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Self Managed Super Fund (SMSF) Article
How do SMSF's value assets which have gone bad?

By Tony Negline.

This article may be out of date.

24th October 2007

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Over the last few months some high profile investments opportunities have failed.

The Basis Capital funds and Westpoint are two examples.

If we believe market rumours then many Self Managed Super Fund trustees had invested into these schemes.

Each investment failure is unique but they are all strangely similar.  To varying degrees they all involve an elements of greed or incompetence or both.  The point here is not to discuss why these investments failed but to discuss what SMSF trustees will need to do when they do invest in a bad apple.

The main problem with any investment that goes bad is to accurately work out its value at any point in time.  This is especially important when trying to work out the real value of benefit payments or the tax owing on these payments.

Large super funds have to follow an accounting standard called AAS25 which demands that they value assets at the net market value.  That is, “the amount which could be expected to be received from the disposal of an asset in an orderly market after deducting costs expected to be incurred in realising the proceeds of such a disposal.”

This standard is not compulsory for small super funds however the ATO released a document in April 2003 which asked SMSFs to comply with it.

SMSFs are not entirely free to value assets in whatever way they see fit.  There are other accounting standards which need to be satisfied.  Apart from the net market value approach there are three other ways for SMSFs to value assets in their financial accounts.

A fund could use historical cost (that is, the purchase price of an asset).  The advantage of this is simplicity as the value of the asset in the financial accounts never changes.  The disadvantage with using historical cost is that it quickly becomes unrealistic even for assets whose value changes infrequently or is difficult and costly to determine.

The next option, which is the one used most often by SMSFs, is to use the historical cost system but revalue the asset on an as needed basis to reflect fair value.  This hybrid system is used because it is too much of a hassle to get the most up to date price of an asset.  For example, it is quite common to find SMSF trustees who will happily make decisions on ASX listed shares during a financial year using a balance date value of the asset.  In effect they are ignoring all the market movements between the 30 June valuation and the day they make their investment decision.  The recent fluctuations in financial markets – when some shares have rapidly dropped more than 30% from their high point and have since recovered some of this price drop – show the folly of this approach.

The final valuation methodology is the use a mixture of historical cost and net market value.  This makes life very confusing when trying to work out what is going on with particular assets and the true value of a fund.  Such an approach is not encouraged by other accounting standards but this doesn’t stop some SMSFs using it.

For Capital Gains Tax purposes assets must be valued at market price even if an asset is not bought or sold for a market price.

When exactly should a trustee decide that an investment is worthless and therefore amend their financial accounts and member benefits accordingly?  From a CGT perspective this generally cannot be done until the ATO agree that the asset has no value.

When should this happen within financial accounts?  Once it becomes clear that an investment is likely to go bad a trustee should not immediately change anything except to note in the fund’s accounts that the value currently given to a particular investment is unreliable but there is insufficient information to provide an accurate valuation.

As trustees involved in these unfortunate cases will know when problems occur the first people to stop talking are those involved in running an investment.  Often they don’t want to incriminate themselves anymore than they already might be.  Sometimes they don’t want give false hope or impressions.

The biggest problem for trustees is not reacting too quickly to market rumour.  For example in one recent case the market initially estimated that investors would receive 80 cents for each dollar invested.  A week or so later another estimation said under 50 cents.  Another estimated 10 cents.  One person even said one cent for each dollar invested.  Clearly no one has a clue what the ultimate value will be and it will probably take a long time before it is fully known.  If the trustee elects to participate in legal action designed to recover some of the losses then it can take even longer to work out a final price.

Trustees need to be aware that when they pay a benefit to a member they have to value assets at the net market value.  For the above example what is the net market value?  The only option open to a trustee is to value the asset at zero and pay the member accordingly but to note that further proceeds may be payable once the value of the underlying asset can be determined with satisfactory accuracy.

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