IAS 40 Fair Value Model vs Cost Model: Which to Choose?
IAS 40 Fair Value vs Cost Model: Key Differences
- IAS 40 offers two subsequent measurement models: the fair value model and the cost model. Entities must choose one and apply it to their entire investment property portfolio.
- Under the fair value model, gains and losses go through profit or loss — no depreciation is charged.
- Under the cost model, the property is depreciated per IAS 16 and fair value is only disclosed, not recognised.
- The choice significantly affects reported profit, balance sheet values, and investor perception.
- Switching from fair value to cost is rarely permitted — the standard strongly favours consistency.
The IAS 40 fair value model and the cost model are the two mutually exclusive approaches to measuring investment property after initial recognition. The fair value model carries the property at its current market value each period — with all changes flowing through profit or loss — while the cost model carries the asset at historical cost less accumulated depreciation and impairment, identical to IAS 16 treatment.
Choosing between these models is one of the most consequential accounting policy decisions a property-holding entity can make. This guide breaks down how each model works, compares the financial statement outcomes using Delta Properties Ltd, and explains the practical considerations that drive the choice.
Overview: Two Models, One Policy Choice
IAS 40 paragraph 30 requires an entity to choose either the fair value model or the cost model for its entire portfolio of investment property. The choice is an accounting policy — it must be applied consistently and disclosed in the financial statements. You cannot apply the fair value model to some properties and the cost model to others unless your investment property includes property held under operating leases (which must use the fair value model if the fair value option is elected for other property).
The Fair Value Model — How It Works
Under the fair value model (IAS 40.33–55), an investment property is carried at its fair value at each reporting date. Fair value is determined in accordance with IFRS 13 Fair Value Measurement, which defines fair value as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
Key Mechanics
- No depreciation: Because the asset is remeasured to fair value each period, there is no separate depreciation charge.
- Gains and losses in P&L: Any increase or decrease in fair value is recognised in profit or loss in the period it arises. This differs from the IAS 16 revaluation model, where surpluses go to OCI.
- Annual remeasurement: The entity must obtain a reliable fair value estimate at each reporting date. This typically involves professional property valuations.
- Rebuttable presumption: IAS 40 contains a rebuttable presumption that an entity can always determine fair value reliably on a continuing basis. If this presumption is rebutted, the entity must use the cost model for that particular property.
Rental Income Under Fair Value Model
Rental income is recognised separately in profit or loss — it is not netted against fair value movements. Operating expenses attributable to the investment property (repairs, management fees, insurance) are also recognised in profit or loss.
Opening carrying amount: $820,000 (cost at acquisition)
Fair value at year-end: $870,000
Fair value gain recognised in P&L: $50,000
Rental income recognised in P&L: $60,000
No depreciation charged
Closing balance sheet carrying amount: $870,000
The Cost Model — How It Works
Under the cost model (IAS 40.56), an investment property is measured at its cost less accumulated depreciation and accumulated impairment losses. This is exactly the same basis as per IAS 16 — which means all the IAS 16 rules on depreciation methods, useful life review, residual value, and impairment testing (IAS 36) apply.
Key Mechanics
- Depreciation required: The depreciable amount (cost less residual value) is allocated over the asset's useful life on a systematic basis.
- Impairment testing: The entity must assess at each reporting date whether there is any indication of impairment and, if so, estimate the recoverable amount under IAS 36.
- Fair value disclosed: Even under the cost model, IAS 40 requires the entity to disclose the fair value of its investment property in the notes (IAS 40.79(e)).
- More predictable P&L: The cost model produces a stable, predictable depreciation charge each period, avoiding the P&L volatility of fair value remeasurement.
Cost: $820,000 | Useful life: 50 years | Straight-line, no residual value
Annual depreciation: $820,000 ÷ 50 = $16,400
Rental income: $60,000
Depreciation expense: ($16,400)
Fair value gain: NOT recognised (fair value $870,000 disclosed in notes only)
Closing carrying amount: $820,000 − $16,400 = $803,600
Journal Entries Compared
At Acquisition (Identical for Both Models)
   Cr Bank                        $820,000
(Purchase price $800,000 + transaction costs $20,000)
Rental Income (Identical for Both Models)
   Cr Rental Income (P&L)       $60,000
Year-End — Fair Value Model
Dr Investment Property                 $50,000
   Cr Fair Value Gain (P&L)           $50,000
No depreciation journal entry required.
Year-End — Cost Model
Dr Depreciation Expense           $16,400
   Cr Accumulated Depreciation  $16,400
No fair value gain recognised. Fair value of $870,000 disclosed in notes.
If Fair Value Falls — Fair Value Model
Dr Fair Value Loss (P&L) Â Â Â Â Â Â Â Â Â Â Â $30,000
   Cr Investment Property          $30,000
This loss is recognised immediately in P&L — there is no buffer or OCI reserve to absorb it.
Financial Statement Impact
| Impact Area | Fair Value Model | Cost Model |
|---|---|---|
| Profit or Loss | Higher if FV rises; volatile; includes FV gain | Stable; includes depreciation charge |
| Balance Sheet (Asset) | Reflects current market value | Historical cost less depreciation (may be understated) |
| OCI | No impact (FV changes go to P&L) | No impact |
| Tax (Deferred) | FV gains may create deferred tax liabilities | Timing differences from depreciation |
| Retained Earnings | Boosted by FV gains; reduced by FV losses | Reduced by depreciation annually |
| Gearing / Leverage | Asset values higher; better gearing ratio in rising markets | Asset values lower; gearing may appear higher |
The impact on retained earnings and distributable profits is a key consideration for dividend policy. See our retained earnings complete guide for how investment property accounting affects equity.
Pros and Cons of Each Model
Fair Value Model
| Advantages | Disadvantages |
|---|---|
| Balance sheet reflects real economic value | P&L volatility — unrealised gains/losses affect profit |
| Transparent for investors and lenders | Valuation costs — professional valuers needed annually |
| No depreciation charge — higher short-term profits in rising markets | Subjectivity in valuation — Level 3 inputs may be used |
| Preferred by REITs and listed property companies | Falling markets can devastate reported profits |
Cost Model
| Advantages | Disadvantages |
|---|---|
| Stable, predictable P&L | Balance sheet may be significantly understated |
| No annual professional valuation required | Fair value still needs to be estimated for disclosure |
| Simpler to apply in practice | May obscure the true economic performance of the portfolio |
| Less sensitivity to market fluctuations in P&L | Impairment testing still required under IAS 36 |
Can You Change Between Models?
IAS 40 allows a voluntary change in accounting policy only if the change results in a more relevant and no less reliable presentation. In practice:
- A change from the cost model to the fair value model is more likely to be justified, as fair value generally provides more relevant information.
- A change from the fair value model to the cost model is unlikely to result in more relevant information and would rarely be permitted.
Any permitted change in accounting policy must be applied in accordance with IAS 8 — retrospectively, adjusting comparative information, unless it is impracticable to do so.
Delta Properties Ltd — Side-by-Side Comparison
Let's see how Delta Properties' financial statements look after Year 1 under each model.
| Financial Statement Line | Fair Value Model | Cost Model |
|---|---|---|
| Rental income | $60,000 | $60,000 |
| Fair value gain | $50,000 | Nil (disclosed only) |
| Depreciation expense | Nil | ($16,400) |
| Net profit contribution | $110,000 | $43,600 |
| Balance sheet — Investment Property | $870,000 | $803,600 |
| Fair value disclosed in notes | N/A (on face of B/S) | $870,000 (note disclosure) |
The difference in reported profit ($110,000 vs $43,600) is striking — largely due to the $50,000 fair value gain included in P&L under the fair value model and the $16,400 depreciation excluded from the fair value model but charged under the cost model.
For the complete journal entry set covering both models across multiple years, transfers, and disposals, see our IAS 40 Examples & Journal Entries guide.
Related Reading
- IAS 40 Investment Property: Complete Guide — Start here for the full standard overview
- Investment Property Accounting: Recognition, Measurement & Entries
- IAS 40 Disclosure Requirements — What to report under each model
- IAS 40 Examples & Journal Entries
- Depreciation Methods — How cost model depreciation works
- Goodwill Impairment: Complete Guide
Frequently Asked Questions — Fair Value vs Cost Model
1. Does the fair value model require a professional valuation every year?
IAS 40 does not explicitly mandate a professional valuation — but it does require the fair value to be determined reliably at each reporting date. In practice, most entities use independent qualified valuers annually, particularly for listed entities where auditors scrutinise fair value estimates closely. For properties with active markets, internal estimates supported by observable data may suffice.
2. What if fair value cannot be reliably determined?
IAS 40 contains a rebuttable presumption that an entity can always determine fair value reliably on a continuing basis. However, if this presumption is rebutted in exceptional circumstances — for example, for a unique property with no comparable market data — the entity must use the cost model for that specific property and continue disclosing its fair value if the situation changes.
3. Can a company apply the fair value model to some properties and cost model to others?
Generally, no. The policy must be applied to the entire portfolio of investment property. The one exception is where property held under operating leases is classified as investment property — these are measured at fair value as a matter of policy, separate from other investment property.
4. How does the fair value model affect distributable profits?
Under the fair value model, unrealised fair value gains flow through profit or loss and into retained earnings. In some jurisdictions, these unrealised gains may not be legally distributable as dividends — companies must check local company law requirements alongside IFRS. This is a critical consideration for dividend policy and capital management.
5. Which model is more common in practice?
The fair value model is more commonly used by entities with significant investment property portfolios — particularly listed real estate companies, REITs, and property funds. It provides more relevant information to investors and lenders. The cost model is more common among smaller entities or those with incidental property holdings.
6. Does the cost model require impairment testing?
Yes. Under the cost model, an entity must apply IAS 36 Impairment of Assets and test for impairment whenever there is an indication that the property's carrying amount may exceed its recoverable amount. Under the fair value model, impairment testing is not applicable because the asset is already carried at its current value.
7. What happens to fair value gains when the investment property is eventually sold?
When investment property measured under the fair value model is sold, the gain on disposal is calculated as net proceeds minus the fair value carrying amount at the date of sale. There is no recycling of previously recognised gains — the gain on disposal simply reflects the difference between the sale price and the most recent carrying amount.
Master IAS 40 and All IFRS Standards
The ACCA DipIFR covers fair value measurement, investment property, and every major IFRS standard in detail. Whether you are preparing for an exam or applying IFRS in practice, our resources will get you there.
About the Author
Eduyush Team — Our content is created by qualified accounting and finance professionals with extensive experience in IFRS, ACCA, CMA, and CPA curriculum design. The Eduyush Team brings together practitioners and educators to deliver technically accurate, exam-relevant guidance for accounting students and professionals worldwide.
Expertise: IFRS Standards | IAS 40 | Fair Value Measurement | ACCA DipIFR | Investment Property
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