INVESTMENT PROPERTY (IAS 40)

Investment property (IAS 40)

An entity may own land or a building as an investment rather than for use in the business. It may therefore generate cash flows largely independently of other assets which the entity holds. The treatment of investment property is covered by IAS 40.

Investment property is 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

A property interest that is held by a lessee under an operating lease may be classified and accounted for as an investment property, if and only if the property would otherwise meet the definition of an investment property and the lessee uses the IAS 40 fair value model. This classification is available on a property-by-property basis.

Examples of investment property include:

(a) Land held for long-term capital appreciation rather than for short-term sale in the ordinary course of business

(b) A building owned by the reporting entity (or held by the entity under a finance lease) and leased out under an operating lease

(c) A building held by a parent and leased to a subsidiary. Note, however, that while this is regarded as an investment property in the individual parent company financial statements, in the consolidated financial statements this property will be regarded as owner-occupied (because it is occupied by the group) and will therefore be treated in accordance with IAS 16.

(d) Property that is being constructed or developed for future use as an investment property. (Different from owner-occupied under development to be used as investment property)

(e) Property that is left as there is no decision by the management whether to use it as owner-occupied or investment property.

The objective of the standard is to prescribe the accounting treatment for investment property and related disclosure requirements. Below are examples of items that are not investment property.

Type of non-investment property Applicable IAS

Property intended for sale in the ordinary course of business (IAS 2 Inventories)

Property being constructed or developed on behalf of third parties (IAS 11 Construction contracts)

Owner-occupied property (IAS 16 Property, plant and equipment)

Investment property should be recognised as an asset when two conditions are met.

(a) It is probable that the future economic benefits that are associated with the investment property will flow to the entity.

(b) The cost of the investment property can be measured reliably.

An investment property should be measured initially at its cost, including transaction costs.

A property interest held under a lease and classified as an investment property shall be accounted for as if it were a finance lease. The asset is recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount is recognised as a liability.

IAS 40 requires an entity to choose between two models.

· The fair value model

· The cost model

Whatever policy it chooses should be applied to all of its investment property.

Where an entity chooses to classify a property held under an operating lease as an investment property, there is no choice. The fair value model must be used for all the entity's investment property, regardless of whether it is owned or leased.

After initial recognition, an entity that chooses the fair value model should measure all of its investment property at fair value, except in the extremely rare cases where this cannot be measured reliably. In such cases it should apply the IAS 16 cost model.

A gain or loss arising from a change in the fair value of an investment property should be recognised in net profit or loss for the period in which it arises.

The cost model is the cost model in IAS 16. Investment property should be measured at depreciated cost, less any accumulated impairment losses. An entity that chooses the cost model should disclose the fair value of its investment property.

Once the entity has chosen the fair value or cost model, it should apply it to all its investment property. It should not change from one model to the other unless the change will result in a more appropriate presentation. IAS 40 states that it is highly unlikely that a change from the fair value model to the cost model will result in a more appropriate presentation.

Transfers to or from investment property should only be made when there is a change in use. For example, owner occupation commences so the investment property will be treated under IAS 16 as an owner-occupied property.

When there is a transfer from investment property carried at fair value to owner-occupied property or inventories, the property's cost for subsequent accounting under IAS 16 or IAS 2 should be its fair value at the date of change of use.

Conversely, an owner-occupied property may become an investment property and need to be carried at fair value. An entity should apply IAS 16 up to the date of change of use. It should treat any difference at that date between the carrying amount of the property under IAS 16 and its fair value as a revaluation under IAS 16.

However the building will be subjected to a fair value exercise at each year end and these gains or losses will go to profit or loss.

Derecognise (eliminate from the statement of financial position) an investment property on disposal or when it is permanently withdrawn from use and no future economic benefits are expected from its disposal.

Any gain or loss on disposal is the difference between the net disposal proceeds and the carrying amount of the asset. It should generally be recognised as income or expense in profit or loss.

Compensation from third parties for investment property that was impaired, lost or given up shall be recognised in profit or loss when the compensation becomes receivable.

Disclosure Requirements:

1.     Choice of fair value model or cost model

2.     Whether property interests held as operating leases are included in investment property

3.     Criteria for classification as investment property

4.     Assumptions in determining fair value

5.     Use of independent professional valuer (encouraged but not required)

6.     Rental income and expenses

7.     Any restrictions or obligations

8.     Reconciliation of the carrying amount of the investment property at the beginning and end of the period.

Question 1

A business owns a building which it has been using as a head office. In order to reduce costs, on 30 June 20X9 it moved its head office functions to one of its production centres and is now letting out its head office. Company policy is to use the fair value model for investment property.

The building had an original cost on 1 January 20X0 of $250,000 and was being depreciated over 50 years. At 30 June 20X9 its fair value was judged to be $350,000.

Required:

How will this appear in the financial statements at 31 December 20X9?

Question 2

An entity owns two investment properties, X and Y, the fair values of which are:

31 December 2006        31 December 2007

$ million                        $ million

Property X                                                          15                                  20

Property Y                                                          10                                   8

The original cost of the properties was $9 million each when they were acquired on 1

January 2005. The entity uses the fair value model to value all its investment properties.

Required:

How will these transactions be accounted for in the financial statement.

Question 3

An entity purchased an investment property on 1 January 2004, for a cost of $400,000. The property has a useful life of 50 years, with no residual value, and at 31 December 2006 had a fair value of $560,000. On 1 January 2007 the property was sold for net proceeds of $540,000.

Required:

How will the disposal be treated using the Cost Model and the Fair Value Model.

Question 4

XYZ plc owns three investment property, X, Y, Z, the values of which are:

31 December 2002        31 December 2003

$ million                        $ million

Property X                                                          27                                  32

Property Y                                                          18                                   24.5

Property Z                                                          26                                   23.5

The original cost of the properties was $20million each when they were purchased on 1^st January 2001. The entity uses the fair value model to value all its investment properties.

Required:

Show the financial statement extract for each of the three years ended 31^st December, 2003.

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BORROWING COSTS (IAS 23)

IAS 23 Borrowing costs

FAST FORWARD

IAS 23 Borrowing costs was revised in March 2007. Previously it gave a choice of methods in dealing with borrowing costs i.e. capitalisation or expense. The revised standard requires capitalisation when incurred in the CAP ( i.e. construction, acquisition and production) of a qualifying assets.

Borrowing Costs: Interest and other costs incurred by an entity in connection with the borrowing of funds.

Qualifying Asset: An asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

The standard lists what may be included in borrowing costs.

· Interest on bank overdrafts and short-term and long-term borrowings

· Amortisation of discounts or premiums relating to borrowings

· Amortisation of ancillary costs incurred in connection with the arrangement of borrowings

· Finance charges in respect of finance leases recognised in accordance with IAS 17

· Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs

Depending on the circumstances, any of the following may be qualifying assets.

· Inventories

· Manufacturing plants

· Power generation facilities

· Intangible assets

· Investment properties

Financial assets and inventories that are manufactured, or otherwise produced over a short period of time are not qualifying assets. Assets that are ready for their intended use or sale when purchased are not qualifying assets.

Under the revised treatment, only borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset can be capitalised as part of the cost of that asset.

Those borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset must be identified. These are the borrowing costs that would have been avoided had the expenditure on the qualifying asset not been made. This is obviously straightforward where funds have been borrowed for the financing of one particular asset.

Difficulties arise, however, where the entity uses a range of debt instruments to finance a wide range of assets, so that there is no direct relationship between particular borrowings and a specific asset. For example, all borrowings may be made centrally and then lent to different parts of the group or entity. Judgement is therefore required, particularly where further complications can arise (eg foreign currency loans).

Once the relevant borrowings are identified, which relate to a specific asset, then the amount of borrowing costs available for capitalisation will be the actual borrowing costs incurred on those borrowings during the period, less any investment income on the temporary investment of those borrowings. It would not be unusual for some or all of the funds to be invested before they are actually used on the qualifying asset.

In a situation where borrowings are obtained generally, but are applied in part to obtaining a qualifying asset, then the amount of borrowing costs eligible for capitalisation is found by applying the 'capitalisation rate' to the expenditure on the asset.

The capitalisation rate is the weighted average of the borrowing costs applicable to the entity's borrowings that are outstanding during the period, excluding borrowings made specifically to obtain a qualifying asset. However, there is a cap on the amount of borrowing costs calculated in this way: it must not exceed actual borrowing costs incurred.

Sometimes one overall weighted average can be calculated for a group or entity, but in some situations it may be more appropriate to use a weighted average for borrowing costs for individual parts of the group or entity.

Three events or transactions must be taking place for capitalisation of borrowing costs to be started.

(a) Expenditure on the asset is being incurred

(b) Borrowing costs are being incurred

(c) Activities are in progress that are necessary to prepare the asset for its intended use or sale

If active development is interrupted for any extended periods, capitalisation of borrowing costs should be suspended for those periods. Suspension of capitalisation of borrowing costs is not necessary for temporary delays or for periods when substantial technical or administrative work is taking place (i.e. a delay that must occur in the process).

Once substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete, then capitalisation of borrowing costs should cease. This will normally be when physical construction of the asset is completed, although minor modifications may still be outstanding.

The asset may be completed in parts or stages, where each part can be used while construction is still taking place on the other parts. Capitalisation of borrowing costs should cease for each part as it is completed. The example given by the standard is a business park consisting of several buildings.

The following should be disclosed in the financial statements in relation to borrowing costs.

(a) Amount of borrowing costs capitalised during the period

(b) Capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation

Question 1

On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which were expected to take a year to build. Work started during 20X6. The loan facility was drawn down and incurred on 1 January 20X6, and was utilised as follows, with the remaining funds invested temporarily.

Asset A                        Asset B

                                                                          $'000                            $'000

1 January 20X6                                                     250                               500

1 July 20X6                                                           250                               500

The loan rate was 9% and Stremans Co can invest surplus funds at 7%.

Required

Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of the assets and consequently the cost of each asset as at 31 December 20X6.

QUESTION 2

Acruni Co had the following loans in place at the beginning and end of 20X6.

1 January                                  31 December

    20X6                                         20X6

      $m                                           $m

10% Bank loan repayable 20X8                               120                                           120

9.5% Bank loan repayable 20X9                                80                                             80

8.9% debenture repayable 20X7                                 –                                           150

The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining equipment), construction of which began on 1 July 20X6.

On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on 1 January 20X6, $20m on 1 October 20X6.

Required

Calculate the borrowing costs that can be capitalised.

Answer

Question 3

An entity already has a number of general loan arrangements:

Loan 1 of $800,000, interest paid at 9%;

Loan 2 of $2 million, interest paid at 8%; and

Loan 3 of $400,000, interest paid at 7.5%.

The entity has commissioned a new printing press to be constructed on its behalf. The total cost will be $800,000 and the entity will be able to fund the purchase from its existing borrowings since it has arranged for stage payments to be made. The construction takes six months.

Required

Calculate the borrowing costs that can be capitalised and the total cost of the printing press.

Question 4

An entity borrowed $5 million to fund the construction of a new building. Interest is payable on the loan at 8%. Stage payments were due throughout the construction period and therefore excess funds were reinvested during that period. By the end of the project investment income of $150,000 had been earned and the construction took twelve months to complete.

Required

Calculate the borrowing costs that can be capitalised and the total cost of the building.

Question 5

The following events take place:

 An entity buys some land on 1 December.

 Planning permission is obtained on 31 January.

 Payment for the land is deferred until 1 February.

 The entity takes out a loan to cover the cost of the land and the construction of the building commenced on 1 February.

 Due to adverse weather conditions there is a delay in starting the building work for six weeks and work does not commence until 15 March.

Required

What date should capitalisation of borrowing cost commenced?

Question 6

Concorde Inc. obtained a term loan during the year ended December 31, 2008, amounting to $650 million for modernization and development of its factory. During the year, buildings costing $120 million were completed and plant and machinery amounting to $350 million were installed.

A sum of $70 million has been given as a capital commitments advance for assets, the installation of which is expected in the following year. The amount of $110 million has been utilized for working capital requirements.

Interest incurred on the loan of $650 million during the year ended December 31, 2008, amounted to $58.5 million.

Required

How should the interest amount of $58.5 million be treated in the financial statements of XYZ Inc.?

Question 7

Funto Construction has three sources of borrowings:

Average Loan                Interest Expenses

                                                                                 N                                               N

7 Years Loan                                                           8,000,000                       800,000

10 Years Loan                                                       10,000,000                       900,000

Bank Overdraft                                                      10,000,000                       900,000

The 7 year loan has been specifically raised to fund the building of a qualifying assets.

The company has incurred the following expenditure on a project funded from general borrowings for the year 31^st December 2014:

Date Incurred                                                    Amount

                                                                             N

31^st March                                                         1,000,000

31^st July                                                            1,200,000

30^th October                                                         800,000

                

Required

Determine the weighted average and the amount that will be capitalised.

Question 8

Lala Plc, a geared company has the following loan arrangements as at 1^st January 2011:

Average Loan               

                                                                                 N                                              

7%Loan notes                                                    55,000,000                          

8% Loan notes                                                  110,000,000                         

12% Debentures                                                85,000,000                         

10% Bank Loan                                                 150,000,000                        

On the 1^st of January 2011, the company commenced the construction of a new office factory. The construction of the factory will cost N100,000,000 and the company funded the construction with the existing borrowings. The factory was completed on 31^st August 2011 but was not available for use until 1^st December 2011 as a result of minor modification. During the construction period, active work was interrupted and the building construction was stopped for two months as a result of adverse weather conditions.

Required

Calculate the borrowing cost to be capitalised and the cost of the building to be recognised upon initial recognition.

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