Accounting for Property under IAS/IFRS
Concerns may arise when accounting for land and buildings in an entity’s financial statements, especially when determining their recognition, classification and measurement. At times, this results in inconsistencies in the treatment of properties between one entity and another. This article will look into the accounting treatment of properties.
The main financial reporting standards which deal with property are: IAS 16: Property, Plant and Equipment; IAS 40: Investment Property; IAS 2: Inventories; and IFRS 5: Non-current Assets Held for Sale and Discontinued Operations.
When should property be recognised as an asset in an entity’s financial statements?
Property should only be recognised in an entity’s financial statements if it meets the definition of an asset and satisfies the following criteria for recognition:
- It is probable that any future economic benefits associated with the item will flow to the entity; and
- The cost of the asset can be measured reliably.
This leads to a very important question: What is an asset? The Conceptual Framework for Financial Reporting defines an asset as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”.
How should an entity classify property in its financial statements? What determines the classification of assets?
Property can exhibit different characteristics and can be held for a variety of uses in order to generate future economic benefits. Hence, their nature and use determine the classification of assets.
Table 1 includes a number of questions which can help determine the classification of property and the appropriate accounting standard:
|If yes, apply|
|Is the property intended for sale in the ordinary course of the business?||IAS 2|
|Is the property in the process of construction or development for sale in the ordinary course of the business?||IAS 2|
Is the property owner-occupied* or being developed for owner occupation?
*Owner-occupied property is ‘property held by the owner or by the lessee under a finance lease for use in the production or supply of goods or services or for administrative purposes.’
|Is the owned or leased property held with the intention of rental purposes or capital appreciation, or both?||IAS 40|
|Is the land held for a currently undeterminable future use?||IAS 40|
|Is the building owned by the entity (or held by the entity under a finance lease) and leased out under one or more operating leases?||IAS 40|
|Is the building vacant but is held to be leased out under one or more operating leases?||IAS 40|
|Is the property being constructed or developed for future use as investment property?||IAS 40|
Will the property’s carrying amount be recovered principally through a sale transaction rather than through continuing use?
IFRS 5 specifies other conditions which must be met for an asset, or disposal group, to be classified as held for sale.
Table 1: Classification of property
There may be instances where a portion of a property may be held to earn rentals or capital appreciation while another portion is used for the production or supply of goods, services or for administrative purposes. How should an entity account for this?
If these portions could be sold separately (or leased out separately under a finance lease), an entity should account separately for the portions. If, however, these portions could not be sold separately, one should ask:
Is the portion being held for use in the production or supply of goods, services, administrative purposes, significant?
If the answer is yes, apply IAS 16. If the answer is no, apply IAS 40.
How should property be initially measured? After initial recognition, how should the property be subsequently measured?
Owner-occupied property should initially be measured at cost and all directly attributable costs necessary to bring the asset into working condition should be capitalised. These costs include delivery and installation costs, architects’ fees and borrowing costs. They may also include the costs of dismantling and removing the asset and restoring the site on which it is located.
After initial recognition, IAS 16 permits an entity to choose either the cost model or the revaluation model.
If the entity chooses the cost model, it will measure the property at cost and deduct any accumulated depreciation and accumulated impairment losses.
Property accounted for under the revaluation model, and whose fair value can be measured reliably, is to be carried at a revalued amount, that is, its fair value at the date of revaluation, less any subsequent accumulated depreciation and any subsequent accumulated impairment losses.
How often should we revalue the property? Revaluations need to be made often enough to ensure that the carrying amount is not materially different from its fair value at the end of the reporting period. Hence, this depends on the volatility of the asset’s value and some properties may need revaluing at least annually whilst others may need revaluing every three to five years.
An investment property shall be measured initially at its cost. Transaction costs shall be included in the initial measurement.
IAS 40 permits entities to choose either:
- A fair value model with changes in fair value recognised in profit or loss; or
- A cost model where, after initial measurement, investment property is to be measured at depreciated cost (less any accumulated impairment losses). An entity that chooses the cost model should still disclose the fair value of its investment property.
An entity that chooses the fair value model shall measure all of its investment property at fair value, except in some specific cases.
A change from one model to another should only be made if the financial statements present more relevant and reliable information.
Inventories shall be measured at the lower of cost and net realisable value. If property is expected to be sold at less than cost, it is valued at net realisable value, which is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.
The cost of inventories shall comprise all costs of purchase, costs of conversion (for example, construction costs) and other costs incurred in bringing the inventories to their present location and condition.
Property held for sale
Property classified as held for sale must be measured at the lower of its carrying amount and its fair value less costs to sell.
This property should be categorised as a current asset in the financial statements as it is expected to be sold within one year. However, depreciation on this property will cease once it is classified as held for sale.
How should an entity account for a change in the use of the property?
Any change in the use of the property may affect the accounting and measurement of the property.
When an entity uses the cost model, transfers between investment property, owner-occupied property and inventories do not change the carrying amount of the property transferred and they do not change the cost of that property for measurement or for disclosure purposes.
When an entity uses the fair value model for investment property, the following accounting treatment is required:
|Investment Property||Owner-occupied property||The property’s deemed cost for subsequent accounting in accordance with IAS 16 shall be its FV at the date of change in use.|
|Investment property||Inventories||The property’s deemed cost for subsequent accounting in accordance with IAS 2 shall be its FV at the date of change in use.|
|Owner-occupied property||Investment property||
Apply IAS 16 up to the date of change in use. At this date, any difference between the carrying value of the property and its fair value should be transferred to revaluation surplus.
After this date, all fair value movements in the investment property are recorded in profit or loss.
|Inventories||Investment property||Any difference between the fair value of the property at that date and its previous carrying amount shall be recognised in profit or loss.|
Table 2: Accounting treatment for change in use of investment property at fair value
In July 2016, the IASB agreed to finalise the amendments to IAS 40: Investment Property – Transfers of Investment Property. The Interpretations Committee recommended the board clarifies that a change in management’s intentions, in isolation, does not provide evidence of a change in use. Some examples in IAS 40 will also be amended so they could relate to property under construction or development as well as completed property. These proposed amendments are expected to be issued by the IASB in the fourth quarter of 2016.
When should property be derecognised from the financial statements?
Property should be derecognised on disposal (for example, by sale or by entering into a finance lease) or when no future economic benefits are expected from its use or disposal.
The present ‘asset’ definition, mentioned above, is expected to change. The IASB has proposed an asset to be defined as: “a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits” (Conceptual Framework Exposure Draft ED/2015/3). This means that the notion of an “expected” inflow of economic benefits has been removed. The board aims to finalise the revised Conceptual Framework in early 2017.