This case has been selected to give you an opportunity to apply financial analysis to a firm. To do this you will use the firm's published financial and select financial ratios to make a determination about the case.

For each case study, your written answers will be typed into a single Microsoft Word file,you?ll answer all of the questions at the end of the case in the form of well-worded short essays.

Case 7-4: Silic: Choosing Cost or Fair Value on Adoption of IFRS In June 2002, the Council of Ministers of the European Union approved regulation requiring all companies quoted on European stock exchanges to use, with effect from January 1, 2005, International Financial Reporting Standards (IFRS) as the basis for their financial statements. Prior to this date, publicly listed companies in France used their domestic accounting standards for financial reporting purposes. Therefore, the transition to IFRS would have a substantial impact on their accounting practices. One company affected by the switch to the new accounting standards was Silic, a France-based investment property company. Before the implementation of IFRS, Silic was applying French accounting standards that required its investment properties to be reported using the historical-cost model. However, the introduction of International Accounting Standard 40 (IAS 40 Investment Properties) under IFRS would require the company to choose between historical-cost or fair-value accounting to report its investment properties. Background Silic (Socit Immobilire de Location pour l'Industrie et le Commerce) was a major and historical player on the French commercial-property market. It was the first company in France to introduce the concept of business parks areas of land, typically located close to major highways, railroads and airports, set aside for office space and light industry. The company's strategy involved developing and operating business parks in the three largest business areas surrounding Paris. Specifically, the company built, refurbished and rented out office space in the La Dfense business district to the west of the city and in the industrial poles located in close proximity to the Charles de Gaulle and Orly airports. Silic also owned and rented out multipurpose office and light industrial space in business parks located in the outer-lying Paris suburbs of Cergy, Courtaboeuf and Evry. In the business parks that it managed, Silic also provided associated services and amenities, such as restaurants, convenience stores, fitness clubs and childcare facilities. In total, the company had over 700 individual tenants, ranging from small and medium-sized companies to major multinationals such as Air France, Alcatel Business Systems, Axa, France Telecom, Danone, LG, Microsoft, Nestle Waters, Peugeot and Xerox. Silic had been listed on the Paris stock exchange in January 1973 and by 2004 had a largely institutional and relatively stable shareholder community. Groupama, a leading French insurance group, represented the company's reference shareholder (see Exhibit 1).1 At December 31, 2004, Silic had over 1.5 billion of investment properties valued on its balance sheet, including buildings recorded at over 1.1 billion and land reported at close to 449 million (see Exhibit 2), and was profitable (see Exhibits 3, 4 and 5). The company's property portfolio consisted of 181 individual investment properties totaling almost 954,000 m 2 of office space (defined as premises where at least 70% of the floor area is occupied by offices) and multipurpose business space (defined as premises providing a mix of both office and light-industrial space) (seeExhibit 6). In line with Silic's development strategy and its focus on both operating and developing business parks, the company was also constructing new office buildings that had been recorded at 62 million. Dominique Schlissinger, Silic's Chairman and Chief Executive Officer, explained that the company's Orly-Rungis site could be expanded by a further million square meters to further consolidate its position as Europe's largest business park. French Investment Property Market and Property Values Since 2001, the French real estate and property management industry had been growing steadily at an average rate of 2.8% per year, reaching a value of 23.8 billion in 2004. Revenues from non-residential properties, including offices and warehouses, accounted for over a fifth of the industry's valuei. France represented Europe's third largest real estate management and development industry after the United Kingdom and Germany, generating 19.9% of the European industry's value. The industry was forecast to grow by a further 3.7% per year by 2010ii. Other major publicly listed companies in the French real estate management and development industry included Gecina, Icade, Klpierre, Socit Foncire Lyonnaise and Unibail. With 49 million m2 of office space, the Paris region represented the largest commercial real estate market in Europeiii. Since the 1980s, the commercial property market of Paris and its surrounding region had experienced substantial upward and downward movements in the values of properties (see Exhibit 7). By the end of 2004, the commercial property market appeared to be on the cusp of an upswing, with sales prices rising on the year by 1.5%iv. Accounting for Investment Properties in France Prior to the introduction of IFRS accounting standards in France, Silic reported its property assets in accordance with the French General Accounting Plan at historical cost, being either the purchase cost for the properties it had acquired or the cost price of its new construction or redeveloped properties. The company depreciated its office and light industrial buildings on a straight-line basis over an average period of 40 years. Older buildings acquired were depreciated over a period taking into account their average age. In 2003, Silic adopted SIIC status. Tile SIIC (Socits d'Investissements Immobiliers Cotes) tax regime was introduced by the French government in 2003 to create a strong and more efficient domestic real estate market. Inspired by the introduction of real estate investment trusts (REIT) in other countries, the SIIC legislation made real estate companies listed on the French stock exchange eligible for tax exemptions on their rental income and real estate capital gains, provided they distributed 85% of rental earning and 50% of capital gains to shareholders. Companies that elected the new regime had to pay a one-off 'exit tax' at a rate of 16.5% of latent capital gains on the buildings that they held. EXHIBIT 8: Comments on Introduction of Fair-Value Accounting in France Investment Property Industry Serge Grybowski (CEO, Gecina) Fair value is more indicative of the development of the property .market than the operational performance of a real estate companyvii Jean-Michel Gault (CFO, Klpierre) Fair-value accounting complicates comparisons with historical accounting dataviii European Public Real Estate Association Fair-value accounting will enhance uniformity, comparability and transparency of financial reporting by real estate companies. It allows performance benchmarking with direct property market indices. Real estate companies should therefore account for their property investments based upon the fair-value modelix. International Accounting Firms and Associations Rene Ricot (International Federation of Accountants) Fair value is inevitable. Instability due to using market. values is a problem of the lack of education of market players and not that of accounting. Franoise Bussac (Ernst & Young) Fair value is the only single guideline to bring a real transparency in financial statements. Financial Institution Investors Federation of French Insurance Companies Accounts reported at fair value can be deceptive and risk injecting a large dose of subjectivity into financial statements. Sylvie Mathrat (General Secretary of the French Banking Commission) The main problem of fair-value accounting is the volatility of earnings Financial Analysts Association of French Financial Analysts The use of fair value can confuse interpretation of a company's operational results. Fair-value accounting is less reliable, allows greater manipulation of results and introduces volatility. National Financial Authorities French National Accounting Council (CNC) The CNC endorsed neither historical-cost nor fair-value accounting since both methods were authorized under IAS 40. French financial market regulator (AMF) Fair-value accounting prevents the manipulation of results by managers by going in and out of the market to make the appearance of results at their will. However, it is better to avoid rushing through too audacious accounting reforms in a period of instability of markets. Source: Compiled by case writerx Having chosen to adopt the new SIIC status, Silic followed the recommendations of the French accounting standards body (Conseil National de la Comptabilit) and financial market regulator(Autorit des Marchs Financiers) and had its buildings and land revalued by two independent external appraisers on an open-market and building-bybuilding basis. This one-off, fair-value revaluation had a significant impact on Silic's 2003 balance sheet. Indeed, the value of the company's investment properties and land increased from 2002 to 2003 by over 600 million or 70%. Adoption of International Accounting Standards The adoption of IFRS in January 2005 would have a number of effects on European property investment companies such as Silic. One major reporting issue related specifically to the International Accounting Standard 40 (IAS 40, Investment Properties). This standard allowed companies to report their investment properties using either a historical-cost model or a fair-value model. Under the historical-cost model, investment property would be reported on the balance sheet at cost less accumulated depreciation and any impairment losses. Any changes in fair value would have to be evaluated by external appraisers and reported in the footnotes of annual reports. Companies that initially adopted the historical-cost model could switch to the fair-value model at a later date, if this would result in a more appropriate presentation of financial results. Under the fair-value model, investment property (but not investment properties under construction or building land) would be revalued and reported on the balance sheet at its current market value, with all changes in value reported in the income statement. IAS 40 defined fair value as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's-length transaction. Under the terms of IAS 40, companies adopting the fair-value method could not switch to the historicalcost method. Although widely used outside of France, the concept of fair-value accounting was by and large unknown to the French. It called into question the country's long-established accounting traditions based on the principles of prudence and an avoidance of a valuation of assets which could lead to the disclosure of overvalued assets in financial statementsv. The implementation of IFRS accounting standards triggered a lively public debate about the strengths and weaknesses of fair-value accounting versus historical-cost accounting (see Exhibt 8). In the face of the implementation of IFRS, Dominique Schlissinger noted that Silic faced important cultural, sectoral and strategic dilemmas. It was against this background that the company's Board of Directors met on this issue on numerous occasions during 2003 and 2004 to better understand IAS 40. How would the two distinctive accounting models impact on Silic's financial statements? Which method would most transparently reflect Silic's real value? In short, which method should Silic ultimately adopt on January 1, 2005