International accounting. Introduction to IAS/IFRS a.a. 2015/2016. Overview of session. 1. Objective. 2. Definitions. 3. Recognition. 4.

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1 UNIVERSITÀ DEGLI STUDI DI BERGAMO International accounting IAS 40 Investment Property Prof. Gervasio Daniele Introduction to IAS/IFRS a.a. 2015/2016 Overview of session 1. Objective 2. Definitions 3. Recognition 4. Measurement 5. Disposal 6. Disclosures

2 Objective IAS 40 Identifies what an investment property is, how it differs from property, plant and equipment (owner-occupied property); and what recognition, measurement and disclosure standards apply to investment properties Definitions Investment property is property (land or a building or part of a building or both) held 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.

3 Definitions An investment property generates cash flows largely independently of the other assets held by an entity 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 property is investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administrative purposes. Definitions Are these Investment properties? Land held for LT capital appreciation rather than ST sale in the ordinary course of business YES Land held for a currently, undetermined future use YES Property intended for sale in the ordinary course of business or in the process of construction or development for such sale NO (IAS 2 Inventories)

4 Definitions Are these Investment properties? Building owned by the entity (or held by the entity under a finance lease) and leased out under one or more operating leases YES Owner occupied property NO (IAS 16 Property, Plant and Equipment) Property being constructed or developed for future use as investment property YES Definitions Are these Investment properties? Property being constructed or developed on behalf of third parties NO (IAS 11 Construction Contracts) Building that is vacant but is held to be leased out under one or more operating leases YES Property leased to another entity under a finance lease NO

5 Example Example of the classification of property A company owns a large building that operates as hotel If the owner signed a rental agreement with an independent third party to use the building as a hotel, the building would not be occupied by the owner. The owner would receive rental income from the tenant and would benefit from the capital growth in the value of the building. The owner might supply insignificant services to the tenant (for example security service). In this case, the building should be classified as an investment property. Example Example of the classification of property On the other hand, if the owner uses the building to operate a hotel, where the hotel business forms part of the main business activity of the owner, then the building should be classified as property, plant and equipment, and depreciated over its estimated useful life. If the owner uses life of the 100 rooms as a private residence and rents out the 95 other rooms to a tenant to run as a hotel, 95 per cent of the building should be accounted for as an investment property, provided that it is possible to apportion costs appropriately. Alternatively, if the owner-occupied portion is considered to be insignificant, the entire hotel could be classified as investment property.

6 Recognition Investment property should be recognised as an asset when: it is probable that the future economic benefits that are attributable to the investment property will flow to the entity; and the cost of the investment property can be measured reliably. Recognition Acquisition date: The acquisition date (the transaction date) is the date on wich the risk and rewards of ownership of the property are transferred from the seller to the buyer. It is the date on which the past event aspect of the asset definition is satisfied, and in almost all cases is the date on which the buyer will recognise the asset.

7 Measurement Initial measurement An investment property should be measured initially at its cost, including transaction costs 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. Measurement The cost of an investment property is not increased by: - start-up costs - operating losses incurred before the investment property achieves the planned level of occupancy - abnormal amounts of wasted material, labour or other resources incurred in constructing or developing the property Journal entry at acquisition date: Dr: Investment property / Cr: Bank/liability

8 Measurement Subsequent expenditure: Expenditure incurred after the initial recognition date is referred to as subsequent expenditure. Entities can incur subsequent expenditure on an investment property either to repair the property or to improve the future uses and economic benefits that will be derived from the property. This expenditure should be added to the carrying amount of the investment property when the definition and recognition criteria of an asset are met, and, more specifically, when the cost can be measured and it is probable that the expenditure will result in the inflow of future economic benefits. Normal repairs and maintenance of the building (such as painting or damp treatments) should be expensed when incurred. Measurement Subsequent measurement Fair value model (FVM) Cost model (CM) Must apply one model to all of its investment property

9 Measurement Fair value model The fair value of a property is usually the market value of the property. The fair value of investment property shall reflect market conditions at the end of the reporting period. The best way to determine the fair value of a property would be to refer to the current market value in an active market for a similar property, in the same location and condition and subject to the same lease and other contracts. The market value is normally the best price reasonably obtainable by the seller and the most advantageous price reasonably obtainable by the buyer, both being independent. Measurement Fair value adjustments Changes in fair value are recognized in profit or loss in period of change Fair value model takes gains and losses to income (i.e. SCI) Journal entries to record subsequent fair value adjustments: Dr: Investment property / Cr: Gain on fair value adjustments (P&L) Or, in the case of a loss: Dr: Loss on fair value adjustments (P&L) / Cr: Investment property

10 Fair value model: example (1) Investment property is acquired September 25, 2010, at a cost of ,00 Fair values: December 31, ,00 December 31, ,00 December 31, ,00 31/12/2010 Loss in value / Investment property ,00 31/12/2011 Investment property / Gain in value 8.000,00 31/12/2012 Investment property / Gain in value 7.000,00 Fair value model: example (2) An investment property was acquired with an original cost price of on 1 April The fair value of the property is determined at at 31 December 2005, the subsequent reporting date of the owner. What are journal entries to record subsequent fair value adjustments?

11 Fair value model: example (2) Investment property / Gain on fair value adjustments (P&L) At each subsequent date, you should determine the fair value of the property and adjust the carrying amount accordingly. This should be done either by increasing or decreasing the profit for the year by the amount of the gain or loss resulting from restating the property at its fair value Fair value model: example (3) On 1 January 20X1 an entity purchases a building with a cost of ,00 The entity paid : professional fees for legal services, property transfer taxes other costs The fair value of the building, at 31 December 20X1, is ,00 and at 31 December 20X2 is ,00 Show how the property would be presented in the financial statements as at 31st December 2012 if the entity adopts the Fair value model

12 Fair value model: example Building ,00 professional fees for legal services 8.000,00 property transfer taxes 2.000,00 Total ,00 The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure Asset Cash Fair value model: example 31/12/20X1: Asset Gain in value /12/20X2: Loss in value Asset

13 Measurement Cost model Applies cost model described in IAS 16 Assets reported at cost less accumulated depreciation and accumulated impairment losses Cost model Example (1) A company owns a property that is classified as an investment property. The property was acquired for , of which related to the lad and to the building. The building is expected to have an estimated useful life of 25 years and a residual value of The land will not be depreciated, and will be carried at its cost of The depreciable amount of the building is and it should be depreciated over the estimated useful life of 25 years. Annual depreciation would therefore amount to At each subsequent reporting date, the property should be considered for any possible impairment, or any change in depreciation method, residual value or estimated useful life.

14 Cost model Example (2) ABC, a manufacturing company, purchases a property for 1m on 1st January 2012 for its investment potential. The land element of the cost is believed to be 400,000 and the buildings element is expected to have a useful life of 50 years. At 31st December 2012, local property indices suggest that the fair value of the property has risen to 1.1m. Show how the property would be presented in the financial statements as at 31st December 2012 if ABC adopts a: - Cost-based policy - Fair value policy Example - solution Cost-based Depreciation in the year is 600,000 = 12, SCI = depreciation charge of 12,000; and SFP = property shown at NBV of 1,000,000-12,000 = 988,000. Fair Value SFP = property shown at fair value of 1.1m; and SCI = gain of 0.1m representing the fair value adjustment.

15 Cost model Example (3) Kerr Limited holds a building for its investment potential. This building originally cost 250,000. The fair value at 31 December 2011 was 500,000. At 31 December 2012 the fair value has risen to 600,000. The property was purchased on 1 January Assume a useful economic life of 25 years. How should this change in fair value be accounted? Value using both methods. Ignore taxation. Example - solution Fair Value: Carry at fair value (2011 = 500k; 2012 = 600k) Gain of 100k to SCI Cost: Carry at depreciated historic cost The property is five years old therefore NBV at the end of 2012 is 200k

16 Disposals An investment property shall be derecognised (eliminated from the statement of financial position) on disposal or when the investment property is permanently withdrawn from use and no future economic benefits are expected from its disposal. Gains or losses arising from the retirement or disposal of investment property shall be determined as the difference between the net disposal proceeds and the carrying amount of the asset and shall be recognised in profit or loss in the period of the retirement or disposal. Disclosure An entity shall disclose 1. whether it applies the fair value model or the cost model. 2. if it applies the fair value model, whether, and in what circumstances, property interests held under operating leases are classified and accounted for as investment property. 3. when classification is difficult, the criteria it uses to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business

17 Disclosure An entity shall disclose 4. the methods and significant assumptions applied in determining the fair value of investment property, including a statement whether the determination of fair value was supported by market evidence or was more heavily based on other factors (which the entity shall disclose) because of the nature of the property and lack of comparable market data. 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. 5. 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. Disclosure An entity shall disclose 6. 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. - 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. 7. he existence and amounts of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal. 8. contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements.

18 Disclosure

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