| From 1 January 2001 the requirements of IAS 40 replaced that part of IAS 25,
Accounting for Investments, that dealt with investment properties. Most other
investments are now dealt with by either IAS 38, Intangible Assets, or IAS 39,
Financial Instruments: Recognition and Measurement, and as a result the rather
dated IAS 25 has been withdrawn.
Investment properties have the distinguishing feature that they earn cash flows
largely independently of an enterprise’s other assets, whereas owner-occupied
properties earn revenues in combination with other assets normally in the production
or supply process. The IASB believe this difference justifies a different accounting
treatment for investment properties. Investment properties are held mainly to
earn rental income or for capital appreciation (or both). They include both
properties that are owned and properties that are held as a finance lease by
an enterprise. Most commentators are of the view that there are few leasing
arrangements for properties that would constitute a finance lease. This view
is reinforced by the IASB in appendix B to this Standard and in IAS 17, Leases.
This can create problems of substance as in many countries, notably the UK and
Hong Kong, properties are leased over very long periods. The IASB intends to
leave this issue to a fundamental review of lease accounting.
Investment properties that are under construction or development are treated
under IAS 16, Property, Plant and Equipment, until they are completed. If a
property is partly owner-occupied and partly let out as an investment property,
the portions should be treated separately if they can be sold separately, if
not it is treated under IAS 16 rules, unless only an insignificant portion is
owner occupied. In some cases enterprises may have to use judgment to determine
whether a property qualifies as an investment property.
Where a property is let to a parent or other subsidiary, then in the consolidated
financial statements it is treated as an owner-occupied property under IAS 16,
but in the individual financial statements of the lessor it is treated as an
investment property under this Standard.
The principle of recognition (i.e. meeting the definition of an asset), initial
measurement (at cost) and subsequent expenditure on investment properties is
similar to other assets (refer to IAS 16, Property, Plant and Equipment).
Measurement Subsequent to Initial Recognition
An enterprise may choose either a fair value or cost model to value investment
properties. Consistency requires that the same policy should be applied to all
investment properties. A change from one method to another should only be made
where it will result in a more appropriate presentation. The Standard envisages
that a change from fair value to cost is unlikely to be appropriate. Where the
cost model is chosen, the fair values of the investment properties must be disclosed.
Fair Value Model
An enterprise that chooses the fair value model should, after initial recognition,
value all its investment properties at their fair values.
A gain or loss arising from a change in the fair value of an investment property
should be included in the net profit or loss of the period in which it arises.
Note: this differs markedly from revaluations in IAS 16, which are generally
treated as movements on an unrealised revaluation reserve. IAS 40 effectively
treats movements in fair values as realised. The introduction to the Standard
makes it clear that the IASB prefer the fair value model, but they also recognise
that this is a controversial issue about which many accountants have reservations,
and this is why, for the time being, the cost model is permitted.
The fair value of an investment property is usually its market value preferably
determined by an independent valuer experienced in the type of property and
local market. It is based on an arm’s length transaction i.e. between independent
unrelated parties on commercial terms. The market value is based on an informed
willing buyer and an informed willing seller in an open market under normal
selling conditions (e.g. after proper marketing of the property). Circumstances
unique to a buyer or seller should be ignored (e.g. where a seller may be in
financial difficulties and requires a ‘quick’ sale or it is a ‘forced’
sale.)
Although current prices on an active market of similar properties represents
the best evidence of fair values, other sources of information can provide evidence
of fair values:
- prices for dissimilar properties adjusted to reflect differences;
- prices on a less active market adjusted to reflect economic changes since
those prices occurred; or
- discounted estimated future net cash flows relating to existing leases.
This would only be appropriate where there is external evidence that they
are similar properties in the same location and condition and the rentals
are at current levels.
Fair values should not ‘double count’ certain assets. For example,
fair values determined from rentals for a furnished letting would include the
value of the furniture, which should not then be recognised again as a separate
asset. In the rare cases where it is not possible to reliably determine a fair
value on a continuing basis for an individual property it should be treated
under the benchmark treatment in IAS 16 (at cost less depreciation and impairments).
When adopting the fair value model this only applies to the individual property,
all other investment properties should be measured at fair value.
Cost Model
An enterprise choosing the cost model should adopt the benchmark treatment in
IAS 16 (as referred to above). Note: the allowed alternative in IAS 16 (of revaluation
reported as reserve movements) is not permitted for investment properties. It
can however, be used for non-investment properties.
Transfers
An individual property can, depending on the circumstances, be classified as
an investment property, an owner-occupied property or as ‘available for
sale’ (included in inventory). The Standard considers the appropriate accounting
treatment of transfers between these categories, which should only occur where
there is a change of use.
Transfers under the cost model
Where the cost model has been adopted, all transfers between classifications
are made at the carrying value (historical cost less depreciation and impairments)
of the property, no gains or losses will arise. This treatment is uncontroversial
and presents no difficulties.
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Example
Speculator owns a number of properties. An independent surveyor has assessed
their market values as:
Property |
Cost 1 July 1999 |
Valuation
30 June 2000 |
Valuation
30 June 2001 |
| |
$ |
$ |
$ |
| A |
41,000 |
52,000 |
73,000 |
| B |
76,000 |
82,000 |
66,000 |
| C |
80,000 |
70,000 |
90,000 |
| |
197,000 |
204,000 |
229,000 |
All the properties had an estimated life of 50 year when they were acquired.
They are all let on short leases under commercial terms, however property
C is let to a fellow subsidiary of Speculator. The group policy (applied
by all members of the group) is to adopt the fair value model in IAS 40
for investment properties and to treat owner-occupied properties under
the benchmark treatment in IAS 16.
Required:
Prepare extracts of the group financial statements of Speculator in respect
of the above properties for the years to 30 June 2000 and 2001.
How would this differ if the question asked for the entity statements
of Speculator?
Answer:
In the consolidated financial statements property C would have to be classified
as an owner-occupied property and treated under IAS 16 (benchmark). This
means it would be carried at deprecated historic cost.
| Income statement: - year to 30 June |
2000 |
2001 |
| |
$ |
$ |
| Depreciation – property C ($80,000/50 years) |
(1,600) |
(1,600) |
| Investment property surpluses - A |
11,000 |
21,000 |
| - B |
6,000 |
|
| Investment property deficits - B |
|
(16,000) |
| Balance sheet: as at 30 June |
2000 |
2001 |
| Property, plant and equipment – C |
78,400 |
76,800 |
| Investment properties |
134,000 |
139,000 |
In the entity financial statements of Speculator property C would be
classed as an investment property. The property would not be depreciated.
Instead a deficit of $10,000 in 2000 and a surplus of $20,000 in 2001
would be reported as well as the above surpluses and deficits on properties
A and B.
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Transfers under the fair value model
Transfers from investment properties should only occur where there is a change
of use. This may be because an owner decides to occupy a property that was previously
used as an investment property or there may be an intention to dispose of the
property. Normally, in the latter case, an enterprise would continue to show
the property as an investment property until it is sold. However, where it is
intended to develop the property before it is sold, it should be transferred
to inventory. For both of the above transfers the ‘cost’ of the property
for the purpose of the transfer is the fair value at the date of the transfer.
An owner occupied property appropriately transferred to investment properties
at the end of the owner occupation should be revalued to its fair value at the
date of transfer. Any difference between its carrying value and fair value should
be treated as a revaluation under IAS 16 (normally a reserve movement). Where
a property that has been included in inventory (because it is available for
sale) and is then let on an operating lease to a third party it should be transferred
to investment properties at its fair value at the date of the transfer. Any
gain or loss on its carrying value immediately before the transfer is included
in the profit or loss for the period. This is consistent with the treatment
of profits on the sale of inventories.
An investment property in the course of (self) construction or development
is treated under IAS 16 as property, plant and equipment. When construction
is complete it is transferred to investment properties at its fair vale at the
date of completion. Any difference between the fair value and the carrying value
of the property is recognised in income in the period of the transfer.
Disposals and derecognition
An investment property should be eliminated from the balance sheet on its disposal
or when it is permanently withdrawn from use and no future economic benefit
is expected. Obviously a disposal will occur if a property is sold, but it would
also be considered as ‘sold’ where it is let under a finance lease.
The gain or loss on disposal is the difference between the carrying value and
the net sale proceeds (discounting should apply to deferred consideration) and
it is recognised as income or expense in the income statement. Special rules
contained in IAS 17, Leases apply to sales and leasebacks.
Disclosure (in addition to that in IAS 17, Leases)
An enterprise should disclose:
- the method of determining fair values. It should state that this was by
reference to market values, or, if not, the other factors in determining the
value should be disclosed;
- that a qualified independent valuer with appropriate experience has valued
the investment properties, or, if not, this fact should be disclosed;
- the amounts in the income statement for:
– rental income from investment properties;
– their direct operating expenses split between those properties that
generated income and those that did not.
- any restrictions on the realisability of investment properties or on the
remittance of rental income;
- contractual obligations to purchase, construct or develop investment properties.
Fair value Model
- a detailed reconciliation (similar to property, plant and equipment under
IAS 16) of the carrying value of investment properties at the beginning and
end of the period;
- net gains or losses from changes in fair values;
- net exchange gains or losses on the translation of the financial statements
of a foreign entity (presumably relating to investment properties held by
a subsidiary);
- transfers to and from inventories and owner-occupied properties.
Where the fair value of an individual property cannot be reliably measured,
the above reconciliation should be disclosed separately for that property. There
should be a description of the property, the reasons why its fair value cannot
be measured reliably and, if possible, a range of fair values for it. Details
of the gains or losses on the disposal of such properties should also be separately
disclosed.
Cost Model
Similar disclosures are required to those that apply to properties classified
as property, plant and equipment under IAS 16:
- deprecation methods and rates, useful lives etc;
- a detailed reconciliation of the carrying value of investment properties
at the beginning and end of the period;
- impairment losses;
- exchange gains and losses;
- transfers to and from inventories and owner-occupied properties; and
- the fair values of the properties.
Transitional provisions
The effect of adopting the fair value model should be treated as an adjustment
to the retained earnings of the period when it is first adopted. This adjustment
would include the reclassification (as realised profits) of any revaluation
surpluses for investment properties. If the enterprise has previously disclosed
fair values then it is encouraged to restate its comparative figures and adjust
the opening balance of the retained earnings for the earliest presented period.
This is slightly different to the rules in IAS 8, Net Profit or Loss for the
Period, Fundamental Errors and Changes in Accounting Policies for dealing with
changes in accounting polices. Where the cost model is adopted, IAS 8 is applicable
to any change of accounting policies.
An interesting anomaly produced by the introduction of the Standard is that
a company may have two similar properties carried at their fair values. If one
is an investment property and the other is not, an increase (say) in value of
the investment property would increase the reported profit (and earnings per
share), but a similar increase in the other property would be reported as a
reserve movement with no effect on profits.
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