Property at valuation, policy for surpluses and deficits, level 3 hierarchy disclosures for unobservable inputs

Ei Group plc – Annual report 30 September 2017

Industry: leisure

  1. Accounting policies (extract)

Property, plant and equipment

Licensed land and buildings are held at their fair value, and landlord’s fixtures and fittings and other assets are held at cost.

The Group’s licensed land and buildings recognised in property, plant and equipment, are revalued each year by external valuers or employees who are professionally qualified to carry out such valuations.

Surpluses arising from the revaluation exercise are taken through other comprehensive income to the revaluation reserve except where they reverse a revaluation decrease relating to the same asset previously recognised as an expense in the income statement. Any deficit arising from the revaluation exercise is taken through other comprehensive income to the revaluation reserve to the extent that there is a surplus in place relating to the same asset. Any further decrease in value is recognised in the income statement as an expense.

Freehold land is not depreciated. Freehold buildings are depreciated so as to write off the difference between their carrying value and residual value over their useful economic life of 50 years. Residual value is reviewed at least at each financial year end and there is no depreciable amount if residual value is the same as, or exceeds, book value.

Landlord’s fixtures and fittings are split into two categories, long-life landlord’s fixtures and fittings and short-life landlord’s fixtures and fittings. Both are held at cost less accumulated depreciation. The useful economic life of additions in the form of long-life landlord’s fixtures and fittings has been calculated at 30 years and additions to short-life landlord’s fixtures and fittings has been calculated at five years. Depreciation is charged on a straight line basis to write off the total cost less residual value over the useful economic life.

Properties held under finance leases are depreciated on a straight line basis over the shorter of the remaining lease term and their useful economic life of 50 years.

Depreciation is provided on other categories of property, plant and equipment over three to 50 years on a straight line basis to residual value.

Property, plant and equipment is reviewed annually for indicators of impairment. Where any indicators are identified, assets are assessed fully for impairment. Impairment occurs where the recoverable amount of the asset is less than its carrying amount. Recoverable amount is the higher of an asset’s fair value less costs to dispose and value in use. Any impairment loss is treated as a revaluation decrease to the extent that a surplus exists for the same asset, and thereafter as an expense in the income statement.

Use of accounting estimates and judgements (extract)

  1. a) Property, plant and equipment and investment property

Property assets are revalued annually to fair value in accordance with the Appraisal and Valuation Manual published by the Royal Institute of Chartered Surveyors (RICS) and IFRS 13. The valuation is based on an assessment of the income generating potential of the properties, and applying an appropriate multiple. The highest and best use for the property assets is assumed to be their current use by the Group, principally due to the legal restrictions imposed by the agreement with the publican, planning regulations and the financial implications of a change of use given those restrictions and the Group’s business model. However, consideration is given to an alternative highest and best use if there are factors that indicate that such an alternative use exists which is physically possible, legally permissible and financially feasible to access.

Further information about the valuation of the estate is provided in note 18 of these financial statements.

The Group estimates the useful economic life and residual value of property, plant and equipment and these estimates influence the depreciation charged each year. For details of these estimates, see the detailed accounting policy for property, plant and equipment.

  1. Property, plant and equipment

The following note has been restated to show the reclassification of those properties leased on commercial terms and included in the Commercial Property segment from property, plant and equipment to investment property.

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If licensed land and buildings had been measured using the cost model, the carrying amounts would be as follows:

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Within the Group the carrying value of property held under finance leases at 30 September 2017 was £100 million (2016: £106 million). Additions during the year include £3 million to property held under finance leases (2016: £3 million). Within the Parent Company the carrying value of property held under finance leases at 30 September 2017 was £30 million (2016: £39 million). Additions during the year include £1 million to property held under finance leases (2016: £1 million).

At 30 September 2017, the Group had entered into contractual commitments to purchase £6 million (2016: £5 million) of property, plant and equipment. At 30 September 2017, the Parent Company had entered into contractual commitments to purchase £3 million (2016: £2 million) of property, plant and equipment.

  1. Investment property

The Group leases some properties on commercial leases within the Commercial Properties segment, the commercial terms of these leases result in the assets meeting the criteria of investment property. As this segment expands the Group recognises that the value attributed to these assets is now a material balance and has consequently reclassified this balance from property, plant and equipment to investment property in the balance sheet.

Although the balance sheet amounts have been reclassified for the comparative period, the impact on the income statement was not assessed as material and it has therefore not been restated.

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Within the Group the carrying value of property held under finance leases at 30 September 2017 was £14 million (2016: £12 million). Additions during the year include £nil to property held under finance leases (2016: £nil). Within the Parent Company the carrying value of property held under finance leases at 30 September 2017 was £9 million (2016: £7 million). Additions during the year include £nil to property held under finance leases (2016: £nil).

  1. Property fair value measurements

In determining the appropriate classes of asset to present for fair value purposes, the Group has considered the nature, characteristics and risks of the assets. This has resulted in determining two separate classes of assets being property assets held in property, plant and equipment and property assets held in investment property.

Revaluation of property, plant and equipment

Valuations are carried out on an annual basis at each year end date. With the exception of properties identified for disposal and transferred to non-current assets held for sale, the Group’s properties were revalued as at 30 September 2017 by GVA Grimley Limited or Colliers International Property Advisers UK LLP, independent Chartered Surveyors, or by the internal Asset and Valuation Director, Simon Millar MRICS, Chartered Surveyor. For further analysis of the pubs valued by valuer see table on page 104.

All valuations of assets have been assessed as being level 3 valuations, as there are no directly comparable market observable inputs.

Property assets held in property, plant and equipment were valued using fair maintainable trade income (FMT) capitalised at an appropriate rate of return (as defined within RICS Valuation – Global Standards 2017) or an equivalent multiple. This method of valuation involves making an assessment of the fair maintainable rent, wholesale and machine income that can be generated from the property assuming they are run by a reasonably efficient operator, taking into account future trading potential. This assessment of profit is then capitalised at an appropriate multiple to reflect the risks and rewards of the property. In determining the multiple to use, the valuers consider evidence of comparable market transactions. The resulting fair value of the pub represents the land and buildings and any fixed landlords’ fixtures and fittings. The valuation of the managed pub assets is prepared using a consistent approach that effectively capitalises the net income attributable to the Group from operating the pub at an appropriate multiple.

Property assets held in investment property include free-of-tie pubs let to tenants at open market rents and non-pub assets, which are predominantly blue-chip let convenience stores. These assets have been valued adopting the investment method of valuation. By reference to the rents, fixed lease terms and market conditions, an appropriate multiple based on comparable market transactions is applied, discounting future rental receipts back to present value.

All classes of asset are, under IFRS 13, required to be valued at highest and best use. IFRS 13 prescribes that the Group’s current use is presumed to be its highest and best value, unless market or other factors suggest that a different use by market participants would maximise the value of the asset. In doing their valuations, the valuers consider whether the asset may have a higher or better feasible use which would be reflected in the fair value where applicable. This is on an asset by asset basis if there are circumstances to indicate that there may be a higher and better use. In the current year the highest and best use of all the property assets in property, plant and equipment and investment property has been assessed as their existing use.

The impact of the Group revaluation is as follows:

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The table below presents, by class of property, the income and multiple bandings within which the properties have been valued, and the number of properties that have been valued in each of the bandings. In determining the bandings to use, the Group has considered a variety of options including size and location of property, but has concluded that the value of the property is principally driven by FMT and multiple, so this forms the most appropriate disclosure.

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Sensitivity analysis table

The significant unobservable inputs used in the fair value measurement categorised within level 3 of the fair value hierarchy of the Group’s estate are FMT and a multiple. There is a limited amount of interrelation between the variation in these inputs.

A change in either of these assumptions could have a significant effect on the overall valuation of the estate. Sensitivities around these assumptions that are deemed to be reasonably likely based on the experience of the valuers are illustrated below:

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The properties used as security for the corporate bonds in Ei Group plc have been valued by GVA Grimley Limited (1,984 properties) and all properties held by Unique Pub Properties Limited (Unique) have been valued by Colliers International Property Advisers UK LLP (2,140 properties). Colliers International Property Advisers UK LLP valued a further sample of properties held in the Parent Company (5 properties). The balance of the estate held in Ei Group plc (245 properties) have been valued by the internal Asset and Valuation Director using RICS valuation guidelines. The results of this internal valuation have been compared to that of the external valuers, to ensure that the results are consistent.

The following table provides a reconciliation of property numbers:

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