Question

Specialized Fraud Areas

Case 3

Patrick Edwards’ parents died recently in a freak accident. He is the executor of their estate. Provisions of their will divide the estate equally among his two brothers, Wesley and Mark, and himself with a few special provisions. The estate consists of cash and marketable securities worth $7.3 million and a duplex located on the beach on Padre Island.

One provision in the will allows the youngest brother, Mark, to keep the duplex as part of his share of the estate, and he wants to do that. This means that Patrick must come up with a market value for the duplex in order to determine what will be the equal division of the estate.

Valuing the duplex is not an easy proposition because of the unusual nature of the property. Part of the lot has a conservation easement, which means that it can never be sold to a developer for more dense development. In Patrick’s search of that entire area of the island, he did not find any other waterfront properties with a similar arrangement.

Patrick was able to find a few somewhat comparable properties in that area that had sold recently. All were considerably newer, and all properties had one more living unit than the estate property. The average selling price of these comparable properties was $1.2 million and average annual rental income was $36,000 per year per building after expenses.

The estimate for the replacement cost of the duplex in the estate is $650,000. The average estimated replacement cost for the comparable properties is $950,000.

As another factor, the owner of a neighboring property has always wanted more open space and would like to buy the property and tear down the duplex. He is willing to pay $1.3 million for the estate property.

Mark has a sentimental attachment to the duplex and does not want to sell it. He wants Patrick to value the property accordingly. Mark and Wesley have agreed to accept whatever valuation Patrick decides on.

Write responses to the following:

1) How should Patrick value the duplex apartment building?

2) Support your response with generally accepted accounting principles.

Answer 1

The valuation shall be based on the statement no 157 by FASB. It states that the real estate shall be valued on the basis of the best possible use of the asset at the fair value of the asset.

FAS 157 provides the following definition of "fair value": The price for which an asset can be sold in an orderly transaction to any willing buyer at the date when such valuation is made.

Therefore, the value of the duplex shall be $1.3 million as offered by the neighbor to buy the asset. This proves to be the fair market value of the asset offered by an independent buyer.

Other valuations are for bigger assets which will be reduced to calculate a value for duplex and doesn't prove to be efficient valuation.