IAS 40 - Investment Property (detailed review)

Thursday, January 23, 2014 Print Email

Objective

This Standard deals with the accounting treatment of investment property and provides guidance for the related disclosure requirements.

Scope

  • The requirements of this Standard are applicable to deal with the accounting treatment of Investment Property.
  • This Standard also applies to:
  • The books of lessee, for the accounting treatment of Property Interest held by lessee.
  • The books of lessor, for the accounting treatment of Investment Property provided to lessee under operating lease.
  • The Standard does not cover the followingaspects:

(a) For the classification of lease contracts,
(b) Treatment of Rental income related to investment property as covered in IAS 18.

Definitions

Investment Property:

It is any:

  • Land or Building, or
  • Part of Land & Building (Owned or held under finance lease)

Held for the purpose of

  • Rental earnings, or
  • Capital appreciation, or both

Other than

  • Property held for the purpose of use in production, supply of goods/services, or use in administration i-e. Owner Occupied Property (IAS 16) and
  • Property held for sale in normal course of business (IAS 2)

Examples of Properties which are treated as Investment Property:

(a) The property which is held for Capital Appreciation in long term.
(b) The Property which is held currently, for undetermined future use, i.e. (the owner has not yet decided the future use of property)
(c) The property held to be leased out under one or more operating leases to lessee.
(d) The property under construction, which will be used as Investment Property in future.

Examples of Properties which are not treated as Investment Property:

(a) The property which is held for sale in the normal course of business (IAS 2 Inventory),
(b) The property being constructed on behalf of third parties (IAS 11 Construction Contracts).
(c) The property held for the purpose of use in production, supply of goods/services, or use in administration i-e. Owner Occupied Property (IAS 16),
(d) The property which is occupied by employees, being provided by employer as part of remuneration package (whether or not the employee pays rent)
(e) The property which is held to be leased out, under a finance lease.

Owner Occupied Property:

The property (Owned or held under finance lease) for the purpose of:

  •  Use in the production,
  • Supply of goods/services or
  • Use in administration

Such type of property is covered under IAS 16

Property Interest:

 The properly held by lessee under operating lease, and lessee has the right to:

  • Sublet the property to other parties and
  • Participate in Capital Appreciation in the value of such property.

The property with such rights is called Property Interest.This Standard provides an option for such kind of Property interest, can be recognized as Investment Property, in the financial statements of lessee, under Fair Value model. This classification option is applicable upon each Property Interest on property-by-property basis.
If this classification option is opted for one such Property Interest, all other Investment Properties have to be accounted for under fair value model, and such classification option should be included in the disclosures.

Dual-Purpose Properties

If a property is being under dual-use i.e. property contains a part of the property which is held for rental earnings or capital appreciation and another part which is held for use in the production, supply of goods/services, or for use in administration. Such property will be accounted for as:

  •  If both portions are separable i.e. (could be sold or leased out separately under finance lease), then entity should account for each portion on individual basis under relevant IAS
  • If both portions are not separable i.e. (could not be sold or leased out separately under finance lease), the propertywill be treated as Investment Property only, if an immaterial part of such property is held for use in theproduction, supply of goods/services or for use in administration.

 

Ancillary Services

Investment property should not include Ancillary Services (Meals, Cleaning, Security, Utilities, and Maintenance services). If in case of a certain property, an entity provides ancillary services to the occupants of a property, the entity shall apply the following:

  • The property will be Investment Property, if quantum of the services is immaterial or insignificant. For example security or maintenance services.
  • The property will not be Investment Property, if quantum of the services is material or significant. For example, owner-managed hotel. Therefore, such properties will be covered in IAS 16

Investment Property in Consolidated Financial Statements

The property which is leased to, the Parent Co. by a Subsidiary Co. or vice versa, will not be treated as Investment Property in the consolidated financial statements, instead it will be treated as Owner-occupied Property under IAS 16, because the property is under owner-occupied use from the Group perspective.
However, the property will remain Investment Property in the individual financial statements of the entity who owns it.

Initial Recognition

A property will be recognized as Investment Property if it meets the following criteria:

  • The definition of Investment Property
  • If future economic benefits are probable to flow to the entity
  • Its cost is reliably measurable.

Initial Measurement

The Investment Property is initially measured at Cost including Transaction Costs.
The cost of Investment Property includes:

  • Purchase Price and
  • Any directly related cost such as (professional or legal charges, property transfer taxes & any other transaction costs).

Other Points related to Initial Measurement:

  • Any other cost which relates to ongoing activities of Investment property will be charged to Profit & Loss account as expense.
  • If the Investment Property is purchased on extended credit period, the cost of the property will be cash price equivalent and any excess over cash price will be treated as interest expense and will be recognize over the period of credit.
  • If lessee chooses to recognize the Property Interest as Investment Property as per classification option available in IAS 40, then the initial cost of such a Property Interest shall be prescribed, as for finance lease under IAS 17. Therefore, such a Property Interest will be recognized at the lower off:
  • The Present value of minimum lease payments and.
  • Fair value of the Property Interest or

The entity will also recognize a liability with an equivalent amount.

Subsequent Recognition:

  • Any expenditure upon Investment Property, during the life of Investment Property will be recognize in the carrying amount of investment property, if such expense results in increase in economic benefits of the investment property that would obtain otherwise.
  • Any other expense to maintain the Investment Property will be treated as expense in the statement of profit or loss.

Subsequent Measurement:

(1) The entity has two options to account for the Investment Property at reporting date;

  • Cost Model
  • Fair Value Model

(2) Whichever model is chosen, it should be applied for all the Investment Properties held by the entity.

  • Cost Model:

The entity which chooses Cost model to account for its Investment Property after initial recognition, will measure the investment Property as per Cost Model rules prescribed in IAS 16 i.e. Cost less Accumulated Depreciation less Accumulated impairment loss.

  • Fair Value Model:

The entity which chooses Fair Value model to account for its Investment Property after initial recognition, will measure the investment Property at Fair Value.

  • Under fair vale model, the investment property will be measured at fair value on reporting date.
  • Any change (increase or decrease) in the fair value of investment property at reporting date, will be reported to the statement of profit or loss.
  • Investment property under fair value model is not depreciated.
  • Once the entity opts to use the fair value model, it should be used for all the investment properties, except the Investment property for which fair value is not available under specified circumstances.
  • The entity which has opted to measure an investment property at fair value, it will continue to measure the property at fair value, up to the date of disposal or until the date of change in use of the property.
  • Fair Value Determination:

The fair value of the investment property is determined as per the requirements of IFRS 13; however the entity should also consider the following points;

  • The fair value should be determined as per the current condition of the investment property, in the current market conditions.
  • In determination of fair value of investment property, the entity should avoid the double-counting, by not considering the different items separately, which are the part of investment property, such items include lifts, air-conditioning, furniture & fixture and integral parts of abuilding.
  • If in exceptional circumstances, the fair value of a certain investment property is not determinable and alternative reliable measurements (discounted cash flows) are also not available, then entity should measure such investment property under cost model till the date of disposal and residual value of such property will assumed to be zero.
  • If the fair value of an investment property being constructed is not available,and entity estimates that the fair value of such property will be determinable upon its completion, then in such circumstances entity should account for the investment property being constructed under cost model until
  • Its fair value becomes available or
  • Construction work is finished

(3) A property interest held by a lessee, which is classified as an investment property as per classification option available in IAS 40, will be accounted for using the requirements of fair value model.
(4 ) An entity has the option, that it may choose cost model or the fair value model for the measurement of all the investment properties backing liabilities, whose return is directly linked to the fair value of, or returns from, specified assets and pool of investment properties.

Transfers

The transfer of property will take place, if there is change in the use of property such
As:
(a) The development of investment property, to be sold in the normal course of business, will result in transfer of property from IAS 40 to IAS 2.
(b) The use of investment property as owner-occupied property will result in transfer of property from IAS 40 to IAS 16.
(c) Cease of use of owner-occupation in a property to be used as investment property, will result in transfer of property from IAS 16 to IAS 40.
(d) If a property is let out under operating lease to other party, which was held for sale in normal course of business, will result in transfer of property from IAS 2 to IAS 40.

In all such circumstances the entity will apply the following accounting treatment:

  • If a property is transferred from inventory (IAS 2) to investment property (IAS 40), it will be measured at fair value, any difference between the fair value of property and its previous carrying value under IAS 2 will be reported in the statement of profit or loss on the date of reclassification. Subsequently, the entity will apply fair value model under IAS 40.
  • If a property is transferred from owner-occupied (IAS 16) to investment property (IAS 40) which will be measured at fair value, the entity will apply IAS 16 rules up to the date of reclassification. However, any difference between the fair value of property and its carrying value under IAS 16 on the date of reclassification will be treated as Revaluation Surplus/Loss,which will be accounted for as revaluation rules under IAS 16. Subsequently, the entity will apply fair value model under IAS 40.
  • If an investment property (IAS 40) is transferred to inventory (IAS 2) or owner-occupied property (IAS 16), no gain/loss will arise on the date of reclassification and carrying value under IAS 40 will become deemed cost for subsequent accounting.
  • When the development of the investment property under construction is completed, which will be measured under fair value model, any resulting difference between its fair value and carrying value will be reported to the statement of profit or loss.

De-recognition of Investment Property

The investment property will be derecognized from the financial statements, under following situations:

  • Upon disposal of Investment property or
  • When no economic benefits are available either by use of property or from its sale
  • However, any gain or loss, resulting from the disposal of investment property will be charged to statement of profit or loss in the related period.
  • Any compensation recoverable from any third parties will be recognized in statement profit or loss, in respect of investment property which was impaired or lost, in the period in which it becomes receivable.

Disclosures

1.The entity should disclose the following:
(a) The measurement model used by the entity i.e. the cost or fair value model.
(b) The circumstance in which entity has opted the classification option for property interest.
(c) How entity has determined the fair value for investment property.
(d) Any amounts recognized in statement of profit or loss in respect of:

  • Any rental earnings from investment property
  • Any operating expense such as repair & maintenance
  • Any movement in fair value of investment property.

(e) For the investment property under cost model, the entity should disclose:

  • Depreciation Method
  • Estimate of useful life
  • Its gross carrying amount
  • Any amount of impairment loss

(f) For the property for which fair value could not be determined and the entity has to measure such property under cost model, the entity should disclose:

  • Nature of the Investment Property
  • Reason why the fair value is not determinable

(g) For the property which has been disposed off the entity should disclose:

  • Its carrying amount on disposal date
  • Any amount of gain or loss on disposal

 

Worked Examples:

Example 1:

AB Ltd is local government organization that owns a credible portfolio of properties which includes the properties which are surplus to the functional requirements and some other properties which are held by the entity for different purposes.
The portfolio includes several plots of land which are held for capital appreciation and may be sold in the future. The entity has also some properties which have no current purpose, as the entity has not yet determined whether it will use those properties to provide services such as those provided by national parks or will put these on sales in the ordinary course of business.
AB Ltd also has a housing department to deal with regular sale and purchase of some plots of land included within the portfolio of the properties, in the normal course of business to supplement its income. Parts of the portfolio, some properties which are not held for sale, are provided as a housing facility to low-income employees at nominal rentals, which are then used to cover the cost of maintenance of the properties.

Required;
How the properties included in the portfolio will be accounted for in the financial statements of AB Ltd.

Solution:

Investment Property is covered under IAS 40, as per IAS 40 Investment property is:

  • Land or Building, or
  • Part of Land & Building (Owned or held under finance lease)

Held for the purpose of

  • Rental earnings, or
  • Capital appreciation, or both

Other than

  • Property held for the purpose of use in production, supply of goods/services, or use in administration i-e. Owner Occupied Property (IAS 16) and

Property held for sale in normal course of business (IAS 2)

A property will be recognized as Investment Property if it meets the following criteria:

  • The definition of Investment Property
  • It is probable that future economic benefits ill flow to the entity
  • The cost is reliably measurable.

Therefore, the plots of land which are held by the entity for capital appreciation and the properties that has no current purpose are both covered by IAS 40 as investment property as they satisfy the definition criteria.
And the plots of land which are held for sale in the normal course of business, by housing department will be treated as inventory under IAS 2. Whereas, the properties which are not held for sale and are provided to low income employees as a housing facility as part of the business will be accounted for as property plan and equipment under IAS 16, as these are not primarily held for rental earnings, which is reflected by the lower rentals.

 

Examples 2:

AB Ltd owns two properties at 1 January 2013:

Property X:
A headquarter building is held by the entity for administrative use. The property has a carrying value of $4 million at 1 January 2013 with a remaining life of 20 years. At 1 July 2013, the entity under goes a reorganization and as a result, the property was let out to a third party and reclassified as an investment property under fair value model as per IAS 40. An independent expert valued the property at a fair value of $4.6 million at 1 July 2013, and this has risen up to $4·68 million at 31 December 2013.

Property Y:
This is an office building, which is sub-let to a subsidiary of AB Ltd. The property had a fair value of $3 million at 1 January 2013, which was raised to $3·30 million at 31December 2013.

Required:

  • Prepare extracts of financial statements of AB Ltd for the year ended 31/12/2013.
  • The treatment of Property ‘Y’, in the consolidated financial statements of AB Ltd.

Solution:

(a) Extracts of AB Ltd. Financial Statements:

Statement of Profit or loss:


For the year ended 31/12/2013

 

                                  

$’000

Depreciation of Headquarter Building ($4,000/20years * 6/12)

(100)

Fair Value Gain on Property X ($4,680-$4,600)

80

                               Property Y ($3,300-$3,000)

300

 

Other Comprehensive Income:

 

Revaluation Surplus on headquarter Building [$4,600-($4,000-100)]

700

Statement of Financial Position:
As on 31/12/2013

Assets:

 

Non-Current Assets:

 

Investment Property (X & Y) ($4,680+$3,300)

7,980

Equity:

 

Revaluation Surplus

700

(b) Property ‘Y’ in Consolidated Financial Statements:

The property will be treated as owner occupied property under IAS 16 in consolidated financial statements, from the group perspective.

Quote Guest, 15 August, 2016
you did record revaluation surplus in profit and lost accounting how is it possible

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