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Choosing Cost or Fair Value on Adoption of IFRS

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Description:A U.K. real estate firm, required to adopt international accounting standards (IAS) by 2005, must change the reporting of its primary asset (investment property) from the revaluation model under U.K. GAAP to either the cost or fair-value model under IAS. This would have a number of effects on European investment property firms, including Land Securities.

Learning Objective:To allow students to compare both the mechanics and relative merits of three models of accounting for long-lived assets (cost, revaluation, and fair value) and gain exposure to IFRS.

Case Questions:

1. Assume there are three separate real estate companies: US Realty (which applies the cost model), UK Realty (which applies the revaluation model), and International Realty (which applies the fair value model). Assume also that on December 31, 2003, each company pays £1,000 cash to obtain investment property comprising land with negligible value and an office building worth £1,000. The building has a 10-year useful life, has no residual value, and is expected to provide a constant stream of economic benefits over time.

What is the accounting entry for each company for the following four scenarios:

(a) on December 31, 2003, at acquisition
(b) on December 31, 2004, assuming the investment property fair value is
£1,300 (c) on December 31, 2005, assuming the investment property fair value is £1,100 (d) on December 31, 2006, assuming the investment property fair value is £500

Using the above illustrations, as well as Exhibit 11, as references, what financial analysis challenges arise as a result of these differing accounting models?

2. Which model (cost, revaluation, or fair value) provides the most relevant information? Explain.

3. Which model provides the most reliable information? Explain.

Required: Prepare a response to the above questions in Microsoft Word. Bring two copies of your document to class on the due date. One copy will be turned in at the beginning of class to be graded. Use the other copy to reference during the in-class discussion of the case.

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