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Understanding IAS 40: Accounting for Investment Properties

May 22, 2023  
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Contrary to a common misconception held by many accountants, the belief that only one standard, namely IAS 16 Property, Plant and Equipment, governs long-term tangible assets is false.
While it is indeed necessary to apply IAS 16 to a majority of long-term tangible assets, it does not hold absolute authority over all such assets. I have previously debunked this myth in detail.
In addition to IAS 16, there are several other standards that specifically address long-term assets. Among them is IAS 40 Investment Property, which provides guidance and regulations for this particular category.

The accounting treatment for IAS 40 Investment Property closely resembles that of IAS 16 Property, Plant and Equipment, with one crucial difference.
While the two standards share many similarities, there is a notable distinction regarding revaluations. In the case of IAS 40, both positive and negative revaluations are reflected in the income statement, rather than being allocated to a revaluation reserve as in IAS 16.
Furthermore, if annual revaluations are conducted for investment property under IAS 40, no depreciation is recognized. This deviation from the depreciation requirement in IAS 16 reflects the specific nature of investment property valuations carried out on a regular basis.

Objective of IAS 40

The primary objective of IAS 40 Investment Property is to establish guidelines for the accounting treatment and disclosure requirements pertaining to investment property.
Now, let’s delve into what constitutes investment property.
According to IAS 40.5, investment property refers to land, a building, or a portion thereof, which is held for specific purposes, including:
1.Generating rental income.
2.Achieving capital appreciation.
3.Both rental income and capital appreciation.

Notably, if a building or land is held for any other purposes, it cannot be classified as investment property. These excluded purposes include:
1.Utilization in the production or supply of goods or services.
2Administrative purposes.
3.Sale in the ordinary course of business.

If a building or land is utilized for the aforementioned excluded purposes, it is appropriate to apply IAS 16. Alternatively, if the property is used for sale in the ordinary course of business, the appropriate standard to follow is IAS 2 Inventories.

Examples of Investment Property

1.Land held for long-term capital appreciation or for future undetermined use: For instance, if you acquire a piece of land with the intention of benefiting from its potential increase in value over time or if you have not yet determined the specific purpose for which the land will be utilized.
It is crucial to emphasize that if you acquire land with the specific intention of constructing a production facility for your own future use, it does not meet the criteria for classification as investment property. In such instances, the relevant standards to be applied are IAS 11 Construction Contracts or IFRS 15 Revenue from Contracts with Customers. These standards provide guidance for accounting and reporting related to construction projects or revenue recognition from customer contracts, respectively.

2.Building owned by the entity and leased under operating leases: This includes buildings that are leased out to third parties under one or more operating lease agreements. Even if a building is currently vacant but there are plans to lease it out, it can still be classified as investment property.

3.Property constructed or developed for future use as investment property: If you construct or develop a property with the intention of utilizing it as investment property in the future, it falls within the scope of investment property under IAS 40.
However, it’s essential to exercise caution here. If you construct a building on behalf of a third party or engage in development activities for a specific customer, it does not qualify as investment property. In such cases, the relevant standards to apply would be IAS 11 Construction Contracts or IFRS 15 Revenue from Contracts with Customers.

When to Recognize investment property

The principles governing the recognition of investment property closely mirror those outlined in IAS 16 for property, plant, and equipment. In other words, an investment property is recognized as an asset only when two conditions are fulfilled:
Recognition of investment property is based on the probability that the entity will realize prospective economic benefits associated with the property.
Additionally, the cost of the property must be measurable with reliability.
These criteria ensure that the recognition of investment property adheres to robust accounting principles and enhances the credibility and relevance of financial reporting.

How to measure investment property initially

Investment property is initially measured at its cost, which encompasses the following elements:
1.Purchase price: The amount paid to acquire the investment property.
2.Directly attributable expenditure: This includes expenses directly related to the property, such as legal fees, professional fees, property taxes, and other similar costs.
However, certain items should not be included in the cost of investment property:
1.Start-up expenses unrelated to the specific property should be excluded. However, if there are start-up expenses directly attributable to the investment property, they can be included.
2.Operating losses incurred before achieving the planned occupancy level should not be included.
3.Abnormal waste of material, labor, or other resources during the construction phase should be excluded.
In cases where payment for investment property is deferred, it is necessary to discount the future payment to its present value to determine the equivalent cash price. This ensures that the recorded cost reflects the time value of money.

Subsequent measurement of investment property

Following the initial recognition of investment property, there are two options available for subsequent measurement, as specified in IAS 40.30 and subsequent sections.
Once a choice is made regarding the measurement model, it is important to maintain consistency and apply the selected model to all investment properties, unless there are specific exceptions outlined in the standard. This ensures uniformity and comparability in the measurement of investment property across an entity’s financial statements.

Option 1: Fair value model

According to IAS 40.33, the fair value model dictates that an investment property should be recorded at its fair value on the reporting date. The process of determining the fair value adheres to the principles outlined in IFRS 13 Fair Value Measurement. This approach ensures that the investment property is accounted for based on its current market value, reflecting the prevailing conditions at the reporting date.

Option 2: Cost Model

The cost model is the second option for measuring investment property in subsequent periods.
IAS 40 refers to IAS 16 Property, Plant and Equipment for detailed guidance on the cost model. This means that the methodology used for measuring investment property under the cost model should align with the principles outlined in IAS 16. By applying the same methodology, consistency and comparability are maintained in the measurement of investment property and property, plant, and equipment.

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