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CIPFA’s Construction and Property Advisor, Chris Brain, considers why indexation of valuations seems to be the issue of the moment among auditors, and why asset valuers should approach it with tremendous care.
During recent conversations with local government finance and property practitioners, CIPFA has noticed that the indexation of valuations has started to be raised as an issue on a frequent basis, most often by auditors.
There are a number of reasons for this, however perhaps the most likely are the continuing ripples of economic downturn and its impact upon the property market. Generally, the one thing that auditors do not like to see is fluctuations in value, and some auditors are promoting indexation as a means of smoothing out changes in carrying amounts in the balance sheet. This is often seen by auditors as a means of ensuring that carrying amounts keep pace with market movement.
But does indexation assist in keeping carrying amounts in line with changes in the market, or does it actually result in equally material misstatements in value of property assets?
Indexation of property asset valuations can be a risky course, fraught with many hurdles. In CIPFA's view it would be best to avoid indexation altogether, but if indexation is to be used, it should be approached with tremendous care. It should only be done where there is sufficient certainty that the transactions comprising any index are comparable to the asset valuation being adjusted, and where there are not contra-movements in other aspects of the valuation.
Indexation, if applied without care, could result in apparent ‘movement’ in value having to be reversed out of the balance sheet at the next formal valuation, particularly following several applications of an index. As such, indexation could introduce less accuracy, not more.
Complying with professional standards, like the Red Book published by the Royal Institution of Chartered Surveyors, can help to ensure better indexation. But CIPFA believe that, even armed with standards, valuers should approach the idea of indexation with extreme caution.