To outline the accounting treatment for investment properties and the disclosure requirements.
The standard does not apply to:
- Biological assets related to agricultural activity
- Mineral rights and reserves
Investment property is property (land or buildings or part of a building) held to earn rental or for capital appreciation or both, rather than for:
- Use in the production or supply of goods or services or for administrative purposes or
- Sale in the ordinary course of business.
Note that the standard says it is “property held”. This means that the entity does not have to own title to the property. Investment property held under a finance lease is included in the definition.
Recent changes to IAS 40 have seen the possible inclusion in the definition of property held under an operating lease. Property held by a lessee under an operating lease shall qualify as an investment property if, and only if, the property would otherwise meet the definition of an investment property and the lessee uses the “fair value” model for the asset recognised. It should be noted, however, that once this model is selected for one property held under an operating lease, all property classified as investment property should be accounted for using the “fair value” model.
This aspect of recognising investment property was included in the Standard in response to the situation in some countries where properties are held under long leases that provide rights that are broadly similar to those of a purchaser. The inclusion in the Standard of such interests allows the lessee to measure such assets at fair value.
The nature of investment properties is different from other types of land and buildings and consequently the accounting treatment will be different also. By earning rentals or capital appreciation (or both), investment properties generate cash flows that are mostly independent of other assets held by the entity.
RECOGNITION AND INITIAL MEASUREMENT
Investment property should be recognised as an asset when, and only when:
- It is probable that future economic benefits will flow to the entity from the property, and
- The cost of the property can be measured reliably.
Such are the normal requirements for the recognition of assets.
An investment property should be measured initially at its cost. Transaction costs should be included in the cost of the property.
The cost of a purchased investment property includes its purchase price and any other directly attributable expenditure, for example:
- Legal fees
- Property transfer taxes (e.g. stamp duty)
- Other transaction costs
The cost of a self-constructed investment property is its cost at the date when the construction is completed. (Up to the date of completion, the property would be accounted for using IAS 16).
If the property is held under a lease, then the asset should be measured initially at the lower of the:
- Fair value of the property, and
- Present value of the minimum lease payments (including any premium paid for lease).
IAS 40 allows the entity to choose from two different options when accounting for the subsequent measurement of its investment properties. These options are:
- Cost model, or
- Fair Value Model
Using this approach, all investment properties are treated like other properties under IAS 16 Property, Plant and Equipment i.e. shown at:
Less Accumulated Depreciation
Less Accumulated Impairment Losses
[Note, that if the investment property is held for sale as defined in IFRS 5 Non-Current Assets Held For Sale and Discontinued Operations, the investment property should be measured in accordance with that standard.]
FAIR VALUE MODEL
This model requires the entity to revalue all of its investment property at fair value.
[As stated earlier, if the property is held by the lessee under an operating lease, the fair value model must be applied.]
Any gain or loss that arises from revaluing to fair value should be treated as part of the profit or loss for the period (i.e. in the income statement).
The fair value is the price at which property could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
This fair value should reflect market conditions at the Statement of Financial Position date. Thus, the fair value is usually calculated by comparing current prices for similar properties in an active market.
In estimating fair value, the entity should consider a number of factors and sources:
- Current prices in an active market for properties of a different nature, condition or location, adjusted to reflect those differences
- Recent prices of similar properties on less active markets, adjusted to reflect changes in economic conditions
- Discounted cash flow projections based on reliable estimates of future cash flows.
[In exceptional circumstances, if the fair value of the property cannot be estimated reliably on a continuing basis, the property should be measured using the cost model in IAS 16. This policy should be applied until the property is disposed of.]
There is a major difference between the fair value policy allowed in IAS 40 and the revaluation policy allowed under IAS 16.
In IAS 40, all gains and losses on revaluation to fair value go to the Income Statement.
In IAS 16, if an asset is revalued to fair value, gains are credited to a revaluation reserve.
The IASB take the view that the fair value model is appropriate for investment properties as this is consistent with accounting for financial assets held as investments require by IAS 39 Financial Instruments: Recognition and Measurement.
Transfers to or from investment property can only be made when there is a change in use.
There are a number of possibilities:
- Transfer from investment property to owner-occupied property i.e. commencement of owner occupation.
The fair value of the property at the date of change is determined and used for subsequent accounting under IAS 16.
- Transfer from investment property to inventories i.e. commencement of development with a view to sale.
The fair value of the property at the date of change is determined and used for subsequent accounting under IAS 2 Inventories.
- Transfer from owner occupied property to investment property i.e. end of owner occupation.
If the investment property is to be carried at fair value, the entity should apply IAS 16 up to the date of change in use.
Any difference at that date, between the carrying amount of the property under IAS 16 and its fair value, is treated in the same way as a revaluation in accordance with IAS 16. That is, gains will be credited to a revaluation reserve and losses will be charged to the income statement.
[Please refer to IAS 16 for treatment of such gains and losses where there have been previous revaluations.]
- Transfer from inventories to investment property through the commencement of an operating lease to another party.
Here, any difference between the fair value of the property and its carrying amount at that date should be recognised in profit or loss.
- Transfer from property in the course of construction or development (covered by IAS 16) to investment property i.e. end of construction/development.
As with (d), any difference between the fair value of the property and its carrying amount at that date should be recognised in profit or loss.
How should WTE account for these property movements under IAS 40 and IAS 16, assuming the company implements the Fair Value Model and the Revaluation Model, respectively?
When the property was acquired in 2008, it was the intention of WTE to let the property out to a government department. The property was held to acquire rentals and thus, qualifies as an investment property under IAS 40. The acquisition cost, together with the cost of renovation, which totalled RWF3,600,000, should be included as investment property in the Statement of Financial Position.
At 31st December 2008, the property is revalued to its fair value of RWF4,000,000 and the gain of RWF400,000 should be recognised in the Income Statement for that year.
In February 2009, the property was valued at RWF4,200,000 and WTE decided to relocate its head office to this property. Since the property is now owner occupied (see Section J below), it no longer meets the definition of an investment property. It is no longer held for rentals (or capital appreciation) but for use in the business. It’s changed in status means that from the date of change, it will now be dealt with under IAS 16.
At the time of the transfer from investment property to PPE, the fair value is deemed to be the “cost” of the property under its new classification. The increase from its book value of RWF4,000,000 to its fair value of RWF4,200,000 (i.e. RWF200,000) should be recorded in the calculation of profit for the period.
In addition, WTE secured tenants for its old Head Office building. Again, there is a change in the status of that building as it is now meets the definition of an investment property, and is no longer PPE. Thus, it will now be dealt with under IAS 40.
IAS 16 applies up to the date of the transfer from PPE to investment property. Any difference arising between the carrying value under IAS 16 at that date and the fair value is accounted for as a revaluation under IAS 16.
The carrying value of the property was RWF3,000,000 and the market value in February 2009 was RWF3,600,000. Therefore, the increase of RWF600,000 is recorded as a revaluation surplus prior to reclassification. It is not included in the profit calculation for the period.
OWNER-OCCUPIED PROPERTY AND INVESTMENT PROPERTY
This is property held for use in the production or supply of goods or services or for administrative purposes, and thus is not investment property.
IAS 40 points out, however, that some properties comprise a portion that is held for rentals and/or capital appreciation and another portion that is owner-occupied.
If these portions could be sold separately, (or leased out separately under a finance lease) an entity accounts for the portions separately. If the portions cannot be sold separately, the property is an investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administration purposes.
The term “insignificant” is not defined and is left to subjective judgement. However, in other Standards, indications are that 2% may be an applicable level.
In the case of groups of companies, where one group member leases a property to another group member, then at group or consolidation level, the property is classified as owner occupied. However, at an individual company level, the owner of the property should treat it as an investment property. Thus, appropriate adjustments would need to be made in the group accounts.
Gains or losses on disposal are calculated in the usual way, i.e.
Net Disposal Proceeds
Less Carrying Amount of the Asset
Such gains or losses should be recognised in the Income Statement, in the period of the disposal, (unless IAS 17 requires otherwise on a sale or leaseback).
DISCLOSURE REQUIREMENTS: FAIR VALUE MODEL AND COST MODEL
The following must be disclosed:
- Whether the fair value model or cost model has been applied.
- If it applies the fair value model, whether, and in what circumstances, property held under operating leases are classified and accounted for as investment property.
- If classification is difficult, the criteria used to distinguish investment property from owner occupied property.
- The methods and assumptions applied in determining fair value.
- The extent to which the fair value is based on a valuation by an independent, qualified, experienced valuer. If there has been no such valuation, this fact must be disclosed.
- The amounts recognised in profit or loss for:
- Rental income from investment property
- Direct expenses arising from investment property that generated rental income for the period
- Direct expenses from investment property that did not generate rental income for the period
- The existence and amounts of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal
- Contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements.
Fair Value Model
In addition to the disclosures required above, if the fair value model is being applied the entity must also disclose a reconciliation between the carrying amount of investment property at the beginning and end of the period, showing:
- Additions resulting from acquisitions through business combinations
- Assets classified as held for sale
- Net gains or losses from fair value adjustments
- Net exchange differences on translating foreign investment property (f) Transfers to and from inventories and owner-occupied properties
- Other changes
If the cost model is being applied, the entity must disclose, in addition to other disclosures mentioned above:
- The depreciation methods used
- The useful lives or depreciation rates used
- The gross carrying amount and the accumulated depreciation (including any impairment losses) at the beginning and end of the period
- A reconciliation of the carrying amount at the beginning and end of the period, showing:
- Additions resulting from acquisitions through business combinations (iii) Assets classified as held for sale
- Impairment losses
- Net exchange differences on translating foreign investment property (vii) Transfers to and from inventories and owner occupied property (viii) Other changes
- The fair value of investment property. If it cannot determine fair value reliably, it must disclose
- A description of the investment property
- An explanation of why fair value cannot be determined reliably
- If possible, the range of estimates within which fair value is highly likely to lie.