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IVSC exposes proposed guidance on valuation uncertainty, forest valuation

  • IVSC (International Valuation Standards Council) (lt green) Image

Nov 19, 2012

The International Valuation Standards Council (IVSC) has released two exposure drafts (EDs) of proposed "Technical Information Papers" on valuation uncertainty and the valuation of forests.

The IVSC's International Valuation Standards (IVS), which were last comprehensively updated in July 2011, contain the principles of valuation rather than prescriptive requirements.

The IVSC Technical Information Papers (TIPs) are designed to provide technical guidance for valuation professionals on generally accepted best practice, but do not provide valuation training or instruction or direct to a particular approach or method that should or should not be used in any specific situation.

Valuation uncertainty

The exposure draft on valuation uncertainty looks at how valuation uncertainty can be identified, explained and disclosed in a way that is informative to those relying on valuations, and responds to calls from the G20 and financial regulators around the world for improved standards of transparency and disclosure of valuation uncertainty factors.

The ED proposes to define "valuation uncertainty" as follows:

The possibility that the estimated value may differ from the price that could be obtained in a transfer of the same asset or liability taking place at the same time under the same terms and within the same market environment.

The ED also notes that material uncertainty can be caused by various factors, including:

  • Market uncertainty — Arises when a market is disrupted at the valuation date by current or very recent events such as sudden economic or political crises.
  • Model uncertainty — Arises from characteristics of either the valuation model, or method, used.
  • Input uncertainty — Arises when there are a number of equally reasonable or feasible inputs or assumptions that can be used from the degree of veracity that can be attached to the data inputs used in the valuation and their impact on the outcome.

The ED makes a clear distinction between market risk, which is both generally understood and acknowledged by investors and reflected in the pricing, and the uncertainty caused by disruption or dislocation in the market place.

The ED also discusses many IFRS concepts and their interaction with IVS, including the Level 1/2/3 hierarchy in IFRS 13, Fair Value Measurement.

The ED notes a simplistic expression of valuation uncertainty might be to provide a range within which the value is considered to fall, but concludes this "is not recommended" for various reasons, including the use of amounts usually requires a single valuation figure, the possibility of unrealistic extremes of a range, and the possibility that users may assume all outcomes within the range are equally likely of occurring, or assume there is no possibility of a valuation falling outside a range.

Valuation of forests

The second ED addresses the way in which valuations of forestry assets are prepared and presented, particularly in light of IAS 41, Agriculture, which requires the fair value of the biological asset (tree crop) to be estimated.

The ED:

  • Proposes that all three approaches described in the IVS Framework (market approach, income approach, and cost approach) are applicable to the valuation of forests and includes some of the strengths and weaknesses of methods under each approach in the context of valuing forestry interests.
  • Points out significant diversity in the length of the explicit forecast period that is used when using a discounted cash flow model to value a forestry interest and seeks constituent feedback on this issue.
  • Discusses the discount rate used in a discounted cash flow model noting "evidence that in some parts of the world inappropriate reliance is being based on models such as the Capital Asset Pricing Model or the Weighted Average Cost of Capital."
  • Notes the use of the cost approach is mostly applicable to recently planted forests because the physical and possible economic changes that occur as a forest matures mean that other methods become more reliable.
  • Explores difficulties with one suggested valuation approach in IAS 41 that the value of the “raw land” be deducted from the value of the combined asset, with the residual representing the value of the biological asset, and discusses the specific question of how to measure a biological asset when the "highest and best use" of the land is not forestry (this issue was also recently considered by the IFRS Interpretations Committee).

Comment period

Both EDs are open for comment until February 15, 2013. Click for (links to the IVSC's Web site):

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