Note 5 - Revaluation, Indexation and Impairment

The residual interest represents the expected fair value of the property at the point of reversion to the Body. The asset is therefore an interest in a future tangible fixed asset. Since revaluation or impairments are, in effect, changes to the future benefits associated with the residual interest, they must both be recognised in full at NPV from the point at which they crystallise. The discounting for the revaluation or impairments is progressively unwound as the concession period progresses to produce the required EFVR.

Indexation changes are analogous to mini revaluations and are applied year by year. Forward estimation using NPV is therefore unnecessary.

Figs 4 and 5 illustrate how the impairments and revaluation values were established for the worked example.

Fig 4 - Calculation of Impairment/Revaluation NPVs

•  Scenario A - represents the recognition of an impairment of £2,000k - in other words, we expect the EFVR of £30 million to have reduced to £28 million by the end of the concession period. Fig 4 demonstrates the difference in NPV for each of the remaining years of the contract. The initial impairment recognised at Year 15 is calculated as the difference between:

(NPV Year 15 @ £28m) - (NPV Year 15@ £30m) = £16.71m - £17.91m = -£1.20m

In each subsequent year, the NPV of the impairment must be adjusted as the discounting unwinds. The adjustment in Year 16 is calculated as:

(NPV Year 16 @ £28m) - (NPV Year 16@ £30m) - ((NPV Year 15 @ £28m) - (NPV Year 15@ £30m)) =

£17.30m - £18.53m - (-£1.2m) = -£1.23m + £1.20m = -£0.03m

•  Scenario B - represents the recognition of a revaluation which will have the effect of adding £7m to the residual interest's EFVR. The logic behind its recognition and subsequent unwinding is similar to that for Scenario A;

•  Scenario C - impairment recognised in the final year to reversion and therefore undiscounted.

•  Note: each of the adjustments to the residual interest's value is superimposed over each other. In other words, a revaluation which eclipses a previous impairment does not mean that the Body should cease unwinding the NPV of the impairment. The end result must be that by reversion, the impairments and/or revaluation to the EFVR have been fully accounted for. In the example given, the net effect of revaluation and impairments is: £30m - £2m +£7m - £1m = £30m + £4m = £34m.

Figure 5 below summarises the base data on which the unwinding of the discounts was calculated.

Fig 5 - Progressive unwinding of discounts