Gaukhar Narbekova, MinTax Group Partner, Certified Auditor of RoK, I category Tax Consultant, CIPA, DipIFR (ACCA)
The article considers the specifics of accounting for investment property, as well as the possibility to qualify the costs of laying service lines to land plots as a value increase of investment properties.
Sometimes, companies receive information about the development plans for those areas in which they have unused land plots that are recorded on the balance sheet as investment properties. At the same time, many decide to invest additional funds in laying service lines (water, sewerage, electricity, gas, etc.) onto these land plots in order to sell them to developers.
A question arises – how these costs should be booked in terms of IFRS application, i.e. is the Company entitled to refer the costs of laying service lines to the land plots to a value increase of the investment property, if a fair value method selected and approved by the accounting policy is used for measurement after initial recognition?
Below we provided an analysis of regulatory legal acts to answer the above question.
According to paragraph 16 of IFRS 40 (IAS)40 ‘Investment Property”, investment property shall be recognised as an asset when, and only when:
- it is probable that the future economic benefits that are associated with the investment property will flow to the entity; and
- the cost of the investment property can be measured reliably. An entity evaluates under this recognition principle all its investment property costs at the time they are incurred. These costs include costs incurred initially to acquire an investment property and costs incurred subsequently to add to, replace part of, or service a property.
According to paragraph 33 IFRS (IAS)40 “Investment property” after initial recognition, an entity that chooses the fair value model shall measure all of its investment property at fair value, with the exception of cases when the fair value of an asset is not practically determinable.
In the meantime, according to paragraph 35 IFRS 40 (IAS)40 “Investment property” a gain or loss arising from a change in the fair value of investment property shall be recognised in profit or loss for the period in which it arises.
Consequently, in view of the fact that the costs of laying service lines to land plots are deemed to be incurred to make additions to a real property item, such expenses are included in the initial value of the investment property. However, one should keep in mind that regardless of expenses incurred to make additions to an investee, at the end of reporting period, if a fair value model was selected, a gain or loss from a change in fair value of such investment property should also be recognized in profit or loss for the respective period.
It often happens that a company that has chosen fair value model in its accounting policy, after the initial recognition of investment property, is unable to apply the specified accounting model, for example, with respect to an unfinished construction item due to the lack of an active market for similar facilities.
In such case, how should the company act in terms of investment property measurement after initial recognition, if the fair value cannot be determined reliably?
According to paragraph 33 IFRS (IAS)40 “Investment property” after initial recognition, an entity that chooses the fair value model shall measure all of its investment property at fair value, with the exception of the case described below.
Pursuant to paragraph 53 IFRS 40, in exceptional cases, there is clear evidence when an entity first acquires an investment property (or when an existing property first becomes investment property following the completion of construction
or development, or after a change in use) that the fair value of the investment property is not reliably determinable on a continuing basis.
This arises when, and only when, comparable market transactions are infrequent and alternative reliable estimates of fair value (for example, based on discounted cash flow projections) are not available. If the entity concludes that the fair value of the investment property under construction can not be reliably estimated, but expects that the fair value of this property can be reliably estimated upon completion of construction, the entity must measure this investment property under construction at its initial cost until either its fair value can be determined reliably or until construction is completed (depending on which of these events occurs first).
Financial statements disclosures required in respect of investment property are presented below.
According to paragraph 74 IFRS (IAS)40 “Investment property”, an entity that holds an investment property under a finance or operating lease provides lessees’ disclosures for finance leases and lessors’ disclosures for any operating leases into which it has entered. At that, an entity shall disclose:
- that it applies the fair value model
- whether, and in what circumstances, the real property held by it under operating leases is classified and accounted for as investment property;
- when classification is difficult, the criteria the entity uses to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business;
- the extent to which the fair value of investment property (as measured or disclosed in the financial statements) is based on a valuation by an independent valuer who holds a recognised and relevant professional qualification and has recent experience in the location and category of the investment property being valued. If there has been no such valuation, that fact shall be disclosed;
- the amounts recognised in profit or loss for:
- rental income from investment property;
- direct operating expenses (including repairs and maintenance) arising from investment property that generated rental income during the period; and
- direct operating expenses (including repairs and maintenance) arising from investment property that did not generate rental income during the period; and
- the cumulative change in fair value recognised in profit or loss on a sale of investment property from a pool of assets in which the cost model is used into a pool in which the fair value model is used;
- the existence and amounts of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal;
- contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements.
At that, an entity that selected the fair value model, in addition to the foregoing information, shall disclose a reconciliation between the carrying amounts of investment property at the beginning and end of the period, showing the following:
- additions, disclosing separately those additions resulting from acquisitions and those resulting from subsequent expenditure recognised in the carrying amount of an asset;
- additions resulting from acquisitions through business combinations;
- assets classified as held for sale or included in a disposal group classified as held for sale in accordance with IFRS 5 and other disposals;
- net gains or losses from fair value adjustments;
- the net exchange differences arising on the translation of the financial statements into a different presentation currency, and on translation of a foreign operation into the presentation currency of the reporting entity;
- transfers to and from inventories and owner-occupied property; and
- other changes.
In practice, the company often acquires a building of a business center (investment property), a part of which is occupied by itself, and another part is leased out for office use to various organizations. At that, a question arises – how the value of investment property should be determined in case of applying the actual cost model of accounting, and this question can be answered on the basis of the following IFRS provisions.
According to paragraph 5 IFRS (IAS)40 “Investment property”:
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:
- use in the production or supply of goods or services or for administrative purposes; or
- sale in the ordinary course of business.
Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes.
Investment property is held to earn rentals or for capital appreciation or both. Therefore, an investment property generates cash flows largely independently of the other assets held by an entity. This distinguishes investment property from owner-occupied property. The production or supply of goods or provision of services (or the use of immovable assets for administrative purposes) generates cash flows that are attributable not only to immovable assets, but also to other assets used in the production or supply process. At that, owner-occupied property is subject to IFRS (IAS) 16 “Property, plant and equipment”.
According to paragraph 10 IFRS 40 “Investment property”, some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion that is held for use in the production or supply of goods or services or for administrative purposes. If these portions could be sold separately (or leased out separately under a finance lease), an entity accounts for the portions separately. If the portions could not be sold separately, the corresponding real property shall be considered as an investment property only if an insignificant portion thereof is held for use in the production or supply of goods or services or for administrative purposes.
According to paragraph 20 IFRS 40 “Investment property” an investment property shall be measured initially at its cost. Transaction costs shall be included in the initial measurement. The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure. Directly attributable expenditure includes, for example, professional fees for legal services, property transfer taxes and other transaction costs.
Thus, if the owner-occupied portion, that is, portion held for use in the production or supply of goods, provision of services or for administrative purposes, is insignificant, then the entire immovable assets will be deemed as an investment property and under the actual cost accounting model is recognized at initial value of the investment property, which comprises its purchase price and any costs directly related to its acquisition.
If the owner-occupied portion is significant, it should be accounted for separately from investment property as owner-occupied property which is subject to IFRS (IAS) 16 “Property, Plant and Equipment” on the basis of a proportionally selected economically grounded base for allocation of the initial value of a real property item.
This material is subject to copyright. Reprinting and other use is prohibited by the copyright holder. This material expresses the author’s opinion and is a recommendation. This material is based on regulatory acts in force at the time of publication.