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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