Branson Restaurants Limited is currently reviewing its financial operations for the past year. Specifically, it is looking
Question:
Branson Restaurants Limited is currently reviewing its financial operations for the past year. Specifically, it is looking to determine what is happening with one of its restaurants (which it owns – including the land). The following summary gives data about the restaurant in question.
Restaurant Orro:
• In business for five years.
• Serves Italian cuisine.
• Initially catered to a young set of patrons but over time this has changed such that the restaurant is attracting mainly tourists.
• Initially very successful and generated significant cash flows.
• In the past year, business has slowed down (cash flows have declined as a result).
• Feedback about the quality of the service has not been as positive lately although there is no consistent thing that the company can readily put its finger on in the comments.
• Other similar restaurants in the area are doing quite well although they do not serve Italian cuisine.
• The surrounding area is doing quite well economically and real estate prices have been rising.
• Many condominiums are being built around the restaurant (there have been numerous condominium developers purchasing land in the past year).
• Rezoning is not an issue (any purchaser will be able to get the land rezoned for condo development).
Branson has decided to sell the restaurant in question and is looking to determine a fair value. The company follows IFRS. It would likely remeasure the investment in the restaurant to fair value less costs to sell in the year-end financial statements (assuming the value is less than carrying value). This is acceptable treatment under IFRS as long as the asset is being held to sell (which it is). Branson is owned by several large investors who are deciding whether to dispose of their holdings in the company.
Instructions
You are the external auditor of the company. Discuss how fair value would be measured for purposes of revaluing the restaurant.
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial...
Step by Step Answer:
Branson Restaurants reports under IFRS as noted in the case The company can remeasure the restaurant to the lower of carrying value and fair value less costs to sell in its yearend financial statements as long as the asset is being held to sell Investors in Branson are deciding whether to dispose of their holdings in the company and therefore this creates a potential preparer bias to make results look better In measuring fair value the company needs to determine 1 The asset being measured Branson has to consider the specific nature condition and location of the asset being measured In this case is the company selling principally a restaurant including all of its tangible and intangible assets as a going business or is it selling the land since the land may be of more interest to a potential purchaser that is looking to develop the property for condos In either case the company is looking to dispose of the restaurant but the determination of which aspect of the restaurant would be of more interest to the purchaser may guide its choice of valuation method 2 How the item wouldcould be used as mentioned above the restaurant could be used by a purchaser as an ongoing restaurant business or as a possible site for future condo development The valuation of the asset is based on its highest and best use in the market regardless of how Branson is currently using the asset Highest and best use as a restaurant Highest and best use as a condo development Even though the restaurant has not been doing well lately it has historically done well and therefore can hopefully do well again With the increasing number of condos in the area demand for restaurants will surely increase Perhaps the condo market will become saturated and therefore an additional development is not wise ie retain the restaurant Demand seems high for new condos This is supported by the many condos being built in the area Rezoning is legally possible according to the facts and it is physically possible and economically viable to build a condo since many are doing it already In analyzing the highest and best use of the restaurant assets Branson has to consider the value that the market would place on the asset Branson may consider the best use to be as an ongoing restaurant but potential purchasers may not view market factors for future restaurant operations in the same way and may offer a higher price for the location as a condo development Given the information provided it is difficult to determine which assumption would give the highest value Under IFRS unless factors suggest otherwise we may assume that the current use is the highest and best use Therefore the highest and best use is as a restaurant In practice additional factors would be considered such as knowledgeable input from realtors planning documents filed with the municipality etc The company would want to calculate alternative valuations to determine which use provides the highest valuation 3 The market The measurement of the fair value of the restaurant would consider the value based on the market that the company normally buys and sells in In this case since the asset being sold is a restaurant Branson would be selling its business through normal business channels and would likely employ a realtor to assist with finding a buyer for either the business or the land 4 The valuation technique Branson can value the restaurant using either a market or an income model Income Market The company could use a traditional or expected cash flow approach The traditional approach is best suited to situations where the cash flows are fairly certain Since the restaurants cash flows have declined it may be preferable to use the expected cash flow approach Would have to project cash flows and discount them using a riskfree rate and assuming the cash flows are probabilityweighted The cash flows are highly variable but could look at past cash flows could assign probabilities looking at various scenarios such as the increased demand from new condos Additional data would be needed Could benchmark against the neighbouring restaurants by using an earnings multiples model Would have to adjust the market prices for the unique characteristics of this restaurant different cuisine location and profitability Recommendation Either approach would be acceptable depending on how much evidence could be found to support the value and the quality of the inputs Objective evidence would be best The valuation of the asset would require additional disclosures in the financial statement ...View the full answer
Intermediate Accounting Volume 1
ISBN: 978-1119496496
12th Canadian edition
Authors: Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield, Irene M. Wiecek, Bruce J. McConomy
