit regression analysis is first used to verify Hypothesis 1, i.e., directors of companies with investment properties with large unrealized profits tend to select an appraiser's valuation. Data of companies that have adopted an appraiser's valuation and those that have adopted a director's valuation are analyzed to elucidate die characteristics of companies using an appraiser's valuation. Specifically, as expressed by Formula 1, the most noteworthy variable is investment property unrealized profit/total assets (c12). If this variable is certified as significant and positive, the probability of a company adopting the appraiser's valuation increases as the unrealized profit of investment property increases. Consequently, HI can be verified.
In Formula 1, nonuse of an appraiser is assigned a value of 0 and use of an appraiser's valuation is assigned 1, with the resulting formula:
Nonuse and use of outside appraisers = cl + c2 return on assets + c3 Tobin's q+ c4 sales volume percent change + c5 interest-bearing debt ratio + c6 natural logarithm (In) total assets + c7foreign stock ownership ratio + c8 shareholding ratio of financial institutions + c9 shareholding ratio of general business companies + cl 0 land asset percentage change + cl 1 investment property/ total assets + cl2 investment property unrealized profit/total assets + cl3 audit corporation dummy +e (1)
Basic Approach to Definition and Description of the Variables
Table 5 shows the variables employed in Formula 1 and their associated explanations. These variables indicate the scale of possessed investment properly and the unrealized profit ratio as well as the companies' financial and governance strengths.
Information from consolidated financial statements of each company is used for Formula 1. Data for each company, as of March 31, 2009, are used for the variables other than investment property/ total assets and investment property unrealized profit/ total assets. (22) In addition, data on the shareholding ratios are based on values shown in the Nikkei Kaisha Joho data book published by Nikkei Inc.
Of the 613 sample companies listed on the first section of the TSE, 216 companies disclosed information on the fair value of investment property in notes to financial statements in the first fiscal year (2010) of using the accounting standard for disclosures about fair value of investment and rental property. Of the 216 companies, 204 had valuation methods that could be clarified, and these are analyzed. Of the 204 companies, 108 used outside appraisers for the fair value of investment property ("participation"), and 96 employed only a director's valuation ("nonparticipation"). Table 6 shows the analytical results for the 204 companies.
First, the results show that companies with large unrealized profits tend to select outside appraisers. The directors of companies have stronger motivation to transmit accurate asset value information to investors as the unrealized profit increases and information asymmetry becomes greater. Second, companies with large interest-bearing debt ratios tend to select a director's valuation. These companies have a strong tendency to obtain property-backed loans from banks for their business activities. Therefore, these companies have accumulated accurate information on the fair value of collateralized real estate. (23) Thus, information on the value of the collateralized real estate accumulated by these companies may be used for information on the fair value of investment property in the notes to financial statements in the present study. Third, companies with high ratios of foreign stock ownership tend to select a director's valuation. At present, companies appear to have no incentive to provide information on the fair value of investment property to foreign investors by using outside appraisers. (24) Fourth, large companies tended to use outside appraisers. As the total assets of a company increase, the visibility and responsibility of the company increase. Therefore, outside appraisers are used to fulfill the company's public accountability.
The motivation to employ an appraiser's valuation is analyzed according to the type of industry. In the analysis, the companies are divided into two categories: (1) manufacturing, and (2) construction, transportation and warehousing, and real estate. The results for the manufacturing industry tend to approximate those of all the industries. According to the tendency of the coefficient, the construction, transportation and warehousing, and real estate industries are generally the same as industries as a whole. Significance is observed only in the foreign stock ownership ratio. This is probably due to major property companies with large unrealized profits tending to use a director's valuation. (25) In these companies, many employees are qualified appraisers, and these employees are well versed in the real estate held by the companies. These companies likely do not employ external appraisers to protect internal company information. In this way the companies in Japan differ greatly from UR companies with investment property, which put a premium on an appraiser's valuation.
Analysis of the Usefulness of the Appraiser's Valuation
If information on the method of measuring the value of investment property held by a company is useful, investors' expectations will increase. Consequently, the company's stock price will increase. The present study uses an event-study methodology to analyze the relationship between the disclosure of fair value accounting information and short-term stock-price fluctuations.
Of the 204 sample companies in the study that disclose the fair value of investment property, 49 had disclosed annotation information, in accordance with the accounting standard for disclosures, about the fair value of investment property in the statement of accounts (26) between April and May 2010. The possible importance to investors of the disclosure is analyzed.
In the present study, abnormal return (AR) is measured, and cumulative abnormal return (CAR) is obtained, using the following formula measuring value:
[R.sub.it] = [[alpha].sub.i] + [[beta].sub.i][R.sub.mt] / [[epsilon].sub.it],
where [R.sub.it] represents the return of company i at day t, [R.sub.mt] represents the return on the market portfolio at day t (the Tokyo Stock Price Index was used in the present study), [[alpha].sub.i] and [[beta].sub.i] represent the parameters for the linear regression model, and [[epsilon].sub.it] represents an error term.
The values of [[alpha].sub.i] and [[beta].sub.i] were estimated from the time-series data of [R.sub.it] and [R.sub.mt] using the least-squares method. (27) Using the estimated values, the estimated value of the abnormal return [[epsilon].sub.it] was obtained as follows:
[[epsilon].sub.it] = [R.sub.it] - ([[alpha].sub.i] + [[beta].sub.i] [R.sub.mt])
This formula is based on the assumption that the return of a company is determined by linking it to the return of the entire market. In this formula, [[alpha].sub.i] + [[beta].sub.i] [R.sub.mt] is the estimated return of a company based on the return of the entire market. However, this is only a theoretical value. Therefore, this does not always agree with the actual return (realized value). This analytical method focuses on the percentage of deviation between the realized value and the theoretical value. If a company discloses highly useful information to investors, this information affects the investors' actions. Consequently, the company's stock price may unexpectedly fluctuate. This increases the percentage of deviation between the realized value and the theoretical value. The increase in the percentage of deviation is expressed as AR in Formula 2. Therefore, the absolute value of CAR increases as the usefulness of the information disclosed by a company increases. Thus, CAR can be used as a scale to measure the usefulness of information disclosed by a company.
In the present study, the CAR for 10 days before and after the release date of the statement of accounts (20-day period) is analyzed. To verily the average effect of the release of the statement of accounts at day t, the AR is obtained as follows, where the number of sample companies is n:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (2)
To verify the average effect of the release of the statement of accounts during the analytical period, CAR in the period between t = a and b is measured as follows:
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]
Subsequently, regression analysis is performed using CAR as the explanatory variable based on the following model:
CAR (a, b) = [a.sub.1] + [a.sub.2] investment property unrealized profit per share + [a.sub.3] earnings forecast dispersion per share + [a.sub.4] dummy valuation method + [epsilon] (3)
In Formula 3, investment property unrealized profit per share ([a.sub.2]) is obtained by calculating the unrealized profit of the investment property based on annotation information from each company and then dividing the obtained value by all issued stocks. Earnings forecast dispersion per share ([a.sub.3]) is obtained by deducting the latest earnings forecast from the earnings published in the statement of accounts and then dividing the obtained value by all issued stocks. To obtain the valuation dummy, 1 was assigned to the case where outside appraisers participated in the appraisal of fair value of the investment property, and 0 is assigned to the case where a director's valuation is used, based on annotation information from each company. When [a.sub.2] and [a.sub.4] are significant coefficients, the correlation among the investment property unrealized profit per share, the dummy valuation method, and CAR is confirmed, and the annotation information can be considered useful.
Figure 1 shows the temporal changes in the CAR, that is, the averages of the 49 companies that use either an appraiser's valuation or a director's valuation. As shown in this figure, the value of CAR increases around the release date of the statement of accounts for companies using an appraiser's valuation, and this increase continues for three days. For companies using a director's valuation, the CAR tends to decrease after the release date. Table 7 shows that there is a significant difference in the CAR between the appraiser's valuation and the director's valuation. The difference in the valuation methods can be assumed to be correlated with stock-price fluctuations. To elucidate the correlation quantitatively, a cross-sectional analysis was performed using Formula 3.
Table 8 displays the results obtained using the cross-sectional analysis. As shown in this table, the coefficients of investment property unrealized profit per share ([a.sub.2]) and dummy valuation method ([a.sub.4]) are always positive. Therefore, the share price increases as the unrealized profit of investment property increases, and this increase is statistically significant.
Regarding the valuation method, the share price increases when outside appraisers are used. Therefore, regarding the valuation of investment property, the results show that investors consider the identity of the valuer important.
This article has examined two hypotheses regarding appraisers' valuations in financial reporting of investment property value.
Hypothesis 1 suggested that directors of companies with investment properties with large unrealized profits tend to select an appraiser's valuation. As shown in Table 6, the directors of companies in the manufacturing industry in Japan tend to select appraisers' valuations when the unrealized profit of the investment property is large. This is because directors recognize the usefulness of unrealized profit information, and they are strongly motivated to transmit accurate asset value information to their investors. Therefore, Hypothesis 1 has been verified in the manufacturing industry. However, this tendency was not observed in the real estate industry. This is probably due to companies in this industry having a strong tendency to use a director's valuation. These Japanese companies differ greatly from property companies in the United Kingdom, which put a premium on an appraiser's valuation. Thus, whether the strong tendency to use a director's valuation is accepted by investors in the international economic community is a topic for the future by future research.
Hypothesis 2 suggested that investors recognize the usefulness of an appraiser's valuation. As shown in Figure 1, and Tables 7 and 8, investors recognized the usefulness of information on the difference between the appraiser's valuation and the director's valuation. Therefore, Hypothesis 2 has been verified.
Typical large companies in Japan often possess large numbers and various types of investment properties. Information asymmetry on investment properties is assumed to be greater in large companies than in medium and small companies. Therefore, directors of the companies and investors both value the accuracy and the reliability of appraisers' valuations performed by outside specialists.
In the International Financial Reporting Standards, investment properties are ranked as assets where the fair values are difficult to grasp. As such, an appraiser's valuation can play a role in Japan and follow the example of more than 90% of European companies that have adopted appraisers' valuations for the fair value of investment property. (28)
In this article, the role and the importance of appraisers' valuations have been clarified in investment property accounting. Appraisers' valuations can be expected to contribute to future investment property accounting. The results obtained in the present study support those of previous studies, which verified the usefulness of appraisers' valuations. Although the number of countries examined in the present study is limited, it makes an important contribution to the literature by identifying problems with information asymmetry in investment property and illustrating how these may be resolved by qualified professional appraisers. It is hoped that studies similar to the present one will be performed in other countries to further verify the usefulness of appraisers' valuations. The results obtained in such studies can be expected to further support the activities of appraisers in investment property fair value accounting. The accumulation of solid research studies on appraisers' valuations will raise the position of appraisers in the international economic community and contribute to the development of the real estate appraisal industry.
Internet resources suggested by the Y T. and Louise Lee Lum Library
Accounting Standards Board of Japan and Financial Accounting Standards Foundation
American Institute of Certified Public Accountants (AICPA)
--AICPA IFRS Resources
--Journal of Accountancy--IFRS Resources
Deloitte Global Services--Standards Resources
Ernst & Young--Applying IFRS to Real Estate: Fair Value Measurement
FASB Accounting Standards Codification (free registration required)
Financial Accounting Standards Board (FASB)
Financial Reporting Council (UR)
IFRS Foundation and International Accounting Standards Board (IASB)
International Valuation Standards Council
--Fair Value Measurement
by Takashi Yamamoto, PhD
(1.) In the United States, the Financial Accounting Standards Board (FASB) is the designated organization in the private sector for establishing standards of financial accounting that govern the financial reports by nongovernmental organizations. These standards are officially recognized by the Securities and Exchange Commission and the American Institute of Certified Public Accountants.
(2.) Japanese accounting standards define investment property as "not a property classified in an inventory but one that has been purchased with the intention of earning a return on the investment, either through rent, the future resale of the property or both"; this is similar to the definition of investment property in International Accounting Standard 40.
(3.) George A. Akerlof, "The Market for 'Lemons': Quality Uncertainly and the Market Mechanism," Quarterly Journal of Economics 84, no. 3 (August 1970): 488-500.
(4.) In Japan, an appraiser's valuation is generally performed by specialists who are recognized as appraisers by the government.
(5.) IFRS 13 (9).
(6.) The Statements of Standard Accounting Practice (SSAP) are issued by the UK Accounting Standards Board. SSAP 19 is available at https://frc.org.uk/Our-Work/Publications/ASB/SSAP-19-Accounting-for-investment-properties/SSAP-19-Accounting-for-investment-properties.aspx.
(7.) This is an accounting processing method based on the IAS 40.33-40.55 where the change in the fair value of an investment property in every quarter is reflected in a statement of profit and loss.
(8.) This is an accounting processing method based on the IAS 40.56 that does not greatly differ from conventional methods, although the fair value of an investment property is disclosed in notes to financial statements.
(9.) In the exposure draft, only the fair value model was included. However, because of dissent from Japan and other countries, the cost model was added. The full content of IAS 40 is available at http://ec.europa.eu/internal_market/accounting/docs/consolidated/ias40_en.pdf.
(10.) IVS Framework 40, in International Valuation Standards 2011 (London: International Valuation Standards Council, 2011), 23.
(11.) IVS Framework 30, Ibid., 20.
(12.) J. Richard Dietrich, Mary S. Harris, and Karl A. Muller III, "The Reliability of Investment Property Fair Value Estimates," Journal of Accounting and Economics 30, no. 2 (October 2000): 125-158.
(13.) Karl A. Muller III, and Edward J. Riedl, "External Monitoring of Property Appraisal Estimates and Information Asymmetry," Journal of Accounting Research 40, no. 3 (2002): 865-881.
(14.) Karl A. Muller III, Edward J. Riedl, and Thorsten Sellhorn, "Mandatory Fair Value Accounting and Information European Real Estate Industry Asymmetry: Evidence from the European Real Estate Industry," Management Science 57, no. 6 (2011): 1138-1153.
(15.) Philip Brown, H. Y. Izan, and Alfred L. Loh, "Fixed Asset Revaluations and Managerial Incentives," ABACUS 28, no. 1 (1992): 36-57.
(16.) Julie Cotter and Ian Zimmer, "Asset Revaluations and Assessment of Borrowing Capacity," ABACUS 31, no. 2 (1995): 136-151.
(17.) Julie Cotter and Scott Richardson, "Reliability of Asset Revaluations: The Impact of Appraiser Independence," Review of Accounting Studies 7, no.4 (2002): 435-457.
(18.) Takashi Yamamoto, "Asset Impairment Accounting and Appraisers: Evidence from Japan," The Appraisal Journal 76, no. 2 (Spring 2008): 179-188.
(19.) In this article, unrealized profit means the difference between the fair value of investment property and its acquisition cost when the former is larger than the latter.
(20.) The Accounting Standards Board of Japan (ASBJ) approved Statement 20 in 2008, and the standard applies to fiscal years ending on or after March 31, 2010, although companies may have adopted it earlier; see https://www.asb.or.jp/asb/asb_e/technical_topics_reports/fudosan-kaiji/fudosan-kaiji_as.pdf.
(21.) A logit model is a stochastic alignment model comprising a combination of variables x (r pieces) as Z = [[beta].sub.0] + [[beta].sub.1][x.sub.1] + [[beta].sub.2][x.sub.2] + ... + [[beta].sub.1][x.sub.r]. The stochastic alignment model does not guarantee that the presumed probability is 0 or 1. To store this presumed probability between 0 and 1, logit conversion is carried out, and the above-mentioned alignment combination is presented as follows: p(x) = exp(z)/(1+exp(z)) = 1/(1+exp(-z)). When this is transformed, it appears as log p(x)/(1-p(x)) = [[beta].sub.0] + [[beta].sub.1][x.sub.1] + [[beta].sub.2][x.sub.2] + ... + [[beta].sub.r][x.sub.r]. Thereby, P can be presumed.
(22.) The companies used outside appraisers in fiscal year 2009, and methods of decision making are considered to be closely related to the data as of March 31, 2009.
(23.) This may be because Japan's Financial Services Agency instructed the banks to strictly value collateralized real estate by adopting the capitalization method.
(24.) This may be because foreign investors not properly understand Japan's real estate valuation systems (such as information systems for public land appraisals, property tax assessment systems, and appraisal systems) and because there is insufficient basic information for decision making.
(25.) The top three property companies with large investment property used the director's valuation.
(26.) The statement of accounts is a document in which financial statements are summarized. As the statement of accounts is published prior to the disclosure of financial statements, investors attach importance to it.
(27.) The values of [[alpha].sub.i] and [[beta].sub.j] were estimated based on stock price data between days -100 and -11.
(28.) According to a survey conducted by Ernst & Young in 2010, of thirty European property companies, only two-companies adopted the director's valuation.
Takashi Yamamoto, PhD, is an associate professor with the Department of Real Estate Sciences at Meikai University in Japan. He has more than 25 years of appraisal experience. He is interested in real estate accounting and has written many articles in accounting and real estate journals. He holds a PhD in economics from Saitama University.
Table 1 Investment Property Accounting in General Business Companies in the United Kingdom Table la General Business Companies in FTSE 350 Adopting IAS 40 Number of Total Sample to Adopt Type of Industry Samples the IAS 40 Resources 44 1 (2.27%) Construction 12 1 (8.33%) Manufacturing 54 1 (1.85%) Commerce 29 7 (24.14%) Real estate 4 3 (75.00%) Transportation 3 1 (33.33%) Energy 1 0 (0.00%) Service 71 3 (4.23%) Communication 20 1 (5.00%) Military 8 2 (25.00%) Total 246 20 (8.13%) Investment Property/Total Assets Standard Type of Industry Average Median Maximum Minimum Deviation Resources 0.000 0.000 0.000 0.000 -- Construction 0.006 0.006 0.006 0.006 -- Manufacturing 0.003 0.003 0.003 0.003 -- Commerce 0.023 0.013 0.078 0.002 0.028 Real estate 0.722 0.823 0.904 0.438 0.249 Transportation 0.004 0.004 0.004 0.004 -- Energy -- -- -- -- -- Service 0.011 0.003 0.030 0.001 0.017 Communication 0.005 0.005 0.005 0.005 -- Military 0.005 0.005 0.005 0.004 0.000 Total 0.119 0.005 0.904 0.000 0.273 Note: This table was created based on the accounting figures in the latest annual reports as of February 1, 2011. Table 1b Valuation Models, General Business Companies in FTSE 350 Adopting IAS 40 Valuation Models Number of Sample to Adopt Type of Industry the IAS 40 Fair Value Cost Resources 1 1 Construction 1 1 Manufacturing 1 1 Commerce 7 3 4 Real estate 3 3 Transportation 1 1 Energy 0 Service 3 2 1 Communication 1 1 Military 2 2 Total 20 12 8 Table 1c Valuation Methods of Fair Value Model, General Business Companies in FTSE 350 Adopting IAS 40 Valuation Methods of the Fair Value Model Type of Industry Appraiser's Valuation Director's Valuation Resources 1 Commerce 1 2 Real estate 3 Service 1 1 Communication 1 Military 1 1 Total 7 5 Table 2 Investment Property Accounting in Financial Institutions in the United Kingdom Table 2a Financial Institutions in FTSE 350 Adopting IAS 40 Number of Total Sample to Adopt Type of Industry Samples the IAS 40 REIT 15 15 (100.00%) Life insurance 8 8 (100.00%) Nonlife insurance 8 1 (12.50%) Others 79 5 (6.33%) Total 110 29 (26.36%) Investment Property/Total Assets Standard Type of Industry Average Median Maximum Minimum Deviation REIT 0.756 0.874 0.986 0.312 0.211 Life insurance 0.028 0.025 0.049 0.011 0.015 Nonlife insurance 0.018 0.018 0.018 0.018 -- Others 0.011 0.009 0.018 0.005 0.006 Total 0.401 0.312 0.986 0.005 0.403 Table 2b Valuation Models, Financial Institutions in FTSE 350 Adopting IAS 40 Valuation Models Number of Sample to Adopt Type of Industry the IAS 40 Fair Value Cost REIT 15 14 1 Life insurance 8 8 Nonlife insurance 1 1 Others 5 5 Total 29 28 1 Table 2c Valuation Methods of Fair Value Model, Financial Institutions in FTSE 350 Adopting IAS 40 Valuation Methods of the Fair Value Model Type of industry Appraiser's Valuation Director's Valuation REIT 14 Life insurance 4 4 Non life insurance 1 Others 4 1 Total 22 6 Table 3 Profile of TSE Companies Adopting Disclosure of Fair Value, Fiscal Years 2010 and 2011 Fiscal Year 2010 Samples with Total Investment Type of Industry Samples Property Agriculture, 4 2 (50.0%) forestry, fishery, and mining Construction 36 23 (63.8%) Manufacturing 465 129 (27.7%) Commerce 43 18 (41.9%) Real estate 7 6 (85.7%) Transportation and 38 27 (71.1%) warehousing Energy 12 4 (33.3%) Service 8 7 (87.5%) Total 613 216 (35.2%) Fiscal Year 2011 Agriculture, 4 2 (50.0%) forestry, fishery, and mining Construction 36 21 (58.3%) Manufacturing 465 128 (27.5%) Commerce 43 19 (44.2%) Real estate 7 6 (85.7%) Transportation and 38 27 (71.1%) warehousing Energy 12 3 (25.0%) Service 8 7 (87.5%) Total 613 213 (34.7%) Fiscal Year 2010 Investment Property (Cost)/Total Assets Standard Type of Industry Average Median Maximum Minimum Deviation Agriculture, 0.181 0.181 0.318 0.044 0.194 forestry, fishery, and mining Construction 0.078 0.065 0.184 0.018 0.045 Manufacturing 0.076 0.043 0.702 0.000 0.098 Commerce 0.088 0.068 0.248 0.009 0.065 Real estate 0.575 0.638 0.849 0.181 0.224 Transportation and 0.161 0.097 0.531 0.021 0.131 warehousing Energy 0.058 0.061 0.093 0.017 0.032 Service 0.170 0.174 0.236 0.084 0.056 Total 0.106 0.063 0.849 0.000 0.131 Fiscal Year 2011 Agriculture, 0.165 0.165 0.285 0.045 0.170 forestry, fishery, and mining Construction 0.097 0.079 0.213 0.024 0.055 Manufacturing 0.077 0.044 0.793 0.000 0.104 Commerce 0.080 0.058 0.258 0.009 0.067 Real estate 0.594 0.623 0.797 0.297 0.171 Transportation and 0.162 0.126 0.558 0.021 0.131 warehousing Energy 0.046 0.047 0.073 0.018 0.028 Service 0.168 0.159 0.268 0.082 0.063 Total 0.108 0.066 0.797 0.000 0.135 Investment Property Fiscal Year 2010 Unrealized Profit and Loss/Total Assets Standard Type of Industry Average Median Maximum Minimum Deviation Agriculture, 0.078 0.078 0.143 0.013 0.092 forestry, fishery, and mining Construction 0.018 0.006 0.088 -0.019 0.027 Manufacturing 0.057 0.027 0.602 -0.077 0.093 Commerce 0.029 0.011 0.171 -0.023 0.046 Real estate 0.267 0.193 0.585 0.050 0.210 Transportation and 0.142 0.062 0.692 -0.000 0.186 warehousing Energy 0.068 0.042 0.161 0.026 0.063 Service 0.116 0.084 0.284 -0.028 0.122 Total 0.069 0.030 0.692 -0.077 0.116 Fiscal Year 2011 Agriculture, 0.073 0.073 0.134 0.012 0.086 forestry, fishery, and mining Construction 0.016 0.005 0.111 -0.024 0.030 Manufacturing 0.055 0.029 0.602 -0.074 0.093 Commerce 0.025 0.005 0.187 -0.025 0.048 Real estate 0.245 0.196 0.466 0.041 0.178 Transportation and 0.129 0.061 0.615 0.001 0.167 warehousing Energy 0.070 0.042 0.132 0.038 0.053 Service 0.107 0.081 0.260 -0.038 0.118 Total 0.066 0.030 0.615 -0.074 0.110 Note: The investment property (cost)/total assets and the investment property unrealized profit and loss/total assets were obtained from companies that have disclosed information of the market value of investment property in notes to financial statements. Table 4 Rental Profit and Loss/Investment Property (Cost) of TSE Companies Adopting Disclosure of Fair Value, Fiscal Years 2010 and 2011 Fiscal Year 2010 Type of Standard Industry Average Median Maximum Minimum Deviation Agriculture, 0.032 0.032 0.047 0.018 0.020 forestry, fishery, and mining Construction 0.032 0.033 0.064 -0.010 0.015 Manufacturing 0.040 0.042 0.132 -0.029 0.024 Commerce 0.030 0.040 0.082 -0.104 0.038 Real estate 0.033 0.032 0.040 0.026 0.005 Transportation 0.046 0.043 0.107 0.004 0.021 and warehousing Energy 0.024 0.024 0.040 0.006 0.014 Service 0.031 0.042 0.050 0.001 0.020 Total 0.038 0.039 0.132 -0.104 0.024 Fiscal Year 2011 Type of Standard Industry Average Median Maximum Minimum Deviation Agriculture, 0.038 0.038 0.054 0.021 0.023 forestry, fishery, and mining Construction 0.035 0.030 0.097 0.003 0.019 Manufacturing 0.042 0.042 0.110 -0.007 0.025 Commerce 0.032 0.041 0.085 -0.095 0.037 Real estate 0.030 0.030 0.036 0.025 0.004 Transportation 0.045 0.040 0.094 0.005 0.017 and warehousing Energy 0.026 0.028 0.039 0.007 0.013 Service 0.034 0.046 0.053 0.004 0.020 Total 0.039 0.038 0.110 -0.095 0.025 Note: In fiscal years 2010 and 2011, 216 and 213 companies were analyzed, respectively. The rental profit and loss were obtained by deducting the rental cost from the rental profit and did not include the profit and loss on the disposition of fixed assets and the impairment loss. Table 5 Description of Explanatory Variables Variable Basic Approach ROA Companies with high profitability are considered able to bear the high costs of using outside appraisers. Tobin's q This value is obtained by adding the book value of the debt to the market capitalization and dividing the obtained value by the total book value of the assets. Companies with strong business performances can afford to bear high costs. Sales volume percent change The sales volume percent change in the past four years is used. Companies with high growth rates can afford to bear high costs. Interest-bearing debt ratio This ratio focuses on interest payments. The relationship with banks is stronger as this ratio increases. Ln total assets The natural logarithm transformation of the total assets is used. As the total assets of a company increase, the social visibility and the accountability of the company increase. Foreign stock ownership ratio Companies with a high foreign stock ownership ratio are strictly observed and regulated by outsiders. Therefore, these companies must shoulder a heavy burden of accountability to outsiders. Shareholding ratio of financial Companies with a high institutions shareholding ratio of financial institutions are strictly observed and regulated by financial institutions. Therefore., these companies must shoulder a heavy burden of accountability to financial institutions. Shareholding ratio of general Regarding companies with a high business companies shareholding ratio of general business companies, external accountability decreases as cross-shareholdings increase. Land asset percentage change This variable indicates the changes in the land assets of a company in the period between fiscal years 1984 and 2003. As this value increases, the company invests more heavily in real estate, and the number of people engaged in the investment increases. Investment property/total assets This variable indicates the degree of dependence of the total assets on the investment property (cost). The number of people engaged in investment property increases as this value increases. Investment property unrealized This variable indicates the profit/total assets degree of dependence of the total assets on the unrealized profit of the investment property. The unrealized profit and loss was obtained based on information disclosed in notes to financial statements. The unrealized profit is used more effectively as this value increases. Therefore, this variable has an important meaning in corporate management. A company with a large value of this variable must shoulder a heavy burden of accountability to stakeholders in the company. Audit corporation dummy This is a dummy variable related to the scale of an audit of the company. In Formula 1, 1 is assigned to three major audit corporations, Ernst & Young ShinNihon LLC, Deloitte Touche Tohmatsu LLC, and KPMG AZSA LLC, and 0 is assigned to other audit corporations. As major audit corporations perform strict audits, the use of real estate appraisers is facilitated. Table 6 Formula 1 Analytical Results, Use of Appraisers' and Directors' Valuations, TSE Companies Adopting Disclosure of Fair Value Total Variable Coefficient f-value Constant -9.723 -2.163 ** ROA -3.945 -1.071 Tobin's q 0.977 0.891 Sales volume 0.102 0.230 percent change Interest--bearing -3.108 -2.686 *** debt ratio Ln total assets 0.373 2.029 ** Foreign stock -0.063 -2.706 *** ownership ratio Shareholding 0.006 0.289 ratio of financial institutions Shareholding ratio -0.007 -0.519 of general business companies Land asset 0.029 1.588 percentage change Investment 0.428 0.246 property/total assets Investment 4.304 2.097 ** property unrealized profit/total assets Audit corporation 0.257 0.702 dummy Log likelihood -129.635 [x.sup.2] 22.827 N 204 participation: 108, nonparticipation: 96 Manufacturing Variable Coefficient f-value Constant -19.572 -2.620 *** ROA -8.598 -1.801 * Tobin's q 0.620 0.518 Sales volume 1.077 1.470 percent change Interest--bearing -4.824 -2.801 *** debt ratio Ln total assets 0.711 2.292 ** Foreign stock -0.072 -2.239 ** ownership ratio Shareholding 0.019 0.614 ratio of financial institutions Shareholding ratio -0.013 -0.643 of general business companies Land asset 0.020 1.134 percentage change Investment 8.164 2.074 ** property/total assets Investment 12.897 3.026 *** property unrealized profit/total assets Audit corporation 0.274 0.518 dummy Log likelihood -65.214 [x.sup.2] 37.878 N 122 participation: 66, nonparticipation: 56 Construction, Transportation, and Warehousing, and Real Estate Variable Coefficient f-value Constant -15.266 -1.333 ROA 51.249 1.634 Tobin's q 0.632 0.194 Sales volume 0.901 0.327 percent change Interest--bearing -1.711 -0.544 debt ratio Ln total assets 0.605 1.250 Foreign stock -0.125 -1.833 * ownership ratio Shareholding -0.038 -0.771 ratio of financial institutions Shareholding ratio -0.001 -0.017 of general business companies Land asset 0.014 0.399 percentage change Investment 0.616 0.169 property/total assets Investment 1.332 0.410 property unrealized profit/total assets Audit corporation 0.178 0.166 dummy Log likelihood -28.874 [x.sup.2] 15.706 N 53 participation: 27, nonparticipation: 26 Note: * 10% significance, ** 5% significance, *** 1% significance. In this table, 1 was assigned to samples when outside appraisers were used and 0 was assigned to samples when director's valuation was adopted. Table 7 Difference in Cumulative Abnormal Return (CAR) between Appraisers' and Directors' Valuation Appraiser's Valuation Director's Valuation CAR(-2,2) 0.018 -0.018 CAR(-2,5) 0.008 -0.034 CAR(-2,10) -0.001 -0.039 Difference of Means Mann-Whitney Test Test (p-value) (p-value) CAR(-2,2) 0.023 0.037 CAR(-2,5) 0.033 0.029 CAR(-2,10) 0.086 0.104 Table 8 Results, Regression Analysis Cumulative Abnormal Return (CAR) Variable Analytical model: CAR = [a.sub.1] + [a.sub.2] investment property unrealized profit per share + [a.sub.3] earnings forecast dispersion per share + [a.sub.4] dummy valuation method Explained variables [a.sub.1] f-value [a.sub.2] f-value [a.sub.3] CAR(-1,0) -0.012 -1.560 0.000 2.385 ** 0.000 CAR(-1,1) -0.030 -2.449 ** 0.000 2.254 ** 0.000 CAR(0,1) -0.025 -2.137 ** 0.000 1.841 * 0.000 CAR(-2,0) -0.011 -1.227 0.000 2.202 ** 0.001 CAR(-2,1) -0.029 -2.364 ** 0.000 2.357 ** 0.000 CAR(-2,2) -0.036 -2.862 *** 0.000 2.801 *** 0.000 CAR(-5,5) -0.050 -3.251 *** 0.000 3.451 *** -0.000 Explained variables f-value [a.sub.4] f-value adj. [R.sup.2] CAR(-1,0) 1.612 0.023 2.525 ** 0.195 CAR(-1,1) 0.736 0.040 2.758 *** 0.192 CAR(0,1) 0.293 0.036 2.537 ** 0.159 CAR(-2,0) 2.202 ** 0.028 2.730 *** 0.217 CAR(-2,1) 1.317 0.045 3.154 *** 0.228 CAR(-2,2) 0.564 0.045 2.984 *** 0.239 CAR(-5,5) -0.223 0.042 2.319 ** 0.261 Note: * 10% significance, ** 5% significance, *** 1% significance. The numbers in the parentheses accompanying the CAR indicate the period of the cumulative AR when the release date of the statement of accounts is expressed as "0." For example, CAR (-2, 2) indicates that the AR in the period two days before and after the release date has been cumulated.
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|Date:||Mar 22, 2014|
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