Financial Accounting. Investment Property

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Cornelius Small
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1 Financial Accounting Investment Property

Disclaimer The DVD lectures and related study material (consisting of Powerpoint slides, summary modules, integrated question banks and other academic material) are based on the views and/or opinions

2 Disclaimer The DVD lectures and related study material (consisting of Powerpoint slides, summary modules, integrated question banks and other academic material) are based on the views and/or opinions of the relevant presenter(s) and preparer(s) thereof and do not necessarily constitute official views and/or opinions of CPDtv or any of its alliance partners. Neither the CPDtv (Pty) Ltd, its directors, employees, agents, nor any of its alliance partners, shall be held liable to anyone in respect of any reliance placed on any information so received. Should you require an official opinion or view on a specific matter, please contact the presenter directly and we will gladly assist you further, after having obtained a thorough understanding of the specific scope of the engagement and your specific facts and circumstances. Copyright notice All rights to the work contained on the website of CPDtv (Pty) Ltd are reserved. No part of the work may be reprinted or reproduced, in any form whatsoever, either in whole or in part or by any electronic or any other means including the making of photocopies thereof, without the express prior written consent of CPDtv (Pty) Ltd.

3 CHAPTER 1 Overview of IAS 40

4 Overview of the Standard Identification: Definitions (.05) Special inclusion (.06) = not examinable in QE Recognition (.16) Measurement at initial recognition (.20) Measurement after recognition (.30) Fair value model (.33) Inability to determine fair value (.53) Cost model (.56) Transfers to and from investment property (.57) Disposal of investment property (.66) Disclosure of investment property (.74) Fair value model and cost model Fair value model Cost model 5

5 Focus points IAS 40 Identification Subsequent Transfers of an IP measurement to/from IP (how to find) of IP.5 to to to.65 emphasis on fair value model 6

6 Link to the framework Investment property is an asset Resource Controlled Past entitling event Inflow Probable FEB Cost or value measured reliably Classified as investment property in terms of IAS 40 What makes this asset an investment property? 7

7 Not examinable for QE.6 Property interest held by lessee under an operating lease.25 Initial cost of a property interest held under a lease.32a to.32c Insurance industry.34 Fair value model compulsory for property interest held under operating lease.41 Guidance on fair value for property interests held under operating leases 8

8 CHAPTER 2 Identification of investment properties

9 Identification: Definitions (.05) Investment property 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 CRUX 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 Helps with the process of elimination! 10

10 Note i.r.o. definition Property Held Intention Exclusion Land Owned Capital Use in Building F/leased Rental inc. production Part of bldg Both or supply Both Sale in ordinary 11 course

11 Identification: Definitions (.05) Owner-occupied property Property Held (by the owner or lessee under a finance lease) For use in GOAL TEST = NB!! The production or supply of goods or services or For administrative purposes Therefore EXCLUDED from the definition of investment property 12

12 Examples of IP Land held for long-term capital appreciation rather than short-term sale in ordinary course of business Land held for currently undetermined future use Building owned or finance leased by entity leased out ito operating lease(s) Vacant building held to be leased out under operating leases(s) Property being constructed/developed for future use as IP (intention principle) 13

13 Intention!!! Examples of == IP Property intended for sale in ordinary course of business or in process of construction/development for such sale (WIP) = IAS 2 Property constructed on behalf of 3 rd parties = IAS 11 Owner-occupied property (= IAS 16), including: Property held for future use as OOP Property held for future development and subsequent use as OOP Property occupied by employees OOP awaiting disposal Property finance leased to another entity (SOF) 14

14 Considerations: Identification.07: Investment property (IP) generates cash flows largely independently of the other assets held by an entity Distinguishes IP from owner-occupied property (OOP) OOP generates cash flows that are attributable not only to property, but also to other assets in the production or supply process Thus governed by IAS 16 Property, Plant and Equipment.10: Can a portion of an asset be an investment property? If the portion can be sold separately (or leased out separately ito a F/L) then accounted for separately If not, the property can only be an investment property if the portion held for use is insignificant 11: Ancillary services (professional judgement required) Insignificant: IP (security & maintenance) Significant: PPE (hotels) 15

15 Consolidated AFS (.15) Separate AFS = IP Consolidated AFS = OOP 16

16 CHAPTER 3 Recognition of investment properties

17 Recognition (.16) All costs that meet the recognition criteria, will be recognised as investment property Probable that FEB likely than not ) will flow to the entity ( more Capital appreciation or Rental income The cost of the investment property can be measured reliably What is this figure? IAS

18 Important recognition points Recognition criteria = best indicator when to recognise IP All costs evaluated when incurred Initially to acquire IP Subsequently to add to, replace part of or service an IP Costs relating to R&M = not capitalised Componentisation of IP Are recognition criteria met? If so, = IP 19

19 Example of componentisation of IP Depreciated over 5 years Depreciated over 20 years Not depreciated at all 20

20 CHAPTER 4 Initial measurement of investment properties

21 Measurement at initial recognition (.20) Investment property shall be measured initially at its cost (including all transaction costs) Exchange of IP (PTO) Basic form: Excludes: Deferred pmt: Leased: Purchase price Start-up costs Cost = cash IAS Operating losses price equivalent test : Directly attrib. Abnormal wastage Difference fair value or costs (prof. fees, interest on if lower, the trf. duties, trans. financing PV of MLP costs etc.) allowed 22

22 Measurement at initial recognition Exchange transactions ( ) Asset 1 Asset 2 As long as commercial substance exists! Refer IAS Cost price of Asset 2 = Fair value of Asset 1 given up Cost price of Asset 2 = Fair value of Asset 2 received Cost price of Asset 2 = Carrying amount of Asset 1 given up 23

23 Measurement at initial recognition How do we know that fair value is reliably determinable when no comparable market transactions exist? (.29) 1. The variability in the range of reasonable fair value estimates is not significant Outcomes Asset 1 1m 1.01m 1.03m 1.05m = OK Asset 2 1m 2m 3m 3.5m = OK 2. The probabilities of the various estimates can be reasonably assessed and used to estimate fair value Outcomes % 30% 25% 5% 24

24 CHAPTER 5 Subsequent measurement of investment properties

25 Subsequent measurement (.30) An entity shall choose as its accounting policy either the fair value model or the cost model; and Apply that policy to ALL of its investment property(consistency) IAS 8: Cost model Fair value model Fair value model = Voluntary change in acc policy if reliable and more relevant information is supplied Cost model = Highly unlikely a change in accounting policy WHY? Ignore IAS 40.32A -.32C relate to insurance industry 26

26 NB Guidance on accounting policy.32 requires all entities to determine fair value of IP for purposes of: Measurement (if fair value model selected) Disclosure (if cost model selected) 27

27 Fair value model (.33) Preferably determined by valuer with knowledge and experience (.32) Gains or losses from fair value adjustments are recognised in profit or loss directly in period in which they arise (.35) Different from fair value less costs to sell (IFRS 5) Fair value reflects market conditions at reporting date 28

28 Significant guidance on fair value Make sure to study.36 to.52 Detailed and explicit guidance on how to reliably determine the fair value of IP 29

29 Example 1: Leased IPs 1/1/2009: Fair value of investment property = R1 million 1/1/2009: PV of MLP = R /12/2009: Fair value of investment property = R1.2m Required: How journalised for Year 1? 1 January 2009 Dr Investment property 900k Cr Finance lease obligation 900k The IAS test is applied here as the fair value and PV of MLP differ The investment property is NOT increased by R100k on 1/1/ December 2009 Dr Investment property 300k Cr Fair value adjustment (P/L) 300k The first fair value adjustment is done at reporting date 30

30 Example 2: Leased IPs 1/1/2009: Fair value of investment property = R900k 1/1/2009: PV of MLP = R1m 31/12/2009: Fair value of investment property = R1.2m Required: How journalised for Year 1? 1 January 2009 Dr Investment property 900k Dr Impairment loss (P/L) 100k Cr Finance lease obligation 1m The IAS test is applied here as the fair value and PV of MLP differ The investment property is decreased by R100k on 1/1/2009 due to IAS s requirement and not due to fair value adjustments 31 December 2009 Dr Investment property 300k Cr Fair value adjustment (P/L) 300k The first fair value adjustment is done at reporting date 31

31 Inability to determine fair value reliably ( ).53 REBUTTABLE ASSUMPTION that fair value can be reliably measured on an ongoing basis Only in exceptional cases where there is clear evidence that the fair value is not reliably determinable on a continuing basis: This can ONLY arise where: Comparable market transactions are infrequent and Reliable estimates of fair value (e.g. discounted cash flows) are not available Then use the cost model in terms of IAS 16 PP&E for that IP Residual value SHALL be zero Apply IAS 16 until disposal 32 The issue here is what the company should do when ONE of its investment properties fair value cannot be reliably determined and the investment properties are carried on the fair value model should all be changed?

32 The cost model (.56) All investment properties shall be measured in accordance with IAS 16 s requirements for the cost model Other than those that meet the criteria to be classified as held-for-sale (IFRS 5) Depreciation will be recognised annually Impairment tests will be done in the presence of an indicator of impairment No fair value adjustments to the P/L (except impairment) No revaluations may be performed in terms of the cost model Carrying amount = cost price less accumulated depreciation less accumulated impairment losses 33

33 CHAPTER 6 Transfers to and from and disposals of investment properties

34 Transfers to and from investment properties (.57) Only when there is a change in use: Commencement of owner-occupation (IP to PPE) Commencement of development with a view to sale (IP to Inventory) (if no development required, then IP stays IP until sale) End of owner-occupation (PPE to IP) Commencement of an operating lease to another party (inventory to IP) 35

35 Transfers to and from investment property When IP is measured on cost model, transfers between IP, PP&E and Inventories do not affect the carrying amount Thus no measurement or presentation or disclosure issues arise When IP is measured in terms of fair value model IP transferred to PP&E or inventory Fair value on date of change in use is deemed cost PP&E transferred to IP Apply IAS 16 up to date of change in use Any difference at that date between the CA and fair value = revaluation in terms of IAS 16 Decrease: Debit revaluation surplus first before debiting impairment through P/L Increase: Credit P/L first with any previous impairment, then create revaluation surplus for excess increase to FV Apply the rules of IAS 36 Impairment of assets 36

36 Transfers to and from investment property Inventory to IP Any difference between CA and fair value at that date, is processed to P/L Completion of construction or development of self- constructed IP (WIP to IP) Any difference between CA and fair value at that date, is processed to the P/L 37

37 Disposals of investment properties Investment properties shall be derecognised (i.e. credited): on disposal or when the investment property is permanently withdrawn from use and no future economic benefits are expected from its disposal Important link with IAS 17 sale and leaseback transactions! Gains/losses from retiring/disposal of IP Net disposal proceeds carrying amount of IP on disposal Difference recognised in profit/loss (P/L) or in terms of IAS 17 (S&L) Compensation from 3 rd parties for IP impaired, lost or given up Recognise in profit/loss when compensation becomes receivable 38

Meet Definition of. Be investment property. & Follow FV Model. Earn Rentals

Meet Definition of. Be investment property. & Follow FV Model. Earn Rentals Meet Definition of Requirements It s Property Held to Use in Production Process Or Admin Purpose Earn Capital Appreciation Earn Rentals & Follow Model Instead of And Available on Property By Property Basis