IAS 40 Investment Property

This briefing document summarizes the main themes, important ideas, and key facts related to the accounting for investment property based on the provided excerpts. It draws primarily from IAS 40 “Investment Property,” illustrative financial statements, and academic papers discussing its application and impact.

1. Definition and Scope of Investment Property (IAS 40):

• Definition: 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 under a finance lease or as a right of use asset) to earn rentals or for capital appreciation or both.”
• Key Intent: The primary purpose of holding investment property is to generate largely independent cash flows through rental income and/or appreciation in value.
• Examples of Inclusion:Land held for long-term capital appreciation or currently undetermined future use.
• Buildings owned or held under a finance lease and leased out under operating leases, or vacant but held to be leased out.
• Property being constructed or developed for future use as investment property (though IAS 16 applies until completion).
• Property interest held by a lessee under an operating lease may be classified as IP if the definition is met, accounted for as a finance lease (IAS 17/IFRS 16 principles), and the fair value model is used.
• Examples of Exclusion:Property held for use in production or supply of goods/services or for administrative purposes (covered by IAS 16).
• Property intended for sale in the ordinary course of business or in the process of construction/development for such sale (covered by IAS 2 Inventories).
• Owner-occupied property (covered by IAS 16 and IFRS 16).
• Property leased to another entity under a finance lease (lessor has a lease receivable, not IP).
• Partial Own Use: If a property has portions for investment and owner-occupation that can be sold or leased separately under a finance lease, they are accounted for separately. If not separable, it’s IP only if the owner-occupied portion is insignificant.
• Ancillary Services: If services provided to lessees (e.g., security, maintenance) are insignificant to the overall arrangement, the property can still be IP. Significant services suggest the property is owner-occupied.
• Intercompany Leases: Property leased by a subsidiary to its parent (or another subsidiary) qualifies as IP in the subsidiary’s individual financial statements but not in the consolidated financial statements.

2. Recognition and Initial Measurement:

• Recognition: An owned investment property is recognized as an asset when it is probable that future economic benefits will flow to the entity and the cost can be reliably measured. For investment property held as a right-of-use asset, recognition is in accordance with IFRS 16.
• Initial Measurement: Owned investment property is initially measured at cost, including transaction costs. Cost excludes start-up costs, abnormal waste, and initial operating losses before planned occupancy. Right-of-use assets related to investment property are initially measured at cost per IFRS 16 and are included within investment property on the statement of financial position.

3. Subsequent Measurement:

• Accounting Policy: Entities choose between the fair value model and the cost model. (IAS 40) The chosen model is applied to all investment property. (IAS 40)
• Fair Value Model:Investment property is measured at fair value at each reporting date. (IAS 40)
• Gains or losses from changes in fair value are recognized in profit or loss. (IAS 40)
• The illustrative financial statements demonstrate the application of the fair value model, showing fair value hierarchy and sensitivity analysis based on changes in discount and capitalization rates.
• Valuation techniques like discounted cash flows and sales comparison are used to determine fair value.
• Concerns exist regarding the subjectivity and uncertainty inherent in fair value measurements.
• Cost Model:Investment property is carried at cost less accumulated depreciation and impairment in accordance with IAS 16.
• Fair value is still disclosed.
• Impact of IFRS 16 (Leases): For investment property held by a lessee as a right-of-use asset, if the fair value model is chosen, the requirements of the fair value model in IAS 40 apply. (IAS 40)

4. Transfers To/From Investment Property:

• Transfers are made only when there is a change in use, evidenced by specific events.
• From IP to Owner-Occupied Property OR Inventory:Fair Value Model Previously Used: The deemed cost for subsequent accounting is the fair value at the date of the change in use. Redevelopment for continued future use as IP is not a change in use. When reclassified to inventories due to commencement of development for sale, it’s at the fair value at the date of reclassification (deemed cost).
• Cost Model Previously Used: The carrying amount or cost of the property does not change for measurement/disclosure purposes.
• From Owner-Occupied Property to IP (at Fair Value): Apply IAS 16/IFRS 16 up to the date of change. The difference between the carrying amount and fair value is treated as a revaluation under IAS 16. (IAS 40)
• From Inventory to IP (at Fair Value): The inception of an operating lease to another party triggers the transfer. (IAS 40)
• Disposal without Development: If an entity decides to dispose of IP without development, it remains classified as IP until derecognized and is not treated as inventory. Such properties meeting the criteria are classified as held for sale under IFRS 5.

5. Disposals:

• Derecognize the carrying amount on disposal OR when permanently withdrawn from use with no future economic benefits expected.
• The date of disposal is determined by IAS 18 criteria for sales or IAS 17/IFRS 16 for finance leases/sale and leaseback.
• Gain or loss on disposal is the difference between net disposal proceeds and the carrying amount.
• Gain/loss is recognized in profit or loss when derecognized (unless sale and leaseback).
• Consideration received is recognized at fair value (may be cash equivalent with deferred interest).

6. Disclosure:

• Entities using the cost model must disclose fair value.
• When classification as IP is difficult, entities must develop criteria and disclose them.
• The illustrative financial statements provide examples of disclosures related to investment property, including:
• Amounts recognized in profit or loss (rental income, operating expenses, changes in fair value).
• Reconciliation of the carrying amount at the beginning and end of the period, including additions, disposals, fair value adjustments, and transfers.
• Details of valuation techniques and inputs used for fair value measurement, including the fair value hierarchy.
• Contractual obligations for the purchase, construction, or development of investment property or for repairs, maintenance, or enhancements.
• Restrictions on the realisability of investment property or the remittance of income and proceeds of disposal.
• Income from subleasing right-of-use assets is required to be disclosed where applicable.

7. Fair Value Measurement and Challenges:

• Fair value is a key aspect when using the fair value model. IFRS 13 “Fair Value Measurement” provides guidance on this.
• Valuation often involves significant judgment and estimation, Fluctuations of +/- 10% in valuation are not uncommon.
• Common valuation approaches include the sales comparison approach and the income approach (discounted cash flow, direct yield capitalization).
• The study in Sweden found a preference for the discounted cash flow model, with sales comparisons used to estimate specific inputs.
• The reliability and validity of fair value measurements, especially in illiquid markets, are ongoing considerations.

8. Interaction with Other Standards:

• IFRS 16 Leases: Significantly impacts the accounting for investment property held under operating leases by lessees, allowing them to recognize a right-of-use asset as investment property under specific conditions.
• IAS 2 Inventories: Governs the accounting for property held for sale in the ordinary course of business. Transfers from IP to inventories occur when development for sale commences, at which point fair value becomes the deemed cost.
• IAS 16 Property, Plant and Equipment: Applies to owner-occupied property and property being constructed for own use (including future IP until completion). Transfers from owner-occupied property to IP are accounted for as revaluations under IAS 16.
• IFRS 5 Non-current Assets Held for Sale and Discontinued Operations: Applies to investment property that meets the criteria to be classified as held for sale.
• IFRS 3 Business Combinations: Relevant when acquiring investment property as part of a business combination. The assessment of whether an acquisition of property with tenants constitutes a business combination depends on the transfer of processes beyond administrative-type services.

9. External vs. Internal Valuation:

• The study in Sweden indicated that most listed property companies use external appraisers for at least a portion of their portfolio, often to validate internal valuations. Some companies rely solely on external valuations, while a few perform all valuations internally, citing strong market knowledge.
• The Swedish Property Index (SFI/IPD) provides a framework and benchmarks for property appraisal.

10. Impact of Regulatory Changes:

• The adoption of IFRS in 2005, including IAS 40, marked a significant shift towards fair value accounting for investment property in the EU.
• The introduction of IFRS 16 Leases has further impacted the scope and accounting for investment property.

This briefing provides a foundational understanding of the key principles and considerations for accounting for investment property under IFRS, particularly IAS 40. Further detailed analysis should refer directly to the full texts of the relevant standards and interpretations.