Workbook on IAS 40 Investments
Scope
Accounting for investment properties differs from that of owner-occupied properties. The key difference is that when an investment property is revalued, the unrealised gain (or loss) is recorded in the income statement.
In contrast, when an owner-occupied property is revalued, any gains are taken directly to equity in the form of a revaluation reserve.
IAS 40 is applied to recognition, measurement and disclosure of investment property. IAS 40 does not deal with matters covered in IFRS 16 Leases, including:
classification of leases as finance leases, or operating leases;
recognition of lease income from investment property;
measurement in a lessee’s financial statements of property interests held under a lease, accounted for as an operating lease;
measurement in a lessor’s financial statements of its net investment in a finance lease;
accounting for sale and leaseback transactions; and
disclosure about finance leases and operating leases.
However, IAS 40 makes reference to both operating and finance leases of investment property and the accounting for both covered in IAS17. When property becomes the subject of a sale-and-leaseback transaction, IAS 40 refers the reader to IFRS 16 to account for the transaction.
IAS 40 does not apply to:
biological assets related to agricultural activity (see IAS 41 Agriculture); and
mineral rights and mineral reserves such as oil, natural gas, and similar non-regenerative resources.
Definitions
Carrying Amount
A carrying amount is the amount at which an asset is recorded in the balance sheet.
Cost
Cost is the amount of cash (or cash equivalents) paid, or the fair value of other consideration given, to acquire an asset at the time of its purchase, or construction. Where payment is in shares, please see IFRS 2 workbook.
Fair Value
Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. (IFRS 13)
Investment Property
Investment property is property that can be:
land, or
a building, or
part of a building, or
both land and building.
It is held by the owner (or by the lessee, under a finance lease) to earn rent, or for capital appreciation, or both.
It includes:
(1) land held for long-term capital appreciation rather than for short-term sale in the ordinary course of business.
(2) land held for a currently undetermined future use. (If an undertaking has not determined that it will use the land as owner-occupied property or for short-term sale in the ordinary course of business, the land is regarded as held for capital appreciation.)
(3) a building owned by the entity (or held by the entity under a finance lease) and leased out under one or more operating leases.
(4) a building that is vacant but is held to be leased out under one or more operating leases.
(5) property that is being constructed or developed for future use as investment property.
It does not include property held by the owner or lessee:
for the owner’s or lessee’s use in the production, supply of goods, services, or for administrative purposes; or
for sale in the ordinary course of business.
Owner-occupied property
Owner-occupied property is property held (by the owner, or by the lessee under a finance lease) for use in the business and IAS 16 Property, Plant and Equipment applies to owner-occupied property.
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EXAMPLE owner occupied You buy a property to let, but the tenant goes bankrupt. Temporarily you use it as offices whilst you seek a new tenant. During this time, it is owner-occupied property. |
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A property interest that is held by a lessee, under an operating lease, may be classified and accounted for as investment property only if the property would otherwise meet the definition of an investment property, and the lessee uses the fair value model for the asset. The lease must be accounted for as a finance lease under IFRS 16.
The fair value model is described later in this book.
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EXAMPLE investment property You buy a 25-year lease of half an office block, sublet all the property to third parties, and use the fair value model. This is investment property. |
Once this classification alternative is selected for one property interest held under an operating lease, all property classified as investment property is accounted for using the fair value model, and accounted for as finance leases under IFRS 16.
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EXAMPLE fair value for whole portfolio Your client buys short-term leases of retail shops and subleases them as bazaars. Your client treats one property as investment property. Due to this, all investment property in your client’s portfolio must be accounted for using the fair value model. |
Investment property is held to earn rent, or for capital appreciation, or both.
The following are examples of investment property:
(1) land held for long-term capital appreciation, rather than for short-term sale in the ordinary course of business. land held for an undetermined future use. The land is regarded as held for capital appreciation.
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EXAMPLE How should management recognise land held for a currently undetermined future use? Issue Investment property is land or buildings (or part thereof) held by the owner or lessee under a finance lease to earn rental income or for capital appreciation, or both. How should management recognise land held for a currently undetermined future use? Background Bank A is involved in real estate development. A has purchased land in Moscow through the exercise of a purchase option that had been acquired some years ago. The purchase price was 10 million and the fair value of the land as determined by an independent valuer is 23.7 million. The bank is undecided about whether to develop the land for sale to a third party or sell it, but will determine a use within the next accounting period. The bank’s accounting policy is to recognise investment property at fair value. Solution The land should be classified as inventory. Although the bank has not determined a use, the property is being held either for sale or for further development and eventual sale in the ordinary course of business. The property would be held at the lower of cost and fair (market) value. Had the bank decided to hold the land for long-term capital appreciation rather than short-term sale in the ordinary course of business, then it would be classified as investment property. |
a building owned by the bank (or held by the bank under a finance lease) and leased out, via operating leases.
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EXAMPLE investment property You own a 99-year (finance) lease on a building. After using it as bank premises, you have organised the building into 50 separate offices, for startup businesses. You sublet these offices (via operating leases) to different entrepreneurs. This is investment property. |
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a building that is vacant, but is held to be leased out via one, or more, operating leases.
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EXAMPLE investment property You own a 99-year (finance) lease on a building. You have converted the building into 50 separate offices, for startup businesses. You plan to sublet these offices (via operating leases) to different entrepreneurs, but are awaiting the approval of the local authorities. This is investment property. |
The following are examples of items that are not investment property and are outside the scope of IAS 40
property held for sale in the ordinary course of business, or in the process of construction, or development. These are accounted for under IAS 2 Inventories, or IFRS 5.
Included as owner-occupied property is property held for future use as owner-occupied property, property held for future development and use as owner-occupied property, property occupied by employees (whether, or not, the employees pay rent at market rates) and owner-occupied property awaiting disposal. Such properties are accounted for under IAS 16, not IAS 40.
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EXAMPLES owner-occupied property. You own the following properties:
All are owner-occupied property. |
IAS 40 applies to existing investment property that is being redeveloped for continued use as investment property.
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EXAMPLES investment property You own the following properties: 1. Land on which you will develop offices to let. 2. An office block that is being modernised to increase rents. The office was leased to third party tenants, and will also be leased to third party tenants when modernised. It will continue to be accounted for as investment property throughout the modernisation. 3. Property being constructed for future use as investment property Issue Investment property is land or buildings (or part thereof) held by the owner or lessee under a finance lease to earn rental income or for capital appreciation, or both. i) can property being constructed for future use as investment property be recognised as investment property during the construction period? ii) how should the accounting change if management is redeveloping an existing investment property? Background A bank has recently acquired a plot of land to construct an office building. The land and building will be leased to a third party under an operating lease agreement when the development is completed. Solution i) IAS 40 applies. ii) Management can continue to recognise the property as investment property during the construction period. Redevelopment of investment property for continued future use as investment property is within the scope of IAS 40. These properties continue to be recognised as investment property, and are measured at either cost, or fair value, depending on the accounting policy the bank has adopted. |
property that is leased to another bank, under a finance lease.
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EXAMPLE owned land leased You own a building that is leased to a third party under a 999-year finance lease. This is not an investment property. You account for the lease as an account receivable. (See IFRS 16) |
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EXAMPLE Investment property is land or buildings (or part thereof) held by the owner or lessee under a finance lease to earn rental income or for capital appreciation, or both. How should management classify a property that is held for undetermined future use? Background B is a supplier of industrial paint in Germany. In 20X3, B purchased a plot of land on the outskirts of Frankfurt that has mainly low-cost public housing and has very limited public transport facilities. The government has plans to develop the area as an industrial park in five years’ time, and the land is expected to greatly appreciate in value if the government proceeds with the plan. B’s management has not decided what to do with the property. Solution Management should classify the property as an investment property. Although B has not determined a use for the property after the park’s development, in the medium term the land is held for capital appreciation. IFRS considers land as held for capital appreciation if the owner has not determined whether it will use the land either as owner-occupied property, or for short-term sale, in the ordinary course of business. The owner should choose either the fair value model, or the cost model, to recognise the investment property. |
Some properties comprise:
a portion that is held to earn rent, or for capital appreciation,
another portion that is held for use in the production, supply of goods, services, or for administrative purposes.
If these portions could be leased out separately, the portions are accounted for separately. This also applies if the law allows the parts to be sold separately.
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EXAMPLE part-leased, part-owned A client owns a petrol station, which it operates. Above the petrol station is an office that it leases to a third party. The petrol station is owner-occupied property, and the office is investment property, and is accounted for separately. |
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EXAMPLE Property held to earn rentals. Issue Property, plant and equipment (PPE) are tangible assets that a bank: i) uses in the production or supply of goods or services, rents to others, or uses for administrative purposes; and ii) expects to use for more than one period. Certain properties include a portion that is held to earn rentals or for capital appreciation, and another portion that is held for use in the production or supply of goods and services or for administrative purposes. If these portions can be sold separately (if the law allows), or leased out separately under a finance lease, a bank accounts for the portions separately. The property is treated exclusively as investment property if an insignificant portion is held for use in production, or supply of goods or services, or for administrative purposes. How should the condition that the portions be capable of separate sale, or lease under finance lease, be interpreted for the purpose of determining if split accounting is appropriate? Background A bank owns an office building. The bank occupies nine of the ten floors as its head office, while the tenth floor is leased out to a third party under an operating lease. Management proposes that the property be treated entirely as PPE because the portion leased to a third party is leased under an operating lease and only represents 10% of the property. Solution Management should recognise nine floors as PPE, but the remaining one floor as investment property. The conditions regarding separate sale or lease under finance lease relate only to management’s ability and not to the terms of any current lease. The requirement for the property to be capable of being leased under a finance lease is to ensure that the definition of an investment property included in of IAS 40 is met. The amount of the property leased, 10%, is more than an insignificant portion of the property. The requirement to account separately for the PPE and investment property elements must be followed, assuming the 10th floor can be sold, or leased out under a finance lease. |
If the portions could not be sold separately, the property is investment property, only if an insignificant portion is held for use in the production, supply of goods, services, or for administrative purposes.
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EXAMPLE sublet You sublet 3 floors of your office block to a third party, but your staff can share the canteen and restrooms within the sublet area. The sublet area is investment property. |
In some cases, a bank provides ancillary services to the occupants of a property it holds. A bank treats such a property as investment property, if the services are insignificant to the arrangement as a whole.
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EXAMPLE insignificant services provided The owner of a building provides security and maintenance services to the lessees, who occupy the building. The building is the owner’s investment property. |
In other cases, the services provided are significant.
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EXAMPLE significant services provided Your client owns and manages a office building. Services provided to guests are significant to the arrangement as a whole. Therefore, an owner-managed office building is owner-occupied property, rather than investment property. |
It may be difficult to determine whether ancillary services are so significant that a property does not qualify as investment property. For example, the owner of an office building sometimes transfers some responsibilities to third parties under a management contract.
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EXAMPLES outsourcing A office building owner’s position may be that of a passive investor, having outsourced all running of the property to another firm. Alternatively, the owner may only have outsourced some day-to-day functions, such as the catering. |
Judgment is needed to determine whether a property qualifies as investment property.
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EXAMPLE Investment and owner occupied You lease your whole factory to your parent company. In your financial statements it is treated as investment property. In the group accounts it is treated as owner-occupied property. |
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EXAMPLE Property occupied by subsidiary
Issue A bank owns property that is leased to, and occupied by, its parent or another subsidiary. The property does not qualify as investment property in consolidated financial statements that include both entities, because it is owner-occupied from the perspective of the group as a whole. However, from the perspective of the individual bank that owns it, the property is investment property if it meets the definition. The lessor therefore treats the property as investment property in its stand-alone financial statements [IAS40]. Should a hotel owned by a bank that was leased to a related company be classified as investment property in the consolidated financial statements? Background Bank A owns a hotel. B, a fellow subsidiary of A, manages a chain of hotels, and receives management fees for operating its chain, except for the hotel owned by A. A’s hotel owned is leased to B for 2,000,000 a month for a period of 5 years. Any profit or losses from operating A’s hotel rests with B. The hotel that A owns has an estimated remaining useful life of 40 years. Solution The hotel should be classified as property, plant and equipment in the consolidated financial statements. The hotel is both owned and managed by the group from the perspective of the group, and therefore it should be recognised as owner-occupied for the use in the supply of goods or services. A should recognise the property (subject to an operating lease) as investment property in its individual financial statement. B should recognise the transaction as an operating lease arrangement in its individual financial statement and charge the rental payments to the income statement over the period of the lease. |
Judgement is also needed to determine whether the acquisition of investment property is the acquisition of an asset, or a group of assets, or a business combination within the scope of IFRS 3 Business Combinations.
Reference should be made to IFRS 3 to determine whether it is a business combination.
Determining whether a specific transaction meets the definition of a business combination as defined in IFRS 3 and includes
an investment property as defined in IAS 40 requires the separate application of both Standards.
Recognition
Investment property is recorded as an asset only when:
it is probable that there will be future benefits from the investment property and the costs of the investment property can be measured reliably.
These costs include costs incurred initially to acquire an investment property and costs incurred subsequently to add to, replace part of, or service, a property.
EXAMPLE site cost
You buy land and a factory building. You remove the building and build offices on the land. The cost of the land, factory and rebuilding costs are all included in the cost of the investment property, as they are effectively all part of the site costs.
Service Costs – Repairs and Maintenance
A bank does not record the costs of repairs and maintenance in the carrying amount of an investment property – they are not capitalised. These costs are recorded in the income statement as incurred. These costs exclude items that significantly add value.
Costs of servicing are primarily the cost of labour and consumables, and may include the cost of minor parts.
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EXAMPLE Costs of servicing Your client owns a block of flats. Your client is responsible for cleaning, repairs and maintenance of the common areas. These costs are expensed when incurred, and matched with the rental income in the income statement. |
Parts of investment properties may have been acquired through replacement. For example, the interior walls may be replacements of original walls.
A bank will record the cost of replacing part of an existing investment property at the time that cost is incurred.
The carrying amount of the parts that have been replaced is eliminated from the balance sheet.
In the following examples, I/B refers to Income Statement and Balance Sheet (SFP).
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EXAMPLE parts that are replaced Your building has a carrying amount of $1 m. New interior walls cost $0,2 m. The original walls have a carrying amount of $0,1 m. Add the cost of the new walls, and remove the carrying amount of the old walls: $1 m + $0,2 m -$0,1 m = $1,1 m. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
$0,2 m |
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Cash |
B |
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$0,2 m |
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This records the purchase of the new walls |
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Depreciation |
I |
$0,1 m |
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Property, plant & equipment |
B |
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$0,1 m |
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This records the disposal of the old walls |
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EXAMPLE parts that are replaced You own a block of flats above your bank. It has a central security system that needs replacing. The replacement cost is $25.000. You estimate that the original security system has a carrying value of $10.000 within the overall value of the block of flats. Increase the carrying value of the flats by $15.000 ($25.000-$10.000) when the new system is installed. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
25.000 |
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Cash |
B |
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25.000 |
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Recording the purchase of the new system |
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Depreciation |
I |
10.000 |
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Property, plant & equipment |
B |
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10.000 |
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This records the disposal of the old system |
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Measurement at Recognition
An investment property is measured initially at its cost. Transaction costs are included in the initial measurement. The cost of an investment property comprises its purchase price and any directly attributable expenditure.
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EXAMPLES attributable costs Directly attributable expenditure includes professional fees for legal services, property transfer taxes and other transaction costs. The cost of a self-built investment property is its cost at the date when the construction, or development, is complete. IAS 40 applies. |
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EXAMPLE self build You are given some land by the local council. Throughout 2XX3, you build a factory on the land. On January 1st 2XX4, you let the factory to a third party. You account for the factory as investment property under IAS 40. |
Examples of costs that should be expensed in the income statement, (and not capitalised) are:
(i) start-up costs (unless they are necessary to bring the property to the condition necessary for it to be capable of operating in the manner intended by management),
(ii) operating losses incurred before the investment property achieves the planned level of occupancy, or
(iii) abnormal amounts of wasted material, labour or other resources incurred in constructing or developing the property.
If payment for an investment property is deferred, its cost is the cash price equivalent. The difference between the cash price equivalent and the total payments is recorded as interest expense over the period of credit.
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EXAMPLE purchase of asset on credit You can pay $1m cash for a building, or pay for it over 3 years for a total cost of $1,3m. Using either payment method, the cost will be $1m. If the second payment option is used, the $0,3m will be treated as interest and will be accounted for as follows: |
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I/B |
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Property, plant & equipment |
B |
$1.0 m |
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Accounts payable |
B |
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$1.0 m |
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Being the purchase of the building |
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Unexpired interest |
B |
$0.3m |
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Accrued interest payable < 1 year |
B |
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$0.1m |
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Accrued interest payable >1 year |
B |
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$0.2m |
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Interest expense |
I |
$0,1 m |
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Unexpired interest |
B |
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$0,1 m |
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Annual interest charge |
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Accrued interest payable < 1 year |
B |
$0,1 m |
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Cash |
B |
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$0,1 m |
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Payment of Interest |
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The initial cost of a property interest held under a lease, and classified as an investment property is accounted for as a finance lease under IFRS 16. This recognises the property at the lower of the fair value and present value of the minimum lease payments. An equivalent amount is recorded as a liability.
(The present value of minimum lease payments is described in the workbook covering IFRS 16).
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EXAMPLE Present value of lease payments You lease a building from the owner. Its fair market value is $1,1m. The present value of the minimum lease payments is $1m. Record the cost as $1m, and the lease liability also as $1m. |
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I/B |
DR |
CR |
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Property, plant & equipment (land) |
B |
$1m |
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Finance lease creditor |
B |
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$1m |
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This records the lease of the property |
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The cost of an investment property acquired in exchange for a non-monetary asset is measured at fair value unless:
the exchange transaction lacks commercial substance or
the fair value of the asset received / given up, is not reliably measurable.
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EXAMPLE asset exchange You can pay $1 m cash, and give up an aircraft with a fair value of $4 m, in exchange for a building, which will be leased to third parties. If the building cannot be measured at fair value, its fair value should be taken to be $5 m. |
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I/B |
DR |
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Investment property |
B |
$5 m |
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Cash |
B |
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$1 m |
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Property, plant & equipment (aircraft) |
B |
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$4 m |
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This records the exchange of aircraft and cash for the building. |
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The acquired asset is measured at the carrying amount of the assets given up, even if a bank cannot immediately de-recognise the asset given up.
If the acquired asset is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
Measurement After Recognition
Accounting Policy
An entity must choose either the fair value model, or the cost model. Once the method is chosen, the entity should apply that method to all of its investment property.
Changes in accounting policies are detailed in IAS 8 (see IAS 8 workbook).
A change of policy from the cost model to the fair value model may result in a more relevant presentation of financial statements.
It is highly unlikely that a change from the fair value model to the cost model will result in a more appropriate presentation.
IAS 40 requires all banks to determine the fair value of investment property, either for measurement (if the bank uses the fair value model) or for disclosure (if it uses the cost model).
Fair value should be determined by an independent valuer who:
holds a recognised and relevant professional qualification, and
has recent experience in the location, and category, of the investment property being valued.
Fair Value Model
After initial recognition of property at cost, a bank that chooses the fair value model will measure all of its investment property at fair value.
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EXAMPLE Fair value model - valuation methods Issue After initial recognition, if fair value model is chosen, all of the bank’s investment property should be measured at fair value. Which fair value valuation methods should management adopt?
Solution IFRS do not prescribe a particular valuation method. The IASC considered the market value guidance issued by the International Valuation Standards Committee (IVS) in developing IAS 40. The valuation methods recognised by IVS include the following: Sales comparison method: similar or substitute properties sold in the market are compared with the subject property. Sales prices are analysed by applying appropriate units of comparison, adjusted by differences between the subject property and related market data.
The sales comparison approach has broad applicability and is persuasive whenever sufficient market data is available. However, its reliability decreases when market conditions are marked by rapid change or volatility or in valuations where market transactions are limited. Income capitalisation method: market value is estimated from the expected future benefits to be generated by the property in the form of income streams. The method considers net income generated by comparable property, capitalised to determine the value for the subject property. The income capitalisation method is often applied to ownership of equity interests in a leased property. Cost method: establishes the value of the property by reference to the cost of constructing an equivalent property. The cost method is often applied in valuations of new or recent construction, and proposed construction, additions or renovation. The valuation methods above do not include any future capital expenditure that will improve or enhance the property, and do not reflect the related future benefits from this future expenditure. |
A lessee must apply fair value to investment property under an operating lease.
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EXAMPLE Recognition of property where the land component is under operating lease Issue Leases of land should be classified as operating leases if title is not expected to pass to the lessee by the end of the lease term [IAS17]. Can management automatically classify, as investment property, property that is leased out under an operating lease? Background A bank owns a hotel that it leases out (as lessor) under an operating lease to a hotel management group. The hotel is situated on land leased by the government to the bank (as lessee) for a period of 99 years with no transfer of title to the bank at the end of the lease. The hotel building’s useful life is expected to be approximately 40 years. There are no provisions in the lease to return the land with the building intact at the end of the 99-year lease. Solution Land The land should be accounted for as operating lease under IFRS 16 and can be recognised as an investment property only if it meets the definition of investment property [IAS40] and the bank has chosen the fair value model for investment property.
Building Management should account for the hotel building as investment property. The building meets the definition of investment property and should be accounted for under IAS 40. A building is recognised as investment property if the lease of land extends beyond the building’s expected useful life and there are no provisions in the lease to return the land with the building intact. |
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EXAMPLE Fair value model - use basis for fair value 1
Issue The concept of fair value under IFRS is similar to the concept of market value as defined by the International Valuation Standard Committee (IVS). The market value of an investment property is determined on the basis of the highest value, considering any use that is financially feasible, justifiable and reasonably probable. The "highest and best-use" value may result in a property’s fair value being determined on the basis of redevelopment of the site. Should management attribute any value to a building if the fair value of the property (land and building) is determined on the basis of redevelopment of the site? Background Bank A owns an investment property that consists of land and a building leased to a department store in the centre of a major city. The carrying value of the property is 80 (land = 60, building = 20). Management commissions a firm of property valuers to value the property. The valuation report provides the following results: Existing use basis - 85 (land 65, building 20) Highest and best-use basis - 100 (land 100, building 0) The highest and best-use valuation assumes redevelopment of the site. This will involve demolishing the current building and constructing an office tower, which would be leased to tenants. Management does not intend to redevelop the property but would like to recognise the higher value (100). However, management proposes that the value be allocated as land 80 and building 20, because the existing building will still be used for the foreseeable future. Solution The highest and best-use value (100) should be used, but none of the value should be allocated to the building. The property’s market value is obtained on the basis of the building being demolished for redevelopment of the site, as opposed to its current use (as a department store). The market value of the current building on the highest and best-use of the property (as an office block) is therefore zero. The building’s carrying amount should therefore be reduced to zero. The land value is increased to 100. |
Gain / losses from a change in the fair value are recognised in the income statement for the period in which they arise. This is a critical difference from property that is subject to IAS 16, where unrealised revaluation surpluses are not recorded in the income statement, but taken directly to the revaluation reserve in equity.
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EXAMPLE gain in value Your block of flats has been revalued, showing increase in value of $1m. This should be shown in the income statement for the period. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
$1m |
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Gain on revaluation of investment property |
I |
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$1m |
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This records the revaluation of the flats |
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The fair value of investment property is the price at which the property could be exchanged between knowledgeable, independent parties.
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EXAMPLE - Fair value model - use basis for fair value 2 Issue The concept of fair value under IFRS is similar to the concept of market value as defined by the International Valuation Standard Committee (IVS). Market value differs depending on the use of a property. On what basis should management determine fair value? Background A bank owns an investment property that is a piece of land with an old warehouse on it. The land can be redeveloped into a modern leisure park. The market value of the land would be higher if redeveloped than the market value under its current use. Management is unclear about whether the investment property’s fair value should be based on the market value of the property (land and warehouse) under its current use, or the potential market value of the land. Solution The fair value of the property should be the market value of the land for its potential use. The "highest and best-use" is used as the most appropriate model for fair value. Using this approach of valuation, the existing use of the property is not the only basis considered. Fair value is the highest value, determined from market evidence, by considering any other use that is financially feasible, justifiable and reasonably probable. This approach is confirmed in IAS 40. It establishes that the guidance in IAS 40 is substantially identical to the fair value guidance in the International Valuation Standards. These standards are published by the International Valuation Standards Committee and require the highest and best-use basis of valuation. |
The definition of fair value assumes transfer of an asset and immediate cash sale. Fair value is determined without any deduction for transaction costs arising on sale.
The fair value of investment property reflects market conditions at the balance sheet date. As market conditions may change, the amount reported as fair value may also change.
Fair value of investment property reflects rental income from current leases, and supportable assumptions about rental income and expected cash outflows from future leases.
Both the buyer and the seller are aware of:
the nature and characteristics of the investment property,
its current and potential uses, and
market conditions at the balance sheet date.
A buyer would not pay a higher price than that of the market.
For the purpose of establishing fair value, a seller is neither over-eager, nor forced, to sell and is prepared to sell at a reasonable price in current market conditions.
In the absence of current prices in an active market, a bank considers information from a variety of sources, including:
i. current prices in an active market for properties of different nature, condition or location (or subject to different lease or other contracts), adjusted to reflect those differences;
ii. recent prices of similar properties on less active markets, with adjustments to reflect any changes in economic conditions since the date of the transactions that occurred at those prices; and
iii. discounted cash flow projections based on reliable estimates of future cash flows, supported by the terms of any existing lease and other contracts and (when possible) by external evidence such as current market rents for similar properties in the same location and condition, and using discount rates that reflect current market assessments of the uncertainty in the amount and timing of the cash flows.
In exceptional cases, the fair value of the property will not be reliably determinable on a continuing basis. This will happen if there ceases to be a market for a particular property, either due to its use, or its location.
EXAMPLE no market for the property
You own a laundry, for which there has been an active market. New regulations require major investments in effluent control, and frequent inspections. Nobody now wants to buy laundries, so the active market disappears. Fair market value cannot be determined on a continuing basis.
The accounting treatment is detailed below in Inability to Determine Fair Value Reliably.
Fair value and value-in-use
Fair value differs from value-in-use, as defined in IAS 36 Impairment of Assets (see IAS 36 workbook).
Fair value reflects the open market.
Value-in-use reflects the bank’s estimates that may not be applicable to the open market.
For example, fair value does not reflect any of the following factors as they would not be generally available to knowledgeable, willing buyers and sellers:
(1) additional value derived from the creation of a portfolio of properties in different locations;
(2) synergies between investment property and other assets, including other properties;
(3) legal rights, or legal restrictions, that are specific only to the current owner; and
(4) tax benefits, or tax burdens, that are specific to the current owner.
These elements would be included in value-in-use.
In determining the fair value of investment property, a bank does not double-count assets, or liabilities, that are recognised as separate.
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EXAMPLES double counting |
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1. equipment, such as lifts or air-conditioning, is often an integral part of a building and is usually included in the fair value of the investment property, rather than recognised separately as property, plant and equipment. |
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2. where an office is leased on a furnished basis, the fair value of the office generally includes the fair value of the furniture, because the rental income relates to the furnished office. When furniture is included in the fair value of investment property, a bank does not record that furniture as a separate asset. |
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3. the fair value of investment property excludes prepaid, or accrued, operating lease income, because it is recorded as a separate liability or asset. |
The fair value of investment property:
does not reflect future capital expenditure that will improve, or enhance, the property does not reflect the benefits from this future expenditure.
This excludes those properties that meet the criteria to be classified as held for sale (or are included in a disposal group that is classified as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
Investment properties that meet the criteria to be classified as held for sale (or are included in a disposal group that is classified as held for sale) shall be measured in accordance with IFRS 5.
Cost includes external transaction costs, such as legal and agents’ costs, registration fees and property taxes, but not the costs of internal staff. The costs must be specifically attributable to the property in question.
The inclusion of external transaction costs in the cost model contrasts with the fair value model where transaction costs are excluded from valuations.
Transfers
An entity shall transfer a property to, or from, investment property when there is a change in use. A change in use occurs when the property meets, or ceases to meet, the definition of investment property and there is evidence of the change in use.
In isolation, a change in management’s intentions for the use of a property does not provide evidence of a change in use.
Examples of evidence of a change in use
include:
(a) commencement of owner-occupation, or of development with a view to owner-occupation, for a transfer from investment property to owner-occupied property;
(b) commencement of development with a view to sale, for a transfer from investment property to inventories;
(c) end of owner-occupation, for a transfer from owner-occupied property to investment property; and
(d) inception of an operating lease to another party, for a transfer from inventories to investment property.
When an entity decides to dispose of an investment property without development, it continues to treat the property as an investment property until
it is derecognised (eliminated from the statement of financial position) and does not reclassify it as inventory.
Similarly, if an entity begins to redevelop an existing investment property for continued future use as investment property, the property remains an investment property and is not reclassified as owner-occupied property during the redevelopment.
When an entity uses the cost model, transfers between investment property, owner-occupied property and inventories do not change the carrying amount of the property transferred and they do not change the cost of that property for measurement or disclosure purposes.
When an entity uses the fair value model for investment property.
For a transfer from investment property carried at fair value to owner-occupied property or inventories, the property’s deemed cost for subsequent accounting in accordance with IAS 16, IFRS 16 or IAS 2 shall be its fair value at the date of change in use.
If an owner-occupied property becomes an investment property that will be carried at fair value, an entity shall apply IAS 16 for owned property and IFRS 16 for property held by a lessee as a right-of-use asset up to the date of change in use.
The entity shall treat any difference at that date between the carrying amount of the property in accordance with IAS 16 or IFRS 16 and its fair value in the same way as a revaluation in accordance with IAS 16.
Up to the date when an owner-occupied property becomes an investment property carried at fair value, an entity depreciates the property (or the right-of-use asset) and recognises any impairment losses that have occurred.
The entity treats any difference at that date between the carrying amount of the property in accordance with IAS 16 or IFRS 16 and its fair value in the same way as a revaluation in accordance with IAS 16.
In other words:
(a) any resulting decrease in the carrying amount of the property is recognised in profit or loss.
However, to the extent that an amount is included in revaluation surplus for that property, the decrease is recognised in other comprehensive income and reduces the revaluation surplus within equity.
(b) any resulting increase in the carrying amount is treated as follows:
(i) to the extent that the increase reverses a previous impairment loss for that property, the increase is recognised in profit or loss.
The amount recognised in profit or loss does not exceed the amount needed to restore the carrying amount to the carrying amount that would have been determined (net of depreciation) had no impairment loss been recognised.
(ii) any remaining part of the increase is recognised in other comprehensive income and increases the revaluation surplus within equity. On subsequent disposal of the investment property, the revaluation surplus included in equity may be transferred to retained earnings. The transfer from revaluation surplus to retained earnings is not made through profit or loss.
For a transfer from inventories to investment property that will be carried at fair value, any difference between the fair value of the property at that date and its previous carrying amount shall be recognised in profit or loss.
The treatment of transfers from inventories to investment property that will be carried at fair value is consistent with the treatment of sales of inventories.
When an entity completes the construction or development of a self-constructed investment property that will be carried at fair value, any difference between the fair value of the property at that date and its previous carrying amount shall be recognised in profit or loss.
When an entity decides to dispose of an investment property without development, it must continue to treat the property as an investment property, until it is eliminated from the balance sheet, and does not treat it as inventory.
If the property is a material item, IFRS 5: Non-current Assets Held for Sale and Discontinued Operations may apply for its disclosure in the financial statements – see IFRS 5 workbook. Banks usually choose this option as they do not normally keep inventories of property.
If an entity begins to redevelop an existing investment property for continued use as investment property, it is not reclassified as owner-occupied property during the redevelopment.
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EXAMPLE redevelopment does not change classification You own a finance lease on a building. You are converting the building into 50 separate offices. You plan to sublet these offices to different entrepreneurs. This remains investment property throughout the redevelopment. |
When an entity uses the cost model, transfers between investment property, owner-occupied property and inventories (or IFRS 5 – see note above) do not change the carrying amount of the property transferred, and they do not change the cost of that property for measurement, or disclosure purposes. Therefore, there is no profit, nor loss, on these transactions.
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EXAMPLE reclassify property from investment to ready-for-sale You use the cost model. When you reclassify property from investment to ready-for-sale, or to owner-occupied, there is no change to the carrying amounts. Therefore, there is no profit, nor loss, on these transactions. |
For a transfer from investment property, carried at fair value, to owner-occupied property or inventories (or IFRS 5 – see note above), the property’s cost for subsequent accounting under IAS 16, or IAS 2, is its fair value.
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EXAMPLE Changes in accounting policies Issue The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions is not a change in accounting policies (IAS8).
How should management recognise the adoption of a new accounting policy in respect of an existing asset?
Background Bank A owns an office building which it uses for its own administrative purposes. Accordingly, the building is classified as property, plant and equipment and is carried at depreciated historical cost (IAS 16). During the current year, management moved the workforce to a new building and leased the old building to a third party. Accordingly, the old building was reclassified as investment property and carried at fair value. Bank A had not previously earned rental income on any of its properties. Management has questioned whether the comparative amounts for the old building should be restated to fair value to aid comparability with the prior period. Solution Management should recognise the effects prospectively, since it is not a change in accounting policy but there is a change in use of the property. No restatement of the comparative amounts should be made. The different accounting treatment applied to the same property in the current and prior years is appropriate, because the building was used for different purposes in the two years. Depending on the materiality of the rental revenue in relation to the bank’s revenue as a whole, management should consider whether a new reportable segment now exists. This is not the same as a situation where an existing segment becomes reportable. Management should not restate operating segment-reporting information (IFRS 8). |
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EXAMPLE reclassification from investment property. You use the fair value model. When you reclassify $20m property from investment property to ready-for-sale, or to owner-occupied property, there is no change to the carrying amounts. The fair value of the investment property becomes the cost of inventory(or IFRS 5 – see note above), or the cost of owner-occupied property so is no profit, nor loss. |
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I/B |
DR |
CR |
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Property, plant & equipment (owner-occupied property) |
B |
$20m |
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Property, plant & equipment (investment property) |
B |
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$20m |
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Being the reclassification of the property |
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I/B |
DR |
CR |
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Inventory (or IFRS 5 – see note above)- Property, plant & equipment |
B |
$20m |
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Property, plant & equipment (investment property) |
B |
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$20m |
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Being the alternative reclassification of the property |
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If an owner-occupied property becomes an investment property carried at fair value, you apply IAS 16 up to the date of change in use. At that date, any difference between the carrying amount under IAS 16 and fair value will treated in the same way as a revaluation under IAS 16.
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EXAMPLE reclassification from owner-occupied property You use the fair value model. You reclassify property from owner-occupied property to investment property. Your property had a carrying value of $15m. It has been revalued at $17m. The $2m surplus will be credited to the revaluation surplus reserve within equity. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
$2m |
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Revaluation reserve |
B |
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$2m |
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This records the revaluation. |
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Property, plant & equipment (owner-occupied property) |
B |
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$17m |
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Property, plant & equipment (investment property) |
B |
$17m |
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Being the reclassification of the property |
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A bank depreciates an owner-occupied property according to IAS 16, and records any impairment losses that have occurred. When an owner-occupied property is transferred to investment property, it may be revalued and carried at fair value,
At the date of transfer from owner-occupied property to investment property, treat any difference between the carrying amount and fair value in the same way as a revaluation under IAS 16:
(1) any resulting decrease in the carrying amount of the property is immediately recorded in the income statement.
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EXAMPLE revaluation- shortfall Your owner-occupied property had a carrying value of $20m. It is transferred to investment property. It has been revalued at $19m. The $1m shortfall is expensed to the income statement |
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I/B |
DR |
CR |
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Accumulated impairment |
B |
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$1m |
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Impairment loss |
I |
$1m |
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This records the revaluation of the property |
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Property, plant & equipment (owner-occupied property) |
B |
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$19m |
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Property, plant & equipment (investment property) |
B |
$19m |
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Being the reclassification of the property |
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However, to the extent that an amount is included in revaluation surplus for that property, the decrease is charged against that revaluation surplus.
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EXAMPLE revaluation- surplus Your owner-occupied property had a carrying value of $10m. It has been revalued at $12m. The $2m surplus is credited to the revaluation surplus reserve within equity. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
$2m |
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Revaluation reserve |
B |
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$2m |
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This records the revaluation of the property |
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It is then transferred to investment property and revalued at $7m. $2m of the shortfall will be charged to the revaluation reserve. The remaining $3m shortfall will be charged to the income statement. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
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$2m |
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Revaluation reserve |
B |
$2m |
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Accumulated impairment |
B |
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$3m |
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Impairment loss |
I |
$3m |
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This records the revaluation of the property following reclassification |
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(2) any resulting increase in the carrying amount is treated as follows:
(i) the increase is recognised in the income statement to the extent that the increase reverses a previous impairment loss for that property, any remaining part of the increase is credited directly to equity in revaluation surplus.
On subsequent disposal of the investment property, the revaluation surplus included in equity may be transferred to retained earnings. The transfer from revaluation surplus directly to retained earnings and not through income statement.
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EXAMPLE revaluation shortfall, then surplus Your owner-occupied property had a carrying value of $20m. It has been revalued at $19m. The $1m shortfall is expensed to the income statement. |
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I/B |
DR |
CR |
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Accumulated impairment |
B |
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$1m |
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Impairment loss |
I |
$1m |
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This records the revaluation of the property in the first year |
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It is then transferred to investment property and it is revalued at $23m. $1m of the surplus will be credited to the income statement. The remaining $3m surplus will be credited directly to the income statement. |
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I/B |
DR |
CR |
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Property, plant & equipment (investment property) |
B |
$3m |
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Accumulated impairment |
B |
$1m |
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Impairment gain |
I |
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$1m |
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Revaluation gain |
I |
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$3m |
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This records the revaluation of the property after the reclassification |
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For a transfer from inventories (or IFRS 5 – see note above) to investment property that will be carried at fair value, any difference between the fair value of the property at that date and its previous carrying amount is recognised in income statement.
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EXAMPLE reclassification and revaluation surplus You have built a shopping complex for sale for a cost of $3m. You include it as inventory for this amount. |
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I/B |
DR |
CR |
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Inventory (or IFRS 5 – see note above) |
B |
$3m |
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Costs |
I |
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$3m |
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Transfer of self- build costs to inventory |
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A client offers to rent the shopping complex from you, which you accept. The fair value of the factory, based on the rent, is $4m. You transfer the shopping complex to investment property, valued at $4m and record the $1m gain in the income statement. |
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I/B |
DR |
CR |
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Property, plant & equipment (investment property) |
B |
$4m |
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Inventory |
B |
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$3m |
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Unrealised gain on investment property |
I |
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$1m |
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This records the revaluation on the reclassification of inventory to investment property. |
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Transfers from inventory to investment property (carried at fair value) is consistent with the treatment of sales of inventories (or IFRS 5 – see note above).
On completion of the construction, or development, of a self-built investment property that will be carried at fair value, any difference between the fair value of the property at that date, and its previous carrying amount, is recognised in income statement.
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EXAMPLE reclassification and gain You have built an office for a cost of $6m. You account for it under IAS 16 for this amount. |
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I/B |
DR |
CR |
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Property, plant & equipment (owner-occupied) |
B |
$6m |
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Costs |
I |
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$6m |
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Costs to build office |
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Clients lease the office from you. The fair value of the office, based on the rents, is $7m. You transfer the office to investment property, valued at $7m, and recognise the $1m gain in the income statement. |
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I/B |
DR |
CR |
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Property, plant & equipment (investment property) |
B |
$7m |
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Property, plant & equipment (owner-occupied) |
B |
|
$6m |
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Unrealised gain on investment property |
I |
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$1m |
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This records the revaluation on the reclassification of owner-occupied to investment property. |
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Disposals
An investment property is eliminated from the balance sheet on disposal, and when no future economic benefits are expected from it.
The disposal may be achieved by sale, or by entering into a finance lease. In determining the date of disposal for investment property, a bank applies the criteria in IAS 18 for recognising revenue.
Sale and leaseback transactions are detailed in the workbook to IFRS 16.
If an entity recognises in the carrying amount of an asset the cost of a replacement for part of an investment property, it also derecognises the carrying amount of the part replaced.
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EXAMPLE new components Your property has a carrying amount of $10m. The new air conditioning unit cost $0,2m. The original air conditioning has a carrying amount of $0,1m. Add the cost of the new air conditioning unit, and remove the carrying amount of the old unit -$10m + $0,2m -$0,1m = $10,1m. |
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I/B |
DR |
CR |
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Property, plant & equipment |
B |
$0,2m |
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Cash |
B |
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$0,2m |
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This records the cost of the new unit |
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Depreciation |
I |
$0,1m |
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Property, plant & equipment |
B |
|
$0,1m |
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This records the disposal of the old unit |
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For investment property accounted for using the cost model, a replaced part may have been accounted for within the total cost of the property.
If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the cost of the replacement as an indication of what the original cost was in the first instance.
Under the fair value model, the fair value of the investment property may already reflect that the part to be replaced has lost its value.
Gains, or losses, arising from the disposal of investment property are determined as the difference between the net disposal proceeds and the carrying amount of the asset. They are recorded in the income statement (unless IFRS 16 requires otherwise on a sale and leaseback) in the period or disposal.
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EXAMPLE gain on disposal $6m is the carrying value of your property that you sell for $8m. You record a gain of $2m ($8m-$6m) in the income statement. |
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I/B |
DR |
CR |
|
Cash |
B |
$8m |
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Property, plant & equipment |
B |
|
$6m |
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Gain on disposal of property |
I |
|
$2m |
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Sale of property |
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The consideration receivable on disposal of an investment property is recognised initially at fair value. In particular, if payment for an investment property is deferred, the consideration received is recognised initially at the cash price equivalent. The difference between the nominal amount of the consideration and the cash price equivalent is recognised as interest revenue in accordance with IAS 18, using the effective interest method.
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EXAMPLE gain on disposal and interest received A property with a carrying value of $6m is to be sold for $8m cash, or for $9m payable in 1 year’s time. You record a gain of $2m ($8m-$6m) in the income statement for either payment method. |
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I/B |
DR |
CR |
|
Cash |
B |
$8m |
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Property, plant & equipment |
B |
|
$6m |
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Gain on disposal of property |
I |
|
$2m |
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Sale of property |
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If your buyer pays $9m in 1 year’s time, the extra $1m will be treated as interest receivable |
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I/B |
DR |
CR |
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Accounts receivable |
B |
$8m |
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Property, plant & equipment |
B |
|
$6m |
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Gain on disposal of property |
I |
|
$2m |
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Sale of property |
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Cash |
B |
$9m |
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Accounts receivable |
B |
|
$8m |
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Interest receivable |
I |
|
$1m |
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Cash receipt and recognition of interest |
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Compensation for impairment is recognised in the income statement when it becomes receivable. Compensation examples: state nationalising assets, payments from insurance companies.
Impairments, or losses, of investment property, claims for compensation, and any purchase, or construction, of replacement assets are separate events and are accounted for as follows:
(1) impairments of investment property are recognised in accordance with IAS 36;
(2) retirements, or disposals, of investment property are recognised in accordance with IAS 40;
(3) compensation for investment property that was impaired, lost, or given up, is recorded in the income statement when it becomes receivable; and
(4) the cost of assets restored, purchased, or built as replacements, is determined in accordance with IAS 40.
Disclosure
Fair Value Model and Cost Model
These disclosures apply in addition to those in IFRS 16.
Under IFRS 16, the owner of an investment property provides lessors’ disclosures about leases into which it has entered.
A bank that holds an investment property under a lease provides lessees’ disclosures for finance leases, and lessors’ disclosures for any operating leases into which it has entered.
A bank will disclose:
whether it applies the fair value, or the cost model.
if it applies the fair value model, whether, and in what circumstances, property interests held under operating leases are classified, and accounted for, as investment property.
when classification is difficult, the criteria it uses to distinguish investment property from owner-occupied property, and from property held for sale in the ordinary course of business.
the methods and assumptions applied in determining the fair value including a statement whether fair values are supported by market evidence, or other factors because of the nature of the property and lack of comparable market data.
whether fair value of is based on a valuation by an independent valuer, who holds a recognised and relevant professional qualification, and has recent experience in the location, and category of the investment property being valued. If there has been no such valuation, that fact is disclosed
the amounts recognised in income statement for:
rental income from investment property
direct operating expenses (including repairs and maintenance) arising from investment property that generated rental income during the period; and
direct operating expenses (including repairs and maintenance) arising from investment property that did not generate rental income during the period.
the cumulative change in fair value recognised in the income statement on a sale of investment property from a pool of assets in which the cost model is used into a pool in which the fair value model is used
the existence and amounts of restrictions on the realisability of investment property, remittance of income or disposal proceeds.
contractual obligations to purchase, build or develop investment property, or for repairs, maintenance, or enhancements.
Fair Value Model
An entity that applies the fair value model will disclose a reconciliation between the carrying amounts of investment property at the beginning, and end, of the period, showing the following:
(1) additions, disclosing separately those additions resulting from acquisitions, and those resulting from subsequent expenditure recognised in the carrying amount of an asset;
(2) additions resulting from acquisitions through business combinations;
(3) disposals;
(4) net gains, or losses, from fair value adjustments;
(5) the net exchange differences arising on the translation of the financial statements into a different presentation currency, and on translation of a foreign operation into the presentation currency of the reporting bank;
(6) transfers to, and from, inventories and owner-occupied property;
(7) other changes.
When a valuation is adjusted significantly for the purpose of the financial statements, for example to avoid double-counting of assets, or liabilities, that are recognised as separate assets and liabilities, the bank will disclose a reconciliation between the valuation obtained, and the adjusted valuation included in the financial statements, showing separately the aggregate amount of any recognised lease obligations that have been added back, and any other significant adjustments.
When an entity measures investment property using the cost model, due to the inability to determine fair value on a continuing basis, the above reconciliation will disclose amounts relating to that investment property separately from amounts relating to other investment property. In addition, a bank will disclose:
(1) a description of the investment property;
(2) an explanation of why fair value cannot be determined reliably;
(3) if possible, the range of estimates within which fair value is highly likely to lie; and
(4) on disposal of investment property not carried at fair value:
(i) the fact that the bank has disposed of investment property not carried at fair value;
(ii) the carrying amount of that investment property at the time of sale; and
(iii) the amount of gain, or loss, recognised.
Cost Model
A entity that applies the cost model will also disclose:
(1) the depreciation methods used;
(2) the useful lives, or the depreciation rates, used;
(3) the gross carrying amount, and the accumulated depreciation (plus with accumulated impairment losses) at the beginning, and end, of the period;
(4) a reconciliation of the carrying amount of investment property at the beginning, and end, of the period, showing the following:
(i) additions, disclosing separately those additions resulting from acquisitions, and those resulting from subsequent expenditure recognised as an asset;
(ii) additions resulting from acquisitions through business combinations;
(iii) disposals;
(iv) depreciation;
(v) the amount of impairment losses recognised, and the amount of impairment losses reversed, during the period, in accordance with IAS 36;
(vi) the net exchange differences arising on the translation of the financial statements into a different presentation currency, and on translation of a foreign operation, into the presentation currency of the reporting bank;
(vii) transfers to, and from, inventories and owner-occupied property; and
(viii) other changes; and
(5) the fair value of investment property. When a bank cannot determine the fair value of the investment property reliably, it will disclose:
(i) a description of the investment property;
(ii) an explanation of why fair value cannot be determined reliably; and
(iii) if possible, the range of estimates within which fair value is highly likely to lie.
