As a U.S. CPA with a foundation in U.S. GAAP, when learning IFRS, one can’t help but compare the two sets of principles and make judgments as to which one makes more sense in any particular topic area. When it comes to investment properties, IFRS has a clear advantage over U.S. GAAP (most notably the fact that IAS 40 covers the topic, whereas U.S. GAAP has nothing – just its basic property, plant, and equipment guidance).
In our recently launched comprehensive IFRS eLearning library, we dedicate one of the courses to investment properties under IAS 40. It makes sense that IFRS treats investment property differently from other property held and controlled by an entity as the purpose of each type of asset is different, and therefore, warrants different information.
Investment property is defined as property (land or a building—or part of a building—or both) held (by the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both. It is not property that is used in the production or supply of goods or services or for administrative purposes (i.e., property, plant, or equipment under IAS 16) or to be sold in the ordinary course of business (i.e., inventory under IAS 2).
Investment property is initially measured at cost (including direct transaction costs), but subsequently may be measured at:
- Fair value (with changes through earnings); or
- Cost (less accumulated deprecation and less accumulated impairment losses) (other than held-for-sale property under IFRS 5 or property representing a right-of-use asset in a lease agreement under IFRS 16)
Is the subsequent measurement under the fair value or cost models an accounting policy choice? Yes and no. Technically, an entity is free to elect either policy, but this must be applied to all investment properties in the entity on a consistent basis (with very limited exceptions). But if you read into the standard a little closer, you also realize that the IASB’s preference is clearly the fair value model. This can be inferred by two separate requirements:
- Even when the cost model is elected, fair value is still required to be disclosed in the financial statements each period.
- If an entity ever wants to “change” its accounting policy, the IASB believes that only a change to the fair value model is acceptable, as it represents an improvement in financial reporting.
Fair value is determined based on the definition in IFRS 13, and often involves significant judgment, but must continue to be provided as long as it can be “reliably measured” (which is typically going to be the case for real estate properties).
While IAS 40 has been around for a number of years now, it still continues to be an area with a number of application issues, many of which we highlight each year in our update training courses. Investment property issues are most frequent in some of our industry updates, including our annual real estate industry and investment management industry courses (we offer via live webinar/ classroom training or eLearning).
Some of the application issues noted regarding investment properties include:
- Dual-purpose property – This relates to property that is part “investment property” and part property for own use (i.e., IAS 16 PP&E). For example, where a company owns a 10-story building and occupies 3 floors and leases the remaining floors to other non-related tenants. In such instances, determination of whether the property is investment property under IAS 40 or IAS 16 is based on whether each portion of the asset can be sold or leased (under a finance lease) separately. If so, the determination of the type of property can be split by each portion. Otherwise, the property is only investment property and accounted for under IAS 40 if only an insignificant portion is held for the entity’s own use. What makes matters more difficult is that IAS 40 does not define “insignificant”, and therefore, judgment is often applied.
- Property under development and undecided use of the property – As a general rule, if an entity holds property and is undecided as to whether it will be held for investment or its own use, the property is considered investment property. The same holds true for property under development, ultimately to be used for investment purposes. However, once an initial determination is made, transfers to or from investment property can only be made when there is an actual change in use by the entity (and there is evidence of this change in use, other than “intent”).
- Fair value of investment property – No matter the accounting model, fair value of investment property must be determined each reporting period. Determining the fair value of a non-financial asset, such as investment property, may involve the application of a market-based, income-based, or replacement-value method (or a combination thereof). Consideration of a market participants “highest and best use” of the asset is also important. This determination often involves considerable judgment depending on the specific circumstances and properties involved in the valuation.
- Among others – There are numerous other issues related to investment properties, all of which are unique to IFRS, given the uniqueness of IAS 40 (as compared to U.S. GAAP).
Got questions on the accounting and reporting for investment properties? Drop us a comment below or check out our course on the topic.
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