2 Accounting and valuation principles
The preparation of the consolidated financial statements requires estimates and assumptions to be made. These relate to the reported amounts of assets, liabilities and contingent liabilities on the balance sheet date and to income and expenditure during the reporting period. The balance sheet is prepared strictly on the basis of acquisition costs, with the exception of investment real estate, which is entered at market values. For significant estimates and assumptions, see the following accounting and valuation principles, in particular 2.29. If these estimates and assumptions, made to the best of our knowledge at that date, subsequently transpire to diverge from the facts, the original estimates and assumptions are adjusted for the year in which the situation changed. Significant changes are disclosed in the consolidated financial statements.
2.2 Derivative financial instruments
In the past, Allreal used interest rate swaps (swaps) to reduce interest rate risk. By resolution of the Board of Directors, these swaps were terminated early on 6 December 2016. Their remaining negative replacement value (after deferred tax) in the hedging reserve is being released to the income statement over the original residual term to maturity.
2.3 Earnings from renting investment real estate
Income from renting investment real estate includes net rental income after deduction of vacancy losses, and losses due to bad debts. Costs for ground rent, management, operation, maintenance and repairs are reported separately in the income statement as direct expenses for rented investment real estate.
Rent-free periods in commercial premises are recognised on a straight-line basis over the contract term.
2.4 Earnings from sale of investment real estate
Gains and losses on the sale of investment real estate correspond to the difference between the realised net proceeds after deduction of transaction costs and the latest recorded market value of the properties sold. The earnings are taken to the income statement at the time of the transfer of benefits and risks.
2.5 Earnings from revaluation of investment real estate
The revaluation of yield-producing properties and investment real estate under construction shows changes in the market value of the real estate portfolio. The report of the external real estate valuer serves as the basis. The real estate valuation underlying the revaluation excludes the deduction of transaction costs at the time of sale.
For more details of the recognition of investment real estate see 2.9.
2.6 Earnings from Projects & Development division
The earnings from the Projects & Development division include income from realisation Projects & Development (third-party projects), income from sales Development (own projects), capitalised company-produced assets and diverse income. Income from realisation Projects & Development includes the project volume completed during the period under review for third parties (third-party projects) and corresponds to the total of all project costs, fees and earnings from construction activity recognised by the percentage of completion method (POC). In the case of loss-making projects, provisions are immediately made for the estimated final loss in the project accounts (trade receivables or payables).
Earnings realised and received from the sale of development real estate (own projects) are recognised as income from sales Development at the time of transfer of benefits and risks, i.e. on transfer of ownership of individual development real estate units and entry of this transfer in the land register. When recognising the revenues, the pro rata project costs and gains are also taken into account; for details see 1.2 for presentation of accounts with effect from 1 January 2018.
Direct expenses from realisation Projects & Development and sales Development contain the accrued project costs of all third-party projects bought in by contractors as well as cumulative investment costs including capitalised company-produced assets and pro rata gains for own projects sold.
Capitalised company-produced assets accrue from investment real estate under construction as well as development real estate and are taken to income at cost if own project work is incurred.
2.7 Transfer of segment reporting to the consolidated statement of comprehensive income
The presentation of net profit in the internal reports is similar to that in the segment reports. As regards the Projects & Development division, the segment reports differ from the consolidated statement of comprehensive income in respect of the quantification of sales.
In the segment reports, the volume of projects completed for all third-party and own projects is taken as the relevant sales figure.
In the consolidated statement of comprehensive income, sales from realisation Projects & Development and sales of development real estate are recognised in accordance with 2.6. In the segment reports, in respect of the volume of projects completed for the Real Estate division (intra-Group sales) and for own projects, the difference between projects completed and sales Development is stated.
2.8 Financial expense/capitalised building loan interest
Interest expenses are accrued/deferred between reporting periods on the basis of the effective interest rate method and taken to income.
For development real estate and investment real estate under construction, debt interest is capitalised. The underlying debt interest rate is the average borrowing rate during the reporting period.
2.9 Investment real estate
The investment real estate reported under fixed assets is divided into yield-producing properties (residential and commercial properties) and investment real estate under construction. All investment real estate is carried at fair value in accordance with IAS 40 and IFRS 13. The valuation at the time of initial recognition is based on acquisition cost, including directly attributable transaction costs. After the initial recognition, the external real estate valuer regularly determines the fair value on the balance sheet cut-off date using the discounted cash flow method (DCF). For details of the valuation method and the key assumptions see 2.29. To be able to establish the highest and best use of a project, it must be approvable, in compliance with legal requirements and financially viable. Changes in fair value are taken to the income statement, factoring in deferred taxes. In the consolidated statement of changes in shareholders’ equity, the cumulative difference between the acquisition cost and fair value of all investment real estate, factoring in deferred taxes encumbering said real estate, is recognised as part of retained earnings (revaluation reserves). Yield-producing properties whose book value is not likely to be derived from continued use but through a sale are reported separately at fair value in working capital as investment real estate held for sale. This is conditional on the sale being highly probable and the investment properties being in a condition ready to be sold immediately. For a sale to be classified as highly probable, it must be expected to take place within one year. For projects to be assigned to investment real estate under construction, realisation must be intended for the portfolio of investment real estate, which is conditional on a minuted decision by the Board of Directors. It must also be possible to form a reliable estimate of expenditure and income so that an estimate of fair value can be made, and a building permit and construction approval which can no longer be contested by third parties needs to have been issued for the project.
2.10 Development real estate
The development real estate carried in working capital includes development reserves, buildings under construction and completed properties which were not sold to third parties. If the criteria for investment real estate under construction mentioned in 2.9 are not met, such projects are carried on the balance sheet as development real estate.
Development real estate is reported in accordance with IAS 2, which requires that these properties be recognised in the consolidated financial statements at acquisition or production costs or, if lower, their net realisable value. The latter corresponds to the estimated sale price less expected project, construction and sales costs up until the disposal. Any impairment is taken to direct expenses from sales Development.
Land already owned by Allreal or payments on account for planned land pur-chases and third-party cost (but not company-produced assets) are capitalised under development reserves if the project is expected to be realised, but work has not yet started.
Projects in progress, on which structural work has yet to be completed, for which the property-specific full statement of accounts is not yet available and for which the transfer of ownership to a third party has not yet been completed are recognised as buildings under construction. Realised development real estate which has reached structural completion and development real estate destined for immediate sale to third parties are reported as completed buildings.
2.11 Other property, plant and equipment
Other property, plant and equipment is stated at acquisition or production costs less operationally necessary depreciation and, where appropriate, less additional depreciation as a result of impairment losses. The estimated useful life of plant and equipment is four to five years and three years for IT infrastructure. The works of art capitalised under other property, plant and equipment are not depreciated. Depreciation is calculated on a straight-line basis.
2.12 Intangible assets
Goodwill from acquisitions corresponds to the surplus of the purchase price, the contribution of minority interests in the companies taken over and the market value of the share of previously held equity over the balance of the assets, liabilities and contingent liabilities valued at market values. Goodwill is not amortised, but subjected to an annual impairment test.
Other tangible assets comprise software and IT developments, which are recognised at acquisition cost and, from the time they are first used, are depreciated to the income statement on a straight-line basis over their estimated useful life of three years.
2.13 Financial assets
Financial assets include long-term loans in the context of usual business operations and the pre-financing of tenant fit-outs. Loans are stated using the amortised cost method and are freely available and not pledged.
2.14 Short-term receivables
Receivables arising from construction activities undertaken on behalf of third parties are recognised according to the net principle, i.e. payments on account received from clients and partial settlements of accounts arising from the construction activities are offset against each other (order balances). Positive net positions are shown under trade receivables, while negative net positions are reported under trade payables; see also 2.6.
Trade receivables and other receivables are reported at their nominal value less necessary value adjustments for irrecoverable claims. Value adjustments are based on an individual assessment of the claim in the light of deposited collateral and also take account of appropriate historical empirical values. All short-term receivables are freely disposable and are not pledged.
Cash includes cash on hand, sight deposits with banks and short-term time deposits with maximum maturities of 90 days. They are reported at nominal value.
2.16 Share capital/treasury shares
The share capital of Allreal Holding AG is reported as equity as it is not subject to any repayment obligation or dividend guarantee. Issuing costs which are incurred in connection with a capital increase and are directly attributable to the issuance of new shares are offset against the capital reserves under equity. The premium paid with capital increases or through conversion of a convertible bond is reported under capital reserves.
Treasury shares may be held by Allreal Holding AG or by one of its Group companies on the balance sheet cut-off date. These are stated at acquisition cost offset directly against equity and are listed as a separate item in the consolidated statement of changes in shareholders’ equity. Gains and losses from transactions with treasury shares are taken to other retained earnings in equity.
Bonds are recognised on issue on the basis of the proceeds received, net of transaction costs. The difference between reported financial liabilities and the repayment amount is amortised to the income statement over the bond’s term to maturity using the effective interest method.
In addition to bond issues, financial liabilities include bank loans secured by mortgages and are recognised as long-term financial liabilities in compliance with IAS 1 if the contractually agreed remaining term to maturity in the credit agreements is longer than twelve months. All other financial liabilities are recognised as a short-term bank debt, including amortisation payments due within twelve months of the balance sheet cut-off date. Borrowings are recognised at amortised costs using the effective interest method.
Provisions are made to the extent that corresponding obligations exist as at the balance sheet cut-off date and the respective event is in the past. In addition, the amount can be estimated reliably and the probability of occurrence is rated higher than that of the non-occurrence. Provisions are classified as short-term or long-term, depending on whether they are expected to be utilised within one year or later. Provisions are reported at the best possible estimate of the amount necessary to meet the obligations as at the balance sheet cut-off date. If the effect is material, provisions are discounted.
2.20 Current liabilities
Liabilities arising from construction activities undertaken on behalf of third parties are recognised according to the net principle, i.e. payments on account received from clients and partial settlements of accounts arising from the construction activities are offset against each other (order balances). Negative net positions are shown under trade payables, while positive net positions are reported under trade receivables.
Trade payables and other liabilities (accrued liabilities) due within one year are recorded at their nominal value.
Interest-free payments (reservation fees and prepayments) made by future owners of units of development real estate are reported as a separate position under liabilities until such time as ownership has been transferred.
Leasing agreements are reported as financial leases if essentially all risks and opportunities associated with ownership of the leased property are transferred to Allreal. They are classified at the beginning of the lease. The leased property is initially capitalised at the lower of the present value of the lease payments or fair value. Leasing instalments are broken down into interest and repayment amounts. The leased property is depreciated over its estimated useful life or over the term of the lease, whichever is the shorter.
Cash flows for operating leasing are taken to income directly at the time of payment.
If there is reason to believe that the value of property, plant and equipment and intangible assets has been impaired, an impairment test will be carried out and the realisable value will be estimated. The realisable value is the lower of value in use or market value less selling costs. Any difference between the asset and the realisable value is depreciated to the income statement and reported separately in the Notes to the consolidated financial statements.
The item tax expenses in the consolidated statement of comprehensive income cover current taxes on business activities, deferred taxes on revaluation and other deferred taxes.
Current taxes on business activities include income taxes due for the business year as well as property gains tax on the completion and sale of development real estate (Projects & Development division) and the sale of investment real estate (Real Estate division).
Current income taxes are calculated net of tax loss carry-forwards and in compliance with the applicable tax regulations on the basis of the results reported by the individual Group companies and are recognised under current tax liabilities.
Deferred taxes are determined using the balance sheet liability method and are calculated at the tax rates in force or announced on the balance sheet cut-off date. With the exception of taxes imposed in the previous year on the replacement values of cash flow hedges and changes in employee benefits recognised through equity, changes in deferred taxes are taken to income.
Deferred tax liabilities take account of discrepancies in income and property gains taxes between the valuation for purposes of the consolidated financial statements and the applicable tax valuation of individual assets and liabilities for tax purposes. At the same time, a deferred tax is calculated on strictly all discrepancies leading to delays in the timing of taxation. For the higher valuation of investment real estate (positive difference between acquisition cost and market value) an individual tax rate is applied, with a realistic holding period defined for each individual investment real estate property.
Deferred tax assets from tax loss carry-forwards and the downward revaluation of investment real estate (negative difference between tax value and market value) are capitalised if they appear certain to be recoverable with future taxable income.
2.24 Employee pension plans
Employees of Allreal Generalunternehmung AG are covered by the Allreal pension fund for mandatory and extra-mandatory staff pension provision as required by the Swiss Federal Law on Occupational Retirement, Survivors’ and Disability Pension Plans (BVG), while employees of Hammer Retex AG are affiliated to the collective foundation of a Swiss insurance company for occupational pension provision.
The Allreal pension fund is a legally independent pension institution based on the principle of defined contributions in accordance with Swiss law.
On the basis of IAS 19, these pension plans qualify as defined benefit plans. The assets and commitments of these plans are recalculated half-yearly by an external actuary. In accordance with IAS 19 (revised), the plan assets are recognised at fair value and liabilities are valued using the projected unit credit method.
Pension expenses comprise a past service and a net interest component which are recognised under personnel expenses as well as a revaluation component which contains actuarial gains and losses and is recognised through other comprehensive income under changes in the pension fund.
Some staff are also covered by a management insurance scheme arranged with an insurance company which is classed as a defined contribution plan under IAS 19. The expenditure reported during the period under review corresponds to the employer’s payments to the plan.
2.25 Share-based reimbursement
Part of the variable remuneration may be paid to the members of Group Management in the form of shares of Allreal Holding AG. Beneficiaries have immediate right of disposal over the first half of the shares allocated to them. The second half will be placed at the beneficiary’s disposal in two years, provided that the employment relationship has not been terminated. Entitlements will be satisfied by the company by means of treasury shares. The amount resulting from the share allocation is charged to personnel expenses over the vesting period. Shares are recognised at market value at the time of allocation.
2.26 Earnings per share
Net profit per share is calculated by dividing net profit by the weighted average number of shares outstanding during the reporting period. Diluted earnings per share take account of additional shares that may be created as a result of the exercising of option or conversion rights and will have a dilutive effect on the result.
2.27 Consolidated cash flow statement
Liquid assets (cash on hand, postal and bank account balances) and short-term deposits with maximum terms of 90 days are used as funds. Cash flow from operating activities consists of operating cash flow before changes in net working capital (NWC), changes in NWC (excl. cash and current tax liabilities), as well as cost of finance paid, financial income received, and income and property gains taxes paid. Cash flows from investing and financing activities are presented separately.
2.28 Foreign currencies
The geographical range of Allreal Group’s activities is confined to Switzerland. The Group has no assets or liabilities in foreign currencies. As all Group companies prepare their annual accounts in Swiss francs, consolidation does not result in any currency translation differences.
2.29 Valuation uncertainties
Investment real estate
As at 31 December 2017, Allreal holds investment real estate with a book value of CHF 3,956.6 million (31.12.2016: CHF 3,574.5 million). The investment real estate is valued at market value calculated using the discounted cash flow method (DCF). The DCF method is based on various estimates and assumptions, with the yield potential of a property being derived on the basis of future revenue and expenditure. Market values do not take account of transaction costs upon sale. Recognised at fair value as at 31 December 2017, yield-producing properties totalling CHF 3,931.2 million (31.12.2016: CHF 3,505.0 million) and investment real estate under construction totalling CHF 25.4 million (31.12.2016: CHF 69.5 million) qualify as category 3 fair values. During the period under review, no adjustments were made to valuation techniques or processes, and there were no shifts within the fair value categories.
Future rental income is forecast on the basis of current contractual rents and target annual rental income. In the case of expiring commercial leases, a typical local market rent which appears sustainable from a current perspective is used. Where tenants have extension options, as a rule the lower of market rent and contractual rent is stated. Sustainable market rents will also be used in the case of open-ended leases where there is a significant difference between the contractual rents and the market level in the exit year. Moreover, property-specific assumptions with regard to temporary and structural vacancies will be factored into the market valuation.
Management and building costs are in principle based on the relevant property accounts and include non-apportionable operating and maintenance costs, as well as future repair costs based on Allreal’s multi-year budgets. These costs include costs for asset maintenance to secure the long-term level of contractual and market interest rates on which the valuation is based as well as value-enhancing investments generating future additional income.
A property-specific discount is made on each investment property on the basis of macro- and micro-locational considerations and depending on real estate segment. Inflation is taken into account in the forecast cash flows. The discount and capitalisation rates are based on the interest paid on long-term, risk-free investments plus a specific risk premium.
If the actual market rents in subsequent years are lower than projected in the DCF valuations, this may lead to an adjustment of the fair values. This devaluation effect on investment real estate would be even stronger in combination with increasing discount and capitalisation rates.
In the case of investment real estate under construction, future rental income is also ascertained on the basis of typical local market rents or rents already contractually agreed. On the cost side, expenses are determined with the aid of investment calculations, the chronological progress of construction phases and cost forecasts. If actual construction costs and rental income in subsequent periods differ from the estimates and planned figures, the fair values may need to be adjusted; see also 4.1.
Development real estate
As at 31 December 2017, Allreal holds development real estate with a book value of CHF 116.5 million (31.12.2016: CHF 165.7 million). It was valued at acquisition or production costs – including company-produced assets for buildings under construction – less value adjustments for impairment losses. On the balance sheet cut-off date at the latest, an impairment test is carried out for all development projects by comparing incurred and future costs with the realisable value. On the cost side, expenses are, among other methods, determined with the aid of investment calculations, the chronological progress of construction phases and cost forecasts. The proceeds are based on market assessments, empirical values and completed sales to date. If actual construction costs and sales proceeds in subsequent periods differ from the estimates and planned figures, the book values may need to be adjusted.
Allreal has significant deferred tax assets totalling CHF 23.3 million (31.12.2016: CHF 34.6 million) and liabilities totalling CHF 202.6 million (31.12.2016: CHF 192.5 million), which stem mainly from valuation differences relating to investment real estate; see 2.23. In calculating the deferred taxes on investment real estate, a remaining holding period was estimated for each property. If the actual holding period of the investment real estate does not correspond to the assumed holding period, this may result in a considerable difference between the tax due and the capitalised deferred taxes when the property is sold.
2.30 Information on the implementation of a risk assessment
Allreal has a comprehensive management system (PAQ) in place. This system describes all parent processes and associated controls and integrates the tasks of management, operational processes and support processes. The PAQ also covers non-financial processes. There is also a documented internal control system in place for accounting and financial reporting to prevent, minimise or identify the risk of material misrepresentation in the annual accounts. The financial reporting controls are based on the COSO framework.
The Board of Directors evaluates quarterly at corporate level the risk assessment prepared by Group Management (identification, quantification, monitoring and control). In particular, the risk assessment must explicitly give consideration to the reliability and completeness of financial information (fair presentation), asset protection, compliance with laws, regulations and contracts, as well as the risk of balance sheet fraud.
Effective internal control and management systems are in place to ensure that the consolidated financial statements of Allreal Group comply with the applicable accounting rules and to ensure the fair presentation of reporting. Accounting and valuation involve making forward-looking estimates and assumptions. Estimates and assumptions which pose a significant risk in the form of an adjustment to the book values of assets and liabilities within the next financial year are shown under the individual positions in the Notes; see 2.29.