Investment Properties - An Overview
Real estate properties are an integral part of the UAE economy. There are many new as well as ongoing real estate projects nearing completion in the UAE, worth billions of Dirhams. In this scenario it is worthwhile to glance through the important accounting principles of IFRS specifically IAS 40 - Investment properties.
What is an investment property?
Investment property is property (land or a building or both or a part) held by the owner or by a lessee under a finance lease to earn rental or capital appreciation or both, rather than for use in the production or supply of goods and services or for the administrative purposes or sale in the ordinary course of business.
A property interest that is held by a lessee under an operating lease may also be classified and accounted for as investment property if the property meets the definition of investment property and the entity uses fair value model to account the investment property.
The following are a few examples of investment properties:
- Land held for long term capital appreciation rather than for short term sale. In this regard, land held for currently undetermined future use is regarded as land held for capital appreciation.
- Buildings owned by the entity or held by the entity under a finance lease and leased out under operating lease.
- Property being developed for future use as investment property
When is investment property recognised as an asset?
asset? An asset is recognised as an investment property as and when:
(1) It is probable to receive future economic benefits, and
(2) Cost can be reliably measured.
At what amount investment property is initially recognized?
An investment property is initially measured at cost. Cost comprises the purchase price and attributable direct costs for a purchased investment property while land and construction costs for constructed investment property. An entity does not consider the costs for the day-to-day servicing under the carrying amount of an investment property but such costs are charged to profit or loss. If the payments to investment properties are deferred then the cash price equivalent is taken as the cost.
The initial cost of investment property held under lease shall be lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount shall be shown as a liability. Here the fair value of the property is the fair value of the interest held in the leased property and not the underlying property.
At what amount investment property is measured after initial recognition?
An entity shall choose a suitable Accounting policy to measure its investment properties at one of the following models:
(1) Fair value model or
(2) Cost model
However, if a property under operating lease is accounted as investment property, then it needs to opt fair value accounting and the cost option is not available.
Starting from January 2009, the investment properties under construction could also be measured at fair value if fair values could be determined which before was being accounted at cost until the completion of the construction.
If an entity opts fair value or cost basis for its investment property it is required to apply the same basis for the similar properties.
Fair value model
Under fair value model the entity measures the investment property at the fair value. Gain or loss arising from a change in fair value of investment property is recognised in profit or loss.
Fair value of investment property is the price at which the property could be exchanged between knowledgeable willing parties in an arm’s length transactions. The fair value of investment property shall reflect the market conditions at the end of the marketing period.
In this regard it is interesting to note that the future capital expenditures for development of a property and the related future benefits from these future expenditures are considered when determining the fair value of the investment property under construction because it is a part of the strategic construction plan.
Examples of fair value: share prices traded at the stock exchanges in case of traded shares and property valuation reports for real estate properties.
Under cost model an entity will measure its investment property in accordance with the IAS 16’s requirement where carrying amount is equal to cost less any accumulated depreciation and any accumulated impairment losses. However, if the cost model is chosen, the residual value of the property should be assumed to be zero. One point to note here is that even if entity opts for cost model it is still required to show the fair value as a note in the financial statements as at the reporting date.
Transfers from and to investment properties shall be made only when there is change in use evidenced by commencement or end of owner occupation or transfer to inventories or commencement of development with a view to sale, etc. Transfer between fair value and cost models are not allowed in the normal course unless it will result in better disclosure of the property values.
Investment properties shall be derecognized or eliminated from the statement of financial position on disposal or when the investment property is permanently withdrawn from use.
An entity shall disclose mainly:
- Whether it applies fair value model or cost model.
- Fair value of the investment properties and significant assumptions applied in determining the fair value of investment properties.
- The amounts recognized in profit or loss for:
- Rental income from investment properties
- Direct operating expenses of investment properties
- Cumulative changes in fair value recognized
- Reconciliation between carrying amounts of investment properties at the beginning and end of the period specifying significant movements.
- Existence of restrictions on investment properties and any contractual obligations.
- Depreciation methods, rates, amounts, gross and net carrying amounts, details of additions and amounts of impairment losses for cost models
- The nature of the change in accounting policy.
- A description of the transition provision, whether the change in accounting policy has been made in accordance with the transition provisions and whether the transition provisions might have an effect on future periods.
- Other disclosures per IAS 16, 17, and 40.
IAS 40 guidelines have been continually revised to resolve the upcoming issues and its application will improve the fair presentation of the investment properties. However, there are two critical challenges to face with:
a. The availability of the reliable information on fair values at the period end. There is serious concern as the reliable information is not always readily and easily available or is available only at a high price. For eg: Fair values of certain properties are not available in the absence of trading of similar properties in the nearby areas. Also the valuation of investment properties requires technical expertise which is available only at a fee, which is an additional recurring cost.
b. The psychological resistance towards accepting a fall in prices. The managements are always willing to recognize profits when there is an upward price trend while they are always unwilling to recognize losses on a downward price trend.
Let us hope for that these issues are taken care in the due course…