Steve Collings FCCA sheds light on elements in the accounting treatment of investment property under FRS 102 that have been foxing preparers of reports
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This article was first published in the October 2019 UK edition of Accounting and Business magazine.
The accounting treatment of investment property under FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland, is notably different from the approach of old UK GAAP, and some aspects are open to interpretation.
The FRS 102 glossary defines investment property as: ‘Property (land or a building, or part of a building, or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both, rather than for: (a) use in the production or supply of goods or services or for administrative purposes, or (b) sale in the ordinary course of business.’
Therefore, if a business has a property that generates rental income, that property will meet the definition of investment property and it will be accounted for under section 16 of FRS 102. Also, keep in mind that the definition refers to ‘land or a building, or part of a building, or both’, which means that properties in the course of construction or being developed for future use as investment property comes within its scope. Land held for long-term capital appreciation also meets the definition.
Preparers of reports should be aware that the correct distinction between investment property and owner-occupied property is crucial because the accounting treatments for investment property (section 16 of the standard) and property, plant and equipment (section 17) are significantly different.
When a property meets the definition of investment property, it is initially recognised at cost: the purchase price plus all directly attributable costs (which may include legal fees, stamp duty and brokerage fees). If payment is deferred beyond normal credit terms, the initial cost of the investment property is the present value of all future payments.
Paragraph 16.6 of FRS 102 states that the initial cost of a property interest held under a lease and classified as an investment property is accounted for as a finance lease even if the lease would be classified as an operating lease if it fell within the scope of section 20, on leases. The asset is therefore recognised at the lower of the fair value of the property and the present value of the minimum lease payments with a corresponding finance lease creditor. Any premium paid is treated as part of the minimum lease payments; it is therefore included in the cost of the asset but excluded from the liability.
When it comes to measurement, a clear understanding of the rules is needed. Section 16 of FRS 102 uses the fair value accounting rules in company law to measure investment property. This means that all fair value gains and losses must pass through the profit and loss account. Unless the entity is a micro-entity reporting under FRS 105, The Financial Reporting Standard applicable to the Micro-entities Regime, investment property is not depreciated but remeasured to fair value at each reporting date. There is an accounting policy choice in FRS 102 (March 2018) for intra-group investment property – see paragraphs 16.4A and 16.4B.
The fair value gain is taken through profit and loss (not directly to a revaluation reserve, as was the case under old UK GAAP). While FRS 102 does not recognise the concept of operating profit, most entities are continuing to present an operating profit line, so such gains are included within operating profit (eg as cost of sales, administrative expenses or as a separate line item if sufficiently material).
Paragraph 29.16 of FRS 102 requires deferred tax to be brought into account for investment properties using the tax rates and allowances that will apply to the sale of the asset.
Using the measurement example provided in the box on the facing page, if it is assumed that the company has no plans to sell the asset for the foreseeable future, then deferred tax is calculated using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date. The company can therefore use a rate of 17%, as this will be the corporation tax rate starting on 1 April 2020 (indexation allowance may also be available depending on when the asset was purchased, although this has been ignored for the purposes of the measurement example).
So, using the example in the box, deferred tax on the £50,000 gain is £8,500 (£50,000 x 17%) and is recorded as follows:
- Dr Tax expense (P&L) £8,500
- Cr Deferred tax provision £8,500
This is the deferred tax on investment property fair value gain at 17%.
It must be emphasised that fair value gains on investment property are non-distributable profits because they are not realised gains. A company could therefore choose to transfer a portion of its profit and loss reserves equal to the net cumulative fair value gain for presentation purposes to a separate reserve (eg a ‘non-distributable reserve’).
The company does not have to do this because it is not a requirement of company law, but it is an efficient means of separating distributable profits from non-distributable profits to avoid the latter being inappropriately distributed.
These are some of the confusing areas of FRS 102 where investment property is concerned that appear to have been causing problems for preparers. In all cases, it is advisable to have a sound understanding of the detailed aspects of FRS 102 so that the accounting treatments can be correctly applied and a true and fair view presented in the financial statements.
Steve Collings FCCA is a partner at Leavitt Walmsley Associates.