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Section 16 – Investment property
16.2 Definition of investment property
16.2.1 Extract from FRS 102 Section 16.2
16.2.2 OmniPro comment – Investment property definition
16.3 Operating lease classified as investment property
16.3.1 Extract from FRS 102 Section 16.3
16.3.2 OmniPro comment – Operating lease classified as investment property
16.4 Mixed use property or property lease to other group companies classified as investment property
16.4.1 Extract from FRS 102 Section 16.4
16.4.2.1 Mixed Use property – Classified as investment property
16.4.2.2 Property leased to other group companies
16.4.2.3 Self constructed investment property
16.4.3 Initial and subsequent measurement
16.4.3.1 Extract from FRS 102 Section 16.5-16.7
16.4.3.2.1 Investment property – initial and subsequent measurement
16.4.3.2.2 Investment property and deferred tax
16.4.3.2.3 Self-constructed properties
16.4.3.2.4 Investment property purchased under abnormal credit terms
16.5 Transfers to/from investment property
16.5.1 Extract from FRS 102 Section 16.7-16.9
16.5.2 OmniPro comment – Transfer to/from investment property
16.6.1 Extract from FRS 102 Section 16.10-16.11
16.6.2 OmniPro comment – Disclosures
16.6.2.1 Investment properties – Accounting policy
16.6.2.2 Extract from notes to the Financial Statements
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16.4 Mixed use property or property lease to other group companies classified as investment property
16.4.1 Extract from FRS 102 Section 16.4
16.4 Mixed use property shall be separated between investment property and property, plant and equipment if the resulting portions could be sold separately or leased out separately under a finance lease. However, if the fair value of the investment property component cannot be measured reliably, the entire property shall be accounted for as property, plant and equipment in accordance with Section 17. The Appendix to Section 2 provides guidance on determining fair value
16.4.2 OmniPro comment
16.4.2.1 Mixed Use property – Classified as investment property
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 under Section 16.4 of FRS 102. 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. If it cannot be valued reliably this must be accounted for as property, plant and equipment.
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.
16.4.2.2.Property leased to other group companies
Section 16, does not exclude property rented to other group companies from 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 would still be required to be classified as investment property even where no rent is charged where the property is held for capital appreciation.
16.4.2.3 Self constructed investment property
Self-constructed investment property is not dealt with specifically in Section 16 however it does state 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.
16.4.3 Initial and subsequent measurement
16.4.3.1 Extract from FRS 102 Section 16.5-16.7
Initial measurement
16.5 An entity shall measure an 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.
Subsequent measurement
16.7 An investment property 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 an investment property, the item accounted for at fair value is that interest and not the underlying property. The Appendix to Section 2 provides guidance on determining fair value.
16.4.3.2 OmniPro comment
Under Section 16.5 of FRS 102 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 at 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 as required by Section 16.10(b) of FRS 102.
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, however this is not specifically required by the Standard.
The fair value movement is 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. The authors belief is that it will be very rare for the undue cost or effort get out to be applied in practice. FRED 67 proposes to abolish the ability to use the undue cost or effort get out for all periods beginning on or after 1 January 2019.
16.4.3.2.2 Investment property and deferred tax
Section 29 of FRS 102 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 as stated in Section 29.16 of FRS 102. Indexation should be applied to the tax cost where relevant.
Note no deferred tax would need to be recognised where there would be no capital gains tax payable on subsequent disposal (e.g. relief on certain disposal of land or buildings acquired in period 7 December 2011 to 31 December 2014 and that property is held for a period of 4/7 years provides exemption from CGT. Consideration will need to be given as to whether a deferred tax asset should be recognised on any valuation below cost (only recognise if it is probable there will be capital gains in future to utilise the loss).
Example 1: Fair value movements and deferred tax impact
Company A purchased a property on 1 February 2015 for CU200,000 which was rented out on 1 March 2015 and therefore met the definition of investment property. Legal costs of CU10,000 were incurred on the purchase and property assessment costs were incurred of CU5,000. At the 31 December 2015 the fair value was CU250,000. The sales deferred tax rate is 20%. The accounting requirements are as follows are
On initial recognition CU CU
Dr Investment Property 210,000
(property assessment costs are not directly attributable)
Cr Bank 210,000
On 31 December 2015
| CU | CU | |
| Dr Investment Property | 40,000 | |
| Cr Fair Value Movement on Investment Property in P&L | 40,000 | |
|
Dr Deferred Tax P&L (CU40,000*20%) |
8,000 | |
| 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
If in this example the deferred tax asset exceeded the deferred tax liability then no deferred tax would be recognised as the assets would set against the liability to bring the liability to CU Nil. The recovery element of the deferred tax asset after set off could not be recognised because as per Section 29.7 of FRS 102 where there is another deferred tax liability to set this off it should not be recognised against (which there would not be in this example as there are no other chargeable assets for CGT purposes in existence at the period end)
Example 2: Investment Property Fair value movements and deferred tax impact
Company A purchased a property on 30 December 2014 for CU210,000 which was rented out on 1 March 2015 and therefore met the definition of investment property. At the 31 December 2015 the fair value was CU250,000 and did not change during the 7 year period. The sales deferred tax rate is 20% (Capital Gains tax rate). Assume indexation is not applicable. Assume this property meets the requirement for CGT exemption and at 31 December it is probable it will be held until the elapsing of a 7 year period. This property was sold in year 10 and the value remained the same throughout.
The journals required for year ended 31 December 2015 was:
| CU | CU | |
| Dr Investment Property | 40,000 | |
| Cr Fair Value Movement on Investment Property in P&L (other operating income) | 40,000 |
Being journal to reflect the movement in fair value during the year. No deferred tax impact as it is exempt from CGT.
The journals required at 31 December 2021 and before:
No journal required as full gain of €40,000 is exempt.
The journals required at 31 December 2022:
| CU | CU | |
|
Dr Deferred Tax in P&L ((CU250,000-210,000) / 8yrs * 1yr )*20%) |
1,000 | |
| Cr Deferred Tax in Balance Sheet | 1,000 |
Example 3: Deferred tax asset recognition
Company A has two investment properties. Investment property 1 is stated at CU200,000 and cost €11,000. Investment property 1 has a base cost of CU100,000 and its fair value stated in the accounts is €U50,000. Assume a deferred tax rate (CGT rate) of 20%.
Under Section 29.6 of FRS 102 the deferred tax 29.7 liability of CU18000 (CU200000 – CU110000) x 20%) is required to be recognised. Under Section 29.7 of FRS 102 the deferred tax asset on Investment property 2 of CU10000 ((CU100,000-CU50,000) x 20%) can only be recognised if it is probable the asset will be recovered against the reversal of deferred tax liabilities or future CGT profits. In this instance as the deferred tax liability of CU18000 exists on investment property 2 this liability can be set against the deferred tax asset of CU10,000 or on a future sale the loss on Investment property 1 can be utilised against the gain on investment property 2. This assumes both properties are subject to tax in the same country/tax jurisdiction (if they were not then there would be no legal right of set off and the deferred tax asset could not be recognised).
If in this example the deferred tax asset exceeded the deferred tax liability, then no deferred tax would be recognised as the assets would set against the liability to bring the liability to CU Nil. The recovery element of the deferred tax asset after set off could not be recognised because as per Section 29.7 of FRS 102 where there is another deferred tax liability to set this off it should not be recognised against (which there would not be in this example as there are no other chargeable assets for CGT purposes in existence at the period end)
16.4.3.2.3 Self-constructed properties
Section 16 of FRS 102 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 17.10 of FRS 102, it can also include directly attributable borrowing costs where a policy of capitalisation of borrowing costs 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.
16.4.3.2.4 Investment property purchased under abnormal credit terms.
Section 16.5 of FRS 102 makes it clear where the payment for the property is deferred beyond normal credit terms, an entity must recognise this at the present value of the future payment discounted at a marke rate of interest. See example 6 in Section 17 of FRS 102.
Example 4: purchasing on deferred credit terms
A company purchased a piece of equipment from a related party supplier on preferential terms for CU300,000. The company does not have to pay for the equipment until 2 years after delivery. Under normal trading conditions, the company would have to pay on delivery. As a result, the Company must present value the CU300,000 using the rate of interest that would be charged on this balance by a third party. Assume the interest that would be charged by a bank for 2 years on a loan of CU300,000 is 7%. The amount to be recognised as an asset is the present value for the future payment.
CU300,000 / (1+.07)^2 = CU262,031.
The difference of CU37,969 (CU300,000-CU262,031) is posted as an interest cost over the two year period assuming it does not meet the requirements for capitalising borrowing costs under Section 25 i.e. it is a qualifying asset where the asset takes a period of time to complete. This CU37,969 is charged to the profit and loss account under the effective interest rate method as detailed in Section 11 of this website.
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Example 1: Fair value movements and deferred tax impact
Example 2: Investment Property Fair value movements and deferred tax impact
Example 3: Deferred tax asset recognition
Example 4: Purchasing on deferred credit terms
Example 5: Transfer to/from investment property
Example 6: Property leased to other group companies classified as investment property
Example 7: Extract from the notes to the financial statements – note on investment property
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