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Section 16 – Example 1 – Extract from an accounting policy and notes in the financial statements
Section 16 – Investment property
Section 16 deals with any property that meets the definition of investment property. It details the required accounting for investment property initially, subsequently and what happens when the investment property cannot be reliably measured. Property held primarily for the provision of social benefits even where they meet the definition (e.g. social housing held by a public benefit entity) are scoped out of Section 16 and instead accounted for under Section 17 PPE.
Definition of investment property
Extract from FRS 102 Section 16.2
16.2 Investment property is 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 or both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
OmniPro comment
Once an entity meets the definition included in Section 16.2 above, the entity is required to measure the property in line with Section 16. Note property includes land. The entity does not have a choice, unless it could argue that preparing a valuation results in undue cost and effort. However, where an entity has valued the property under old GAAP it will be difficult to argue that it would result in undue cost or effort.
The key point to consider when determining whether a property should be classified as investment property is the entity’s intention with regard to the use of the property. Where an entity has not determined what they will use the property for, it would indicate that it should be accounted for as an investment property as they are willing to hold on to it in the meantime which in itself suggests they are holding it for capital appreciation. The only exception to this would be where the company itself is engaged in the business of developing property for onward sale. In that situation it would be classified as inventory.
The standard does not deal specifically with how the provision of ancillary services would affect whether a property is classified as investment property. IAS 40 (IFRS) deals with such services. Where ancillary services provided to a property are significant then the property cannot be classified as investment property. For example if an entity that owns an office building that it rents out and as part of this provides maintenance and security services to the tenants, this would be seen as an insignificant services. However, if the entity also provides broadband, housekeeping and other services then this may suggest that the entity is actually engaged in a trade of providing these services and are therefore not insignificant so as a result it should be classified as property, plant and equipment.
The costs to be included in investment property and included in the fair value calculation, are the other assets such as lifts, air conditioning, built in furniture, they should not be accounted separately as property, plant and equipment.
Operating lease classified as investment property
Extract from FRS 102 Section 16.3
16.3 A property interest that is held by a lessee under an operating lease may be classified and accounted for as investment property using this section if, and only if, the property would otherwise meet the definition of an investment property and the lessee can measure the fair value of the property interest without undue cost or effort on an on-going basis. This classification alternative is available on a property-by-property basis.
OmniPro comment
Where an entity leases a property on an operating lease who then sublease this to another tenant and thereby meets the definition of an investment property, it then has to be accounted for as an investment property unless it incurs undue cost and effort in fair valuing the property. The classification can be carried out on property by property basis for each operating lease.
Mixed use property or property lease to other group companies classified as investment property
Extract from FRS 102 Section 16.4
16.4 Mixed use property shall be separated between investment property and property, plant and equipment. However, if the fair value of the investment property component cannot be measured reliably without undue cost or effort, the entire property shall be accounted for as property, plant and equipment in accordance with Section 17.
OmniPro comment
Where an entity uses a property for its own use and has excess space which it rents out (e.g. the first floor of a property is used for business purposes and the second floor is rented to a third party or a group company), it is possible to allocate the portion of the space rented to investment property if that portion can be valued reliably. Where it can be valued reliably and there is no argument to support the undue cost or effort principal it must be accounted for as an investment property.
Where the portion of the property used for own use as compared to the total size of the property is insignificant then it may be possible to value the whole property as investment property. This will require judgement on a case by case basis.
Section 16, does not exclude property rented to other group companies for coming within the scope of Section 16. Therefore where it is held for capital appreciation or earns rental income, it comes within the definition of investment property and therefore will need to be accounted for as such assuming it can be measured without undue cost or effort. It may be possible to classify this as investment property even where no rent is charged as it is held for capital appreciation.
Self-constructed investment property is not dealt with specifically in Section 16 however it does stated that the initial cost should be dealt with in line with Section 17-PPE. However, this does not preclude self-constructed assets from being classed as investment property where they meet the definition of investment property and it can be reliably measured without undue cost or effort.
Initial and subsequent measurement
Extract from FRS 102 Section 16.5-16.7
16.5 An entity shall measure investment property at its cost at initial recognition. The cost of a purchased investment property comprises its purchase price and any directly attributable expenditure such as legal and brokerage fees, property transfer taxes and other transaction costs. If payment is deferred beyond normal credit terms, the cost is the present value of all future payments. An entity shall determine the cost of a self-constructed investment property in accordance with paragraphs 17.10 to 17.14.
16.6 The initial cost of a property interest held under a lease and classified as an investment property shall be as prescribed for a finance lease by paragraphs 20.9 and 20.10, even if the lease would otherwise be classified as an operating lease if it was in the scope of Section 20 Leases. In other words, the asset is recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount is recognised as a liability in accordance with paragraphs 20.9 and 20.10. Any premium paid for a lease is treated as part of the minimum lease payments for this purpose, and is therefore included in the cost of the asset, but is excluded from the liability.
16.7 Investment property whose fair value can be measured reliably without undue cost or effort shall be measured at fair value at each reporting date with changes in fair value recognised in profit or loss. If a property interest held under a lease is classified as investment property, the item accounted for at fair value is that interest and not the underlying property. Paragraphs 11.27 to 11.32 provide guidance on determining fair value. An entity shall account for all other investment property as property, plant and equipment using the cost model in Section 17.
OmniPro comment
Investment property is initially required to be recognised at purchase cost plus legal, brokerage fees, stamp duty etc. Assessment studies carried out prior to the purchase cannot be capitalised as they are not directly related.
Investment property is subsequently measured at fair value which can be reliably measured unless it results in undue costs or effort. Fair value is defined in FRS 102 as the amount in which an asset could be exchanged between knowledgeable willing parties in an arm’s length transaction. There is no requirement to use a professional valuer, however if one is not used this has to be disclosed.
The fair value movement posted to the profit and loss account would not be deemed to be a realised profit as the property is not readily convertible into cash without incurring costs and taking time. Therefore, in order to keep track, it may be appropriate for an entity to create a non-distributable reserve and transfer the fair value movement from profit and loss reserves to a non-distributable reserve in the statement of changes in equity.
The fair value movement in posted to the profit and loss account. In assessing whether fair valuing will result in undue costs or efforts, a certain degree of judgment will be required and will be based on facts and circumstances of the entity.
For small entities, it may be possible to prove this undue cost based on the results and economics of the entity. However in reality where an entity was able to fair value investment property under old GAAP it would be very difficult for the client to make this argument. This will require judgment on a case by case basis.
Section 29 requires deferred tax to be recognised on the uplift in value and posted to the tax line in the profit and loss account. The deferred tax rate to use is the sales tax rate.
Example 1: Fair value movements and deferred tax impact
Company A purchased a property on 1 February 2015 for 200,000 which was rented out on 1 March 2015 and therefore met the definition of investment property. Legal costs of 10,000 were incurred on the purchase and property assessment costs were incurred of 5,000. At the 31 December 2015 the fair value was 250,000. The sales deferred tax rate is 20%. The accounting requirements are as follows are:
On initial recognition
Dr investment property 210,000 (property assessment costs are not directly attributable)
Cr bank 210,000
On 31 December 2015
Dr investment property €40,000
Cr fair value movement on investment property in P&L €40,000
Dr deferred tax P&L €8,000 (€40,000*20%)
Cr deferred tax in balance sheet €8,000
Being journal to reflect the movement in fair value during the year including the deferred tax impact
Self-constructed properties
Section 16 does not exclude self-constructed property from being classed as investment property where it can be measured reliably. Initially self-constructed property should include all directly attributable purchase costs in line with Section 17, it can also include directly attributable borrowing costs where a policy of capitalisation to borrowing has been chosen. Only costs incurred in getting it to its present condition up to the time it is ready to use can be capitalised, hence where a property is ready for use but requires necessary legal sign off, then capitalisation can continue until that sign off has been obtained.
At the end of each period during construction assuming it can be reliably measured, the purchase cost is uplifted for the valuation. In subsequent periods during self-construction, the purchase cost capitalised are compared to the updated valuation, however the difference is reduced for any uplift reflected in prior periods so that fair value adjustments are not double counted.
However, if this approach in relation to self-constructed property is taken care needs to be taken to ensure that the valuation incorporates all risks on completion of the full contract, the stage of completion and the likelihood of future cash flows.
Transfers to/from investment property
Extract from FRS 102 Section 16.7-16.9
16.8 If a reliable measure of fair value is no longer available without undue cost or effort for an item of investment property measured using the fair value model, the entity shall thereafter account for that item as property, plant and equipment in accordance with Section 17 until a reliable measure of fair value becomes available. The carrying amount of the investment property on that date becomes its cost under Section 17. Paragraph 16.10(e)(iii) requires disclosure of this change. It is a change of circumstances and not a change in accounting policy.
16.9 Other than as required by paragraph 16.8, an entity shall transfer a property to, or from, investment property only when the property first meets, or ceases to meet, the definition of investment property.
OmniPro comment
A transfer is made from investment property to PPE in the following cases:
- The property can no longer be measured reliably e.g. the property market has changed in the location where the property is and a lot of the neighboring buildings are vacant.
- The property can no longer be valued at fair value due to undue cost or effort.
- The property is moved to own use
- The property is moved to inventories
In each of the above cases, the carrying value at that time transferred to PPE/inventory becomes the deemed cost in PPE and is depreciated over its remaining useful life from that date where a nil residual value is assumed. This is merely treated as a change in circumstances and adjusted in the year it occurs and disclosed as such in the financial statements.
A transfer is made from PPE to investment property in the following cases:
- The property can be reliably measured
- The property can be valued now without undue cost
- The property is moved from own use
- The property is moved from inventory
In each of the above cases, at the date any of the above occurs, the difference between the carrying amount in PPE at that date and the fair value is posted as a profit/loss to the profit and loss account.
Example 2: transfer to/from investment property
Company A purchased a property which met the definition of an investment property in year 1. At the end of year 3, the company transferred it to own use. The fair value as stated in the trial balance prior the end of year 3, was €200,000. Therefore given the change in use, Section 16 no longer applied from that date, therefore there would be journal posted to credit investment property and debit PPE for €200,000. At that date the company determined the remaining life was 20 years. Therefore with effect from the start of year 4, the property will be depreciated each year at €10,000.
Transition to FRS 102
Section 35.10 provides an exemption to allow a prior valuation as deemed cost. This exemption is not likely to be beneficial as all investment property under old GAAP had to be carried at open market value which should equate to fair value so there would be no transition adjustments in any event.
Principal transition adjustments
1) Recognition of fair value adjustments through the profit and loss and the related deferred tax to include transfer from revaluation reserve to a non-distributable reserve
Example 3: Fair value and tax adjustments
Assume the date of transition is 1 January 2014 which is the opening balance sheet. Under old GAAP the company purchased a property for €100,000. The valuation at 31 December 2013 was €200,000 which equated to the open market value which also equates to the fair value at that date. Under old GAAP the open market value at 31 December 2014 and 2015 was €250,000, the movement of which was posted to the STRGL in the year ended 31 December 2014. The revaluation reserve under old GAAP was €100,000 and €200,000 for year ended 31 December 2013&2014 respectively. Assume the deferred tax rate is 20% (the sales (CGT) rate). The transition adjustments required on adoption of FRS 102 are:
Transition journals to be posted on 1 January 2014
Cr non-distributable reserve €100,000
Dr revaluation reserve €100,000
Being journal to transfer the old revaluation reserve to a non-distributable reserve.
Dr deferred tax in P&L €20,000 ((€200,000-€100,000)*20%)
Cr deferred tax liability balance sheet €20,000
Being journal to reflect the deferred tax on the uplift in value at the future expected sales tax rate
Transition journals to be posted on 31 December 2014 assuming the journals above are posted to reserves etc
Cr fair value movement on
investment property in P&L €50,000 (€250,000-€200,000)
Dr STRGL €50,000
Being journal to transfer the fair value uplift to the profit and loss account.
Dr deferred tax in P&L €10,000 (€50,000*20%)
Cr deferred tax liability balance sheet €10,000
Being journal to reflect the deferred tax on the uplift in value at the future expected sales tax rate
Cr non-distributable reserve €50,000
Dr revaluation reserve €50,000
Being journal to transfer the old revaluation reserve to a non-distributable reserve.
No journals are required at the 31 December 2015 assuming the above journals are posted and any profit and loss journals posted in 31 December 2015 are posted to profit and loss reserves.
2) Recognition of investment property for property rented to group companies
Where an entity leases property to another member of the group on transition this may require the property to be reclassified from property, plant and equipment to investment property and the property then to be shown at fair value. Under old GAAP, where a property was leased to another group company this was classified as property, plant and equipment and depreciated (it could not be classified as investment property). This example assumes that the property meets the definition of investment property.
Example 4: Property leased to other group companies classified as investment property
Assume the date of transition to FRS 102 is 1 January 2014 the date of transition to FRS 102 is 1 January and the deferred tax rate is 20% which is the sales tax rate. Company A is a member of a group. Company A leases property to a sister Company; Company B for 10 years and receives an annual rent of €50,000. The property was purchased for €150,000 and the net book value at 1 January 2014, 31 December 2014 and 2015 in the old GAAP books is €100,000, 90,000 and 80,000 respectively. The directors have determined the fair value of the property at 1 January 2014 was €200,000. Assume the property did not qualify for capital allowance purposes and the property remained at its fair value of €200,000 at 31 December 2014 and 2015 as this still equated to fair value. Assume the property met the conditions for investment property from 1 January 2014. The adjustments required on transition are:
Transition journals to be posted on 1 January 2014
Cr non-distributable reserve €50,000 (200,000-150,000) – fair value uplift
Cr profit and loss reserves €50,000 (150,000-100,000) – prior depreciation
Cr property, plant and equipment €100,000
Dr investment property €200,000
Being journal to transfer the property from PPE to investment property, derecognise prior years depreciation and recognise the fair value uplift.
Dr deferred tax in P&L €10,000 ((200,000-150,000 cost)*20%)
Cr deferred tax balance sheet €10,000
Being journal to reflect the deferred tax on the uplift in value at the future expected sales tax rate
Transition journals to be posted on 31 December 2014 assuming the journals above are posted to reserves etc
Cr depreciation in P&L 10,000 (being movement in book value yr on yr)
Dr property, plant and equipment 10,000
Being journal to reverse depreciation posted in 2014 on the property under old GAAP.
The same journal as above is posted in 2015 to reverse the depreciation charged in the 2015 trial balance.
Disclosures
Extract from FRS 102 Section 16.10-16.11
16.10 An entity shall disclose the following for all investment property accounted for at fair value through profit or loss (paragraph 16.7):
(a) the methods and significant assumptions applied in determining the fair value of investment property;
(b) 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 class of the investment property being valued. If there has been no such valuation, that fact shall be disclosed;
(c) the existence and amounts of restrictions on the reliability of investment property or the remittance of income and proceeds of disposal;
(d) contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements; and
(e) a reconciliation between the carrying amounts of investment property at the beginning and end of the period, showing separately:
(i) additions, disclosing separately those additions resulting from acquisitions through business combinations;
(ii) net gains or losses from fair value adjustments;
(iii) transfers to property, plant and equipment when a reliable measure of fair value is no longer available without undue cost or effort (see paragraph 16.8);
(iv) transfers to and from inventories and owner-occupied property; and
(v) other changes.
This reconciliation need not be presented for prior periods.
16.11 In accordance with Section 20 Leases, an entity shall provide all relevant disclosures required in that section about leases into which it has entered.
OmniPro comment
In relation to the above requirements, Section 16 does not require details for the comparative years however, under Company law it will be necessary to include the comparatives. Detailed below is an illustration of the various disclosure requirements which would meet the requirements above.
Example 5 – Extract from an accounting policy & notes in the financial statements
Investment properties
The group owns a number of freehold office buildings that are held to earn long term rental income and for capital appreciation. Investment properties are initially recognised at cost. Investment properties whose fair value can be measured reliably are measured at fair value. Changes in fair value are recognised in the profit and loss account.
Extract from the notes to the financial statements – note on investment property
| 12 Investment properties | 2015 | 2014 |
| € | € | |
| Investment property at fair value at 1 January | 1,000,000 | 1,000,000 |
| Additions (see note (i) below) | 200,000 | – |
| Additions as a result of acquisitions | 50,000 | – |
| (Decrease)/uplift in fair value (see note (ii) below) | (100,000) | 200,000 |
| Transfer to property, plant and equipment (see note (iii) below) | (50,000) | – |
| Transfer to property, plant and equipment (see note (iv) below) | 50,000 | – |
| Disposal | (50,000) | – |
| Investment property at fair value at 31 December | 1,100,000 | 1,200,000 |
(i) During the year the company completed the construction of a number of units which are now rented to third parties. As a result these units were transferred at cost from inventory to investment properties.
(ii) The land and buildings of the company were valued by [state name], [state qualification] to open market value reflecting existing use [or state alternate basis if appropriate] on [state date] 20XX. The valuation was carried out in accordance with the SCS Appraisal and Valuation Manual. {If the valuer is an officer or employee of the company or a group company this fact must be stated}. The critical assumptions made relating to the valuations are set out below:
2015 2014
Yields X% X%
Inflation rate X% X%
OR WHERE APPLICABLE WHERE NO VALUATION WAS COMPLETED AT THE YEAR END
The land and buildings of the company were valued by [state name], [state qualification] to fair value reflecting existing use [or state alternate basis if appropriate] on [state date] 20XX. The valuation was carried out in accordance with the SCS Appraisal and Valuation Manual. {If the valuer is an officer or employee of the company or a group company this fact must be stated}. An updated valuation was not performed by the company as the directors believe the valuation performed in XXX is not materially different from the carrying valye at 31 December 2015.
(iii) At 31 December 2015, the company could no longer reliably estimate the fair value of the investment property held at XXX due to market conditions in that location. As a result, in accordance with Section 16 of FRS 102, the property has been transferred from investment property and reclassified to property, plant and equipment at the carrying amount of €50,000 and is depreciated from that date.
OR
At 31 December 2015, the company could no longer estimate the fair value of the investment property without undue cost and effort, therefore, the property has been transferred from investment property and reclassified to property, plant and equipment at the carrying amount of €50,000 and is depreciated from that date.
(iv) At 31 December 2015, a property which met the definition of investment property but which could not be classified as investment property due the inability to reliably measure its fair value due to market conditions can now be reliably measured. As a result, in accordance with Section 16 of FRS 102, the property has been transferred from property, plant and equipment and reclassified to investment property at its fair value at that date with the uplift recognised in the profit and loss.
OR
At 31 December 2015, a property which met the definition of investment property but which could not be classified as investment property due the inability to reliably measure its fair value without undue cost or effort can now be reliably measured. As a result, in accordance with Section 16 of FRS 102, the property has been transferred from property, plant and equipment and reclassified to investment property at its fair value at that date with the uplift recognised in the profit and loss.
(v) All investment property has been pledged as security on loans taken out by the company.
(vi) The historical cost of the investment properties is as follows:
At 31 December 2015 600,000
At 31 December 2014 800,000
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