Resource Consents Do they have an Impact on Fair Value?

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1 Resource Consents Do they have an Impact on Fair Value? Lindsay Hawkes & Lin Tozer* Lecturers School of Accountancy Massey University Palmerston North New Zealand Phone X2199 Fax L.C.Hawkes@massey.ac.nz or L.Tozer@massey.ac.nz ABSTRACT The move to International Financial Reporting Standards has included significant developments in financial reporting which have resulted in an increased use of fair values when recording assets and liabilities within the financial statements of organisations. We believe that resource consents can have a significant impact on the measurement of fair value of assets and as such there needs to be a reconsideration of the level of disclosure made about resource consents held by organisations and the conditions these consents impose. Resource consents do not lend themselves to valuation or measurement under the historical cost model of valuation as they do not usually have a cost attached to them other than an application fee (Hawkes and Tozer, 2001). However due to their nature (as a right to act) they do have value to the entity and as such that value should be measured and recorded in the financial statements of the entity. Fair value accounting makes it possible to do this. The recorded value of assets must be considered on an annual basis to identify if any impairment to the carrying value has occurred. Changes in resource consent conditions fall within the range of factors that can cause the impairment of assets as they have the potential to change the use of an asset significantly in many cases. This means that resource consents held would need to be reviewed to identify any potential change that affects the value of an asset affected by the resource consents held. Resource consents in many cases provide the right to operate assets or a group of assets in a particular location. The lost or expiry without renewal of a resource consent could have a considerable impact on the value of asset or group of assets as the current use will change, and if unable to operate predicted future cash flows are unlikely to remain unchanged. The need to renew resource consents can also result in significant changes in the conditions under which an asset can be operated and the expenses faced when operating the asset, which could have significant impacts on the fair value of the asset. This potential impact on the recorded value of assets means that disclosure about the terms and conditions of resource consents is significant as it could impart valuable information to readers of the financial statements. Historically the level of disclosure about resource consents has been very low which combined with the potential for resource consents to have a significant impact on the fair value of assets and the assessment of any impairment of them leads us to the conclusion that the disclosure and reporting of information on resource consents needs to be reviewed. In this paper we consider the impact of changes in reporting standards on the desirability to disclose details of resource consents and how resource consents can be valued. Keywords: * Presenting author Environmental disclosures, Intangible assets

2 Resource Consents Do they have an Impact on Fair Value? Introduction The decision to adopt International Financial Reporting Standards (IFRS) in New Zealand has meant accounting professionals, both practitioners and academics, have again been faced with an enormous interpretation task. The move from New Zealand Financial Reporting Standards (FRS) to IFRS has meant in some cases a less than dramatic change in terminology. Other aspects of accounting practice have changed significantly, for example the valuation of assets and the treatment of the changes in the value of tangible assets. This has lead to an increased focus on the recording and treatment of tangible assets but the changes also have significant impacts on the recording of intangible assets. Resource Consents are one intangible asset that we believe should receive more attention as a result of the current changes in financial reporting. Tozer and Hawkes (2001) explained the nature of resource consents, they stated that consents include land use consents; sub division consents; coastal, water and discharge permits (p.160). They also provided examples including the right to operate a dairy processing plant, extract gravel from a waterway, or the right to discharge particles into the atmosphere (Tozer and Hawkes, 2001, p. 160). As such they are a right to perform an otherwise forbidden act which will have an impact upon the physical environment. Resource consents have finite lives in that they have defined expiry dates. It is this right that constitutes the asset in the case of consents an intangible asset by definition, which cannot be recognised in the financial statements due to difficulties associated with the measurement of the asset 1. This position has not changed with the introduction of IFRS in New Zealand. The adoption of the new financial reporting framework has also had a significant impact on accounting for intangible assets. Not only has NZ IAS 38 significantly tightened the recognition criteria and basis of measurement for intangible assets, it has also banned the recognition of internally generated intangible assets such as brands. Another significant change is that intangibles are to be subjected to an annual impairment review (NZ IAS 38, para 111) in the same manner as for plant and equipment under NZ IAS 36 Impairment of Assets. What has changed, it may be argued, is the impact of Resource Consents on the other underlying tangible assets of an entity, in particular with the 1 For a full discussion see Tozer, L. & Hawkes, L. (2001). Resource Consents Intangible Fixed Assets? Accounting Forum, 25(2), pp

3 introduction of NZ IAS 36 Impairment of Assets which requires the annual assessment of the potential for an asset to be impaired. This has created several ways in which resource consents can be viewed when considering external reporting for organisations. Resource Consents as Intangible Assets According to NZ IAS 38 Intangible Assets (NZICA, 2004) an intangible asset is an identifiable non monetary asset without physical substance (p.6) which will in all probability generate future economic benefits for the entity and can be reliably measured (p.6). Initial valuation of an intangible asset is to be at historical cost (p.6), with subsequent optional adoption of a cost or valuation model as a matter of accounting policy (p.6). Particular discussion of fair value is found in paragraph 75 which stipulates that fair value is related to the existence of an active market for the asset. Therefore, as no active market for resource consents exists, they cannot be reliably measured other than by the costs incurred in gaining them. The cost of gaining a resource consent is often not related to the significance of the consent to the holder of the resource consent as the cost is usually the application fee plus any direct cost of advertising the resource consent application and the submission process costs (Tozer & Hawkes, 2001). This also means any historical cost is not a reliable measure of the value of a resource consent so is not an acceptable basis for justifying the recognition of a resource consent in the financial statements of its holder. Therefore the move to NZ IFRS continues to preclude recording resource consents as separate intangible assets in the financial statements of the holder of the consent. Resource consents as part of a package asset Where an intangible asset is purchased, in an arms length transaction, its valuation is not problematic as a cost is established in the conduct of the transaction. Resource consents are not tradable in the ordinary course of business; however they may be traded as part of a land package. So does this mean they can be separately valued as a result? For example, where a resource consent is purchased with a land asset, such as a sub division consent being acquired along with the purchase of a 20 acre block of land, it is theoretically possible to value the Resource Consent separately from the land i.e. the value of the land with the consent minus the value without it equals the value of the consent. However, the consent is still not separable from the asset according to NZ IAS 38 but it is separable from the entity in so far as the land may be sold/traded in an active market. Therefore we argue resource consents cannot be recorded as a separate asset when it is part of a package of assets purchased by an organisation. However, the consent has impacted upon the 2

4 valuation of the underlying asset which means it has an impact on the reported asset values of a entity which we believe creates a case for disclosure of the nature and impact of the resource consents held by a reporting entity. Once a resource consent is granted to perform a particular activity related to a particular site, the asset is no longer just the land it is the land plus the consent. The consent while it may be defined as an intangible asset according to NZ IAS 38, is attached to the land and they are intrinsically inseparable. This land package is therefore subject to recognition, measurement and disclosure rules contained in NZ IAS 16 Property, Plant and Equipment which requires initial valuation at historical cost (para 15) with a subsequent option of adopting either the cost or valuation model. Fair value as it relates to property, plant and equipment assets is generally market based and is evidenced by an appraisal by a reputable person (NZ IAS 16, para 32) using historical market trends and future predictions about the behaviour of the market based on expert knowledge. It is theoretically possible then, to request a valuation of the land without the associated consent and another with it logically the value of the consent is the incremental value of the land with the addition of the consent, this could be used as a surrogate for the market value of the consent. If it were separable, the consent could theoretically be recognised as an intangible asset on the Balance Sheet. This is much the same as the valuation of a dwelling based on land value plus improvements. But as the resource consent is not separable it cannot be included separately in the financial statements of an entitiy but it does in many instances change the nature of the tangible asset to which it attaches. All tangible assets are subject to the usual rules regarding depreciation and impairment under NZ IAS 16 and 36. If a property, plant or equipment asset is only useable with an accompanying resource consent, then any changes to (or the expiration of) the associated consent would mean the tangible asset would need to be assessed to ascertain if it had been impaired or not. Therefore any change in the conditions of resource consents or the impending need to renew resource consents has the potential to change the reported asset values of an organisation. The renewal of a resource consent can expose an organisation to political pressures as in a greening of politics for example the banning of coal fired heating/electricity generation, or an increase in emission quotas etc. If these changes reduce the ability of the entity to generate revenue from an asset or impose additional costs to operate an asset the related tangible assets could be said to be impaired. What is Impairment? According to NZ IAS 36 impairment can be said to exist when the carrying value of an asset exceeds its recoverable amount (the higher of its fair value from sale or value in 3

5 use). Both NZ IAS 16 (para 63) and NZ IAS 36 (para 9) require annual consideration of any impairment in the carrying value of property plant and equipment over their estimated useful lives over and above the requirements to depreciate (or amortise) the carrying value (cost or valuation less estimated residual value). To determine whether an indication of impairment exists, reference must be made to such factors as where: fair value declines more rapidly that expected from normal wear and tear; the entity suffers adverse economic, technological, market or legal impacts; market interest rates have increased to affect the discount rate used to calculate value in use; the carrying amount of the net assets of the entity are greater than its market capitalisation; there is evidence of obsolescence or damage to the asset; the use of the asset has changed significantly such as from restructured operations, or the expiry of a resource consent; or the asset s economic performance will be worse than expected. (Adapted from NZ IAS 36 para 12) A case can be made for the impairment of an asset when a resource consent which governs the use/operation of the asset is revoked or its expiry is due the consent is at the end of its useful life. It may be that the asset is not yet at the end of its potential useful life to the entity but the associated consent is revoked this situation could see the underlying asset rendered obsolete therefore, impairment would be indicated as per NZ IAS 36. When this occurs and it is considered that impairment may exist, a full review of the recoverable amount must be conducted. NZ IAS 36 defines this as the higher of: 1) an assessment of the fair value (para 25 29): estimated market (sale) price less costs of disposal; and 2) an estimate of value in use (paras 30 57): based on the present value of future net cash inflows generated from the use of the asset, discounted at a (pre tax) interest rate that reflects: a) the time value of money; and b) the risk attaching to this specific income stream. The recoverable amount must then be compared with the carrying value of the asset. Any shortfall in the recoverable amount (the impairment) must be expensed in the current period income statement (para 126, NZ IAS 36). Therefore it can be seen that resource consents have a potentially significant impact on the reported values of tangible assets as they can influence both the value in use of an asset and the fair value as it affects the value a purchaser could extract from the sale of an asset. 4

6 An added complication to the recognition of resource consents is that they may attach to group of assets rather than individual assets in that a resource consent may allow for the operation of a group of assets as a whole as they apply to the operation of an entire process or location within an organisation. The impact of a resource consent may therefore be wide ranging in its impact on an organisation. Resource Consents and Business Combinations Intangible assets can be recorded when they are purchased, therefore a consent acquired as part of the acquisition of another entity in a business takeover/combination would be covered by the requirements of NZ IFRS 3 Business Combinations. It is theoretically possible that in this case resource consents could be valued and purchased as along with the acquiree s intangible assets which are defined as fitting the definition in NZ IAS 38 and whose fair value can be readily determined. In terms of NZ IFRS 3 the determination of fair value does not require reference to an active market (see NZ IFRS 3 Appendix A), only the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction (p.24). The criteria set out for determining if an intangible asset is identifiable are, it: a) is separable, ie capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations (para 46, NZ IFRS 3). This means in a combination the requirement for a resource consent to be separable from the asset it attaches to does not exist so resource consents purchased as part of a combination can be reported in financial statements under current accounting standards. This creates an anomaly that allows some resource consents to be recorded while others are not. Resource Consents and the Going Concern Assumption A further issue to consider is the impact of resource consents on the ability of an organisation to continue to operate. Auditors are required to evaluate and report on the ability of an entity to continue to trade as a going concern at each balance date, and to report on any potential threats to this assumption in the foreseeable future. The expiry or revocation of a resource consent may pose a threat to this assumption, especially if the entity cannot continue to conduct its business, and therefore generate revenue without the consent. Tozer and Hawkes (2001) argue that (f)rom this perspective the resource consent 5

7 is material and at least narrative disclosure of its existence, duration, and any other relevant terms and conditions should be made to facilitate reliable decision making (p.163), however this is not usually the case. Any potential threat to going concern may result in the revaluation of all assets to exit or realisation values. If a resource consent is due to expire at some future date, an entity is in the position where it needs to determine if it can renew the consent. This decision may be made in a very public manner if the activity permitted by the consent is considered to be damaging to the local environment. The scrutiny and potential for altered resource consent conditions on renewal is often clearly signalled in advance, for example the Manawatu Regional Council set specific water quality targets which would be applied to consent renewals and applications over an eleven year period from 1998 to 2009 as part of its Water Quality Regional Plan (Manawatu Wanganui Regional Council, 1998) This scrutiny may mean pressure on the entity to modify its operations or on the local authority to amend the conditions of the consent or to revoke it all together. This presents the potential for impairment of the underlying tangible assets possessed by the entity as the way in which they can be operated or the costs involved in operating them are increased by the changes in the conditions imposed by the resource consent. Current Practice Are Resource Consents disclosed? It has been established that according to GAAP resource consents cannot be recognised in the financial statements (NZ IAS 38), but an argument has been mounted for the inclusion of consents in the note disclosures included with the financial statements (see Tozer & Hawkes, 2001). Historically, however this has not occurred with the level of disclosure about resource consents being very low. A document study of New Zealand listed companies revealed that a minority of companies make any disclosures about the resource consents they hold or plan to apply for. The level of disclosure is falling with the percentage of New Zealand companies listed on the New Zealand Stock Exchange making any disclosure about resource consents being 21% in 2001, 14.3% in 2002 and 13.5% in The study considered disclosure of resource consents to include any comment on resource consents held or to be applied for in the annual report of the company. The study reviewed the available annual reports of 156 companies in 2003, 147 in 2002 and 143 companies in The study excluded listed investment funds and companies not operating in New Zealand as these entities would not directly hold resource consents. The majority of disclosures were descriptive comments on the consents held or needing to be gained before future plans that were being detailed could be pursued. Less than 2% of companies in all years included any reference to resource consents in their financial statements or notes to the financial statements. 6

8 One reason that may be put forward for the non disclosure of resource consents per se, is that true and fair view presentation, and the concept of substance over form, may be considered by practitioners as being of secondary importance to the application of GAAP or that compliance with accounting standards is all that is necessary to present a true and fair view.. This perception may stem from the mandatory application of GAAP (seen as the application of relevant accounting standards) as required under the Financial Reporting Act 1993 versus the moral standards embodied in true and fair and substance over form. Conclusion The above discussion explores the impact on the disclosure requirements that apply to resource consents of the change in New Zealand financial reporting requirements to reflect IFRS. The discussion explored several aspects of the reporting requirements of IFRS, and the New Zealand adaptation of them, and concluded in all but one situation resource consents cannot be separately recorded as assets. Resource consents cannot be separately recorded if purchased as other intangible assets can because they are not separable from the underlying asset or land they attach to. The one situation they could possibly be recorded in the financial statements is on a combination were assets acquired as a group of assets need not be separable to be recorded they just need to be capable of separate valuation. The new reporting requirements implemented as part of the move to IFRS therefore do not create an environment were resource consents can be formally recognised and valued within the financial statements of the organisations which hold the consents. The conclusion that resource consents cannot be recognised within the financial statements of holders conflicts with the significance of the resource consents to the operations and asset values reported by many entities holding resource consents. We believe this conflict needs to be addressed by disclosing details of resource consents held and the scope of their impact on an entities operation as narrative disclosures in the notes to the financial statements where they have the potential to significantly affect the value of assets reported or the costs of operations (i.e. have an impact on the future profit generated form an asset or group of assets). The extent of these disclosures could be significant as in some cases entities will have good information on the likely future conditions they will face when consents are renewed and the costs of these new conditions on the entity. The disclosure of this information may have a significant impact on the interpretation by users of the financial statements of the asset values reported by entities on their balance sheets. 7

9 In conclusion we believe that resource consents do have an impact on the fair value of many assets. When this is coupled with the increased level of assets being reported at their fair value in the financial statements of entities this creates an environment were information on resource consents has an increased relevance to the users of financial statements and therefore should be detailed in the disclosures made by entities in their financial statements. 8

10 References: Financial Reporting Standards Board (FRSB) (2004). New Zealand Equivalent to International Financial Reporting Standard 3: Business Combinations (NZ IFRS 3), NZICA: November Financial Reporting Standards Board (FRSB) (2004). New Zealand Equivalent to International Accounting Standard 16: Property, Plant and Equipment (NZ IAS 16), NZICA: November Financial Reporting Standards Board (FRSB) (2004). New Zealand Equivalent to International Accounting Standard 38: Intangible Assets (NZ IAS 38), NZICA: November Financial Reporting Standards Board (FRSB) (2004). New Zealand Equivalent to International Accounting Standard 36: Impairment of Assets (NZ IAS 36), NZICA: November Manawatu Wanganui Regional Council (1998). Manawatu Catchment Water Quality Regional Plan, retrieved October from /mcwq.pdf Tozer, L. and Hawkes, L. (2001) Resource Consents Intangible Fixed Assets? Accounting Forum, 25(2), STATUTES Resource Management Act. No. 69 of Wellington: GP Print. Companies Act. No. 105 of Wellington: GP Print. Financial Reporting Act. No. 106 of Wellington: GP Print. 9