for Accounting Professionals

IAS 40 INVESTMENT PROPERTY

2011

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IAS 40 INVESTMENT PROPERTY

IFRS WORKBOOKS

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Welcome to IFRS Workbooks! These are the latest versions of the legendary workbooks in Russian and English produced by 3 TACIS projects, sponsored by the European Union (2003-2009) and led by PricewaterhouseCoopers. They have also appeared on the website of the Ministry of Finance of the Russian Federation.

The workbooks cover various concepts of IFRS based accounting. They are intended to be practical self-instruction aids that professional accountants can use to upgrade their knowledge, understanding and skills.

Each workbook is a self-standing short course designed for approximately of three hours of study. Although the workbooks are part of a series, each one is independent of the others. Each workbook is a combination of Information, Examples, Self-Test Questions and Answers. A basic knowledge of accounting is assumed, but if any additional knowledge is required this is mentioned at the beginning of the section.

Having written the first three editions, we want to update them and provide them to you to download. Please tell your friends and colleagues. Relating to the first three editions and updated texts, the copyright of the material contained in each workbook belongs to the European Union and according to its policy may be used free of charge for any non-commercial purpose. The copyright and responsibility of later books and the updates are ours. Our copyright policy is the same as that of the European Union.

We wish to especially thank Elizabeth Appraxine (European Union) who administered these TACIS projects, Richard J. Gregson (Partner, PricewaterhouseCoopers) who led the projects and all friends at Bankir.Ru for hosting the books.

TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the workbooks and edited the first two versions. We are proud to realise his vision.

Robin Joyce

Professor of the Chair of

International Banking and Finance

Financial University

under the Government of the Russian Federation

Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Updated

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IAS 40 INVESTMENT PROPERTY

IAS 40 INVESTMENT PROPERTY

TABLE OF CONTENTS

1. Introduction 3

2. Bank accounting and investment property 4

3.Definitions 6

4. Recognition 14

5. Disclosure 32

6. Multiple choice questions 36

7. Answers to multiple choice questions 41

Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook: Applying IFRS

Illustrative Corporate Consolidated Financial Statements 2006

1.  Introduction

Aim

The aim of this workbook is to assist the individual in understanding the IFRS accounting treatment and disclosures of Investment Properties, as detailed in IAS 40.

Summary

Accounting for investment properties differs from that of owner-occupied properties. The key difference is that when an investment property is revalued, the unrealised gain (or loss) is recorded in the income statement.

In contrast, when an owner-occupied property is revalued, any gains are taken directly to equity in the form of a revaluation reserve. The table below identifies the different accounting treatment applied to properties under IFRS depending on their current and future uses and their ownership.

Scope

IAS 40 is applied to recognition, measurement and disclosure of investment property.

IAS 40 does not deal with matters covered in IAS 17 Leases, including:

1.  classification of leases as finance leases, or operating leases;

2.  recognition of lease income from investment property;

3.  measurement in a lessee’s financial statements of property interests held under a lease, accounted for as an operating lease;

4.  measurement in a lessor’s financial statements of its net investment in a finance lease;

5.  accounting for sale and leaseback transactions; and

6.  disclosure about finance leases and operating leases.

However, IAS 40 makes reference to both operating and finance leases of investment property and the accounting for both covered in IAS17. When property becomes the subject of a sale-and-leaseback transaction, IAS 40 refers the reader to IAS 17 to account for the transaction.

IAS 40 does not apply to:

1.  biological assets related to agricultural activity (see IAS 41 Agriculture); and

2.  mineral rights and mineral reserves such as oil, natural gas, and similar non-regenerative resources.

2. Bank accounting and investment property

Summary

Most banks are heavily involved in property: their own property and that of their clients. Their clients often use property as collateral, as well as using bank funds to finance the purchase and sometimes for the construction of property. As a bank’s involvement in property increases, so does the need for banks to employ their own property experts.

Banks’ primary involvement in investment property is where it owns a building and uses a relatively-small part of it for banking. It leases the rest of the building for commercial or residential use. The parts leased to others may be accounted for as investment property.

In general, banks will not build up a portfolio of investment properties unless the profits from these are considerably higher than those that can be earned from banking activities. (Banks will prefer to use their funds in their banking business.) Investment in properties involves medium and long-term financing, and therefore may have a negative effect on liquidity from banks.

Banks may acquire properties when they foreclose on clients’ loans. Usually such properties will be shown as ‘’held for sale’’ (see IFRS 5 workbook). If the properties are to be sold, they are normally disposed of swiftly, as regulations of the Central Bank may demand that the value of such properties are reduced in the books of the banks holding them.

The bank may decide to maintain ownership of the properties (having completed any outstanding legal steps) either for its own use (IAS16) or as investment properties (IAS 40).

The bank may acquire an unfinished building when it forecloses on a loan. It may decide to complete the building rather than sell it in its unfinished state. IAS 40 applies.

IAS 40 applies to existing investment property that is being redeveloped for continued use as investment property.

The use of IAS 40 would also be found if the bank owns a subsidiary, associate or joint venture that is directly involved in investment property. Its consolidated accounts would include investment property as a result.

Bank clients may be involved in investment property. If so, financial analysis of their IFRS financial statements would require knowledge of IAS 40.

Concerns for Bankers

IFRS primarily concerns the economic value and profit of transactions, whilst bankers are deeply concerned about liquidity and cash flows.

Investment properties are medium and long-term ventures. There may be little, or no, inflow of cash until the property is finished and rented to third parties. This may require the developer to provide finance for much of the work for considerable periods of time before reimbursement, with a potential for liquidity problems arising as a result.

Regular reviews of the cash flows are needed to ensure that any slippage in the development and any anticipated reduction in rental values are quickly identified and action taken.

Another major concern with investment property is hidden losses generated by making insufficient progress, or mistakes in the early or middle stages of the development, causing cost overruns to appear in later accounting periods.

Credit officers need to understand the impact of IAS 40 in the financial statements of clients. Where clients use the fair value model for accounting for investment property, gains will appear in the income statement even if they have not been realised. Such unrealised gains have not generated cash flows, and may become losses in future periods if significant revaluations occur.

Appraisers utilised to provide valuations for clients should be recognised by the bank as acceptably professional and knowledgeable in the locations and type of properties being appraised.

Clients should provide professional appraisals based on all acceptable approaches, including the Income Approach, from which the future cash flows can be analysed for possible impairment.

Clients may use the cost model for their investment property. Any impairment charges need to be examined by the bank to decide whether there is evidence that the bank’s loan is at risk.

Impact of Property Value Decreases

Property values tend to decrease in economic recessions, but also decrease in specific towns (or areas of towns) if a major employer (private sector or public sector) moves away from that location.

Investment properties, both commercial and residential, may loses tenants, and will be replaced by tenants who pay lower rents, or some of the property may be left empty, generating no rent.

Banks which are financing such property are seeing the value of their collateral decrease, based on cash flows, and may experience late payments and defaults.

In reviewing loans for impairment, the bank may have to change its discount rate to reflect investors’ new expectations of yields in the new market conditions.

In addition, if the property needs to be sold, the number of buyers will be fewer than in more-favourable economic periods. Those buyers may be expecting to pay extremely-low ‘’fire-sale’’ prices, rather than higher prices that were being paid a few months before. The property market may have a surplus of sellers and fewer buyers leading to lower prices.

3.Definitions

Carrying Amount

A carrying amount is the amount at which an asset is recorded in the balance sheet.

Cost

Cost is the amount of cash (or cash equivalents) paid, or the fair value of other consideration given, to acquire an asset at the time of its purchase, or construction. Where payment is in shares, please see IFRS 2 workbook.

Fair Value

Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. (IFRS 13)

Investment Property

Investment property is property that can be:

1.  land, or

2.  a building, or

3.  part of a building, or

4.  both land and building.

It is held by the owner (or by the lessee, under a finance lease)

to earn rent, or for capital appreciation, or both.

It includes:

(1) land held for long-term capital appreciation rather than for short-term sale in the ordinary course of business.

(2) land held for a currently undetermined future use. (If an undertaking has not determined that it will use the land as owner-occupied property or for short-term sale in the ordinary course of business, the land is regarded as held for capital appreciation.)

(3) a building owned by the entity (or held by the entity under a finance lease) and leased out under one or more operating leases.

(4) a building that is vacant but is held to be leased out under one or more operating leases.

(5) property that is being constructed or developed for future use as investment property.

It does not include property held by the owner or lessee:

1.  for the owner’s or lessee’s use in the production, supply of goods, services, or for administrative purposes; or

2.  for sale in the ordinary course of business.

Owner-occupied property

Owner-occupied property is property held (by the owner, or by the lessee under a finance lease) for use in the business and IAS 16 Property, Plant and Equipment applies to owner-occupied property.

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IAS 40 INVESTMENT PROPERTY

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IAS 40 INVESTMENT PROPERTY

Property type- different accounting treatment applied to properties under IFRS depending on their current and future uses and their ownership
Standard / Standard Name / Valuation
Owner-occupied property / IAS 16 / Property, plant and equipment
(see also IAS 20 Government grants) / Cost or revaluation.
Property acquired in an exchange of assets / IAS 16 / Property, plant and equipment / Fair value or the carrying amount of the assets given up.
Investment property / IAS 40 / Investment property / Cost or fair value.
Investment property being redeveloped for continuing use as investment property. / IAS 40 / Investment property / Cost or fair value.
Investment property held for sale without development (unless it meets the criteria of IFRS 5 – see below). / IAS 40 / Investment property / Cost or fair value.
Property held under an operating lease classified as an investment property / IAS 40 / Investment property / Fair value (accounted for as a finance lease under IAS 17).
Property held under a finance lease / IAS 17 / Leases. Owner-occupied IAS 16,
Investment property IAS 40. / The lower of fair value and the present value of the minimum lease payments.
Property held under an operating lease – owner -occupied / IAS 17 / Leases / Leasing costs expensed.
Property lease to another party under a finance lease / IAS 17 / Leases / Account receivable equal to the net investment in the lease.
Property sale and leaseback / IAS 17 / Leases / As operating lease or finance lease, as appropriate
Trading properties – property (including investment property) intended for sale in the normal course of business or being built or developed for that purpose / IAS 2 / Inventories (Properties held for sale that meet the criteria of IFRS 5 should be recorded according to IFRS 5 – see below. These are generally not in the normal course of business.) / Lower of cost and net realisable value.
Property held for sale, or included in a disposal group that is held for sale. / IFRS 5 / Non-current assets held for sale and discontinued operations / Lower of carrying amount and fair value less costs to sell.
Assets received in exchange for loans (taking possession of collateral) / IFRS 5
IAS 16 / Non-current assets held for sale and discontinued operations
Property, plant and equipment (see Property acquired in an exchange of assets above) / Lower of fair value less costs to sell and carrying amount of the loan net of impairment at the date of exchange.
(see HSBC plc Annual Report 2005 page 247)
Property provided as part of a construction contract / IAS 11 / Construction contracts / Stage of contract completion or cost.
Future costs of dismantling, removal and site restoration. / IAS 37 / Provisions, contingent liabilities and contingent assets (see also IFRIC 1, IFRIC 5) / Present value of the expected costs, using a pre-tax discount rate.

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