IAS 40 Investment Property - Essay Example

IAS 40 – Investment Property Introduction There has been a widely held debate in terms of a need to ify a property as an investment property or a property which is in use by the owner. International Financial Reporting Standards (IFRS) provides a clear cut difference between the property which is intended to be held as investment and the property to be held for the purpose of use other than any investment purpose (Deloitte, 2012). On the other hand, if Generally Accepted Accounting Principles are taken into consideration, then there cannot be found any difference between the two as such. However IFRS has recognized the need for providing specific guidance especially for the property which is to be held by the owner for the purpose of investment (Deloitte, 2012). This article aims to study the various impacts of IAS 40 “Investment Property” with respect to different elements. The paper is structured in such a manner that first section highlights the overview of IAS 40 in which a brief history, definition, objective and scope of Investment Property is briefly discussed. Second part of this article outlines at the accounting treatment of Investment Property such recognition, measurement and disclosure requirements are explained in detail. Next section provides a brief comparison of IFRS and GAAP in respect of Investment Property followed by a section which illustrates an example reproduced from the annual report of a publicly listed company. Discussion and conclusion of IAS 40 will summarize this article. Overview of IAS 40 The overview of IAS 40 is split into four areas such that a brief history of IAS 40 is provided in the beginning followed by the definition of investment property which is used in IAS 40. Later on objective and scope of IAS 40 are described. Brief History of IAS 40 There has been a significant evolution with respect to Investment Property made by International Accounting Standard Board (IASB) such that the first issue of Investment Property was made in 1984 when an Exposure Draft E26 with the name of “Accounting for Investment” was issued. Within a period of 2 years, IASB issued a full fledge accounting standard on this area with the name of IAS 25 “Accounting for Investments”. However, in April 200, IASB replaced IAS 25 “Accounting for Investments” with a new standard named as “Investment Property” and withdrew previously issued IAS 25. IAS 40 is still applicable with having revised versions twice in 2003 and 2009. Investment Property Definition According to IAS 40, Investment Property is referred to as the property which is used by either the owner of the property or the lessee of the property under finance lease for the purpose of earning both of future rentals and capital appreciation or either of them. Objective of Investment Property As mentioned earlier, the core objective of this standard is to differentiate the property which is intended to be used in the ordinary course of the business with the one which is held by the owner or lessee under finance lease, for the purpose of generating rentals or capital gains. Scope of IAS 40 IAS 40 has outlined its scope such that this standard is applicable under the following kinds of properties (International Accounting Standards Board, 2008): 1. Holding land for the purpose of generating capital gains in future 2. Holding land for the unspecified future use 3. Leasing out a building classified as an operating lease 4. Holding a vacant building for the purpose of leasing it out classified as an operating lease 5. Underdeveloped and under-constructed property to be used as investment property in future The following items are specifically highlighted by IAS 40 which does not come under its domain: 1. Property which is in use for production, supply or for other administrative purposes 2. Property subject to IAS 2 which is used for the purpose of sale as an inventory 3. Property subject to IAS 11 which is used for construction purposes on behalf of third parties 4. Property subject to IAS 16 which is in use by the owner in the ordinary course of business 5. Property subject to IAS 17 which is leased out to another party and classified as finance lease Accounting Treatment of Investment Property under IAS 40 This section emphasizes upon the guidance provided by IASB under IAS 40 in terms of accounting treatment of investment property. Recognition, measurement and disclosures of investment property are discussed as under: Recognition The following recognition criterion is provided under IAS for investment property: Investment property should be recognized as an asset in the statement of financial position in the even when the cost of investment property can be measured and estimated reliably as well as there are likelihoods that future economic benefits which are associated with that investment property, would flow to the entity (International Accounting Standards Board, 2008). Measurement As per IAS 40, Initial measurement of an investment property must be made at cost which also comprises of the transaction cost in the form of brokerage charges or any other similar charges (International Accounting Standards Board, 2008). However, other costs do not include any start-up cost, wastages, initial losses etc. Subsequently, an entity has two choices to measure its investment property but must be adopted on consistent basis, which is either of (International Accounting Standards Board, 2008): Fair value, or Cost Fair Value Model According to the definition of Fair Value, “an investment property must be measured at the value which can be agreed between the knowledgeable, agreed and willing parties under an arm’s length transaction” (International Accounting Standards Board, 2008). In case, if the market for that particular investment property does not exist, IAS 40 guides that the current prices from different market with similar estimates should be considered by the entity to estimate the fair value of the investment property. Once the investment property is measured on fair value basis, the fair value model should be consistently applied on that investment property until its disposal. Cost Model IAS 40 also allows an entity to use cost model after the initial measurement on the basis of IAS 16 such that the net book of value of the investment property should be estimated by deducting the accumulated depreciation from the initial cost of the investment property (International Accounting Standards Board, 2008). Disclosures As there are two valuation models prescribed by IAS 40, therefore, disclosures in respect of both models are presented as under (International Accounting Standards Board, 2008): Fair Value Model Disclosures 1. Method of Valuation, Fair Value model or Cost model 2. Whether Investment property is an operating lease 3. Significant assumptions applied for estimating the fair value 4. Use of expertise of independent valuer and the extent to which his valuations are used 5. Income statement should have the amounts arising as a result of investment property including rentals, operating expenses, changes in the fair value of the investment 6. Reconciliation of the investment property for the books values including purchases, disposals, foreign exchange and fair value adjustments, transfer from or to investment property and other related matters. Cost Model Disclosures 1. Method of depreciation used by the entity 2. Useful life of the investment property 3. Book values of the investment property at the beginning and at the end of the period 4. Reconciliation of the book values of investment property including purchases, disposals, foreign exchange adjustments, depreciation charges, impairments and other related matters Comparison of IFRS and GAAP Till now, GAAP has not taken into consideration investment property as a separate class of property other than that of general property, plant and equipment. The following briefly highlights the comparison of both the standards. Items IFRS GAAP Relevant Standard IAS 40 Investment Property Section 4.1 on PP&E Classification Property should be either investment property or other than investment property (Grant Thornton, 2007) No classification as such. Investment Property is dealt in the same manner as with any other property Accounting Treatment Fair value model or Cost model (Grant Thornton, 2007). Cost model Operating Leased Property Lessee accounts for only rent expense and does not recognize it as an asset. (Grant Thornton, 2007). Same as IFRS Illustrated Example Following illustrated example has been taken from the 2009 annual report of Ahold Inc. The following excerpts are reproduced from the financial statement along with the reconciliation provided in the notes to the financial statement (Ahold Inc, 2009). 12 Investment property ((Ahold Inc, 2009)) € million 2009 2008 At the beginning of the year     At cost 664 658 Accumulated depreciation and impairment losses (163) (195) Carrying amount 501 463 Additions 14 52 Acquisitions through business combinations 10 – Depreciation (21) (18) Impairment losses (6) (2) Assets classified from/(to) held for sale or sold 4 (32) Transfers from property, plant and equipment 35 24 Exchange rate differences (6) 14 Closing carrying amount 531 501 At the end of the year At cost 734 664 Accumulated depreciation and impairment losses (203) (163) Carrying amount 531 501 Ahold has recognized its shopping centers as investment property such that they include Ahold store as well as the retail units for the third parties. Rental income is earned from the retail units of the third parties but those retail operational units are significant to Ahold strategically on primary basis. Those areas of shopping centers that are leased out to the third-party retailers are also recognized as investment property by the company. The book value of investment property comprises of an amount pertaining to those assets which are held by the company classified as finance leases and funding of €47 million and €42 million, respectively. These assets are not legally entitled to Ahold. The fair value of the investment property which is estimated by Ahold amounts to around €744 million as on January 3, 2010. In some instances, due to lack of reliable measures and estimates of the investment property, Ahold used the carrying values of those investment properties as their fair values. Income Statement of Ahold includes a rental income of around €65 million which is recognized as in investment property. Direct operating expenses in respect of rental income amounts to around €29 which under investment property. However, if depreciation expense is deducted from the direct operating expenses, the direct operating expenses in respect of vacant property which is also part of Ahold’s investment property amounts around €8 million. Discussion The recognition of a property as an investment property is still at its struggling stage. The biggest factor behind this issue is the lack of interest shown by GAAP in which investments property in its individual capacity has not been recognized as yet (Deloitte, 2008). It can be claimed that those companies that have adopted IFRS, only they treat investment property as a unique and different asset. However, the followers of GAAP do not consider such type of property and takes into account all kinds of properties under the broader standard that encompasses property, plant and equipment. The hopes are still alive with the increasing convergence between the two accounting bodies and there are likelihoods that investment property will be dealt by GAAP as well however the actual time frame for recognition of Investment Property under GAAP is yet to be decided (Deloitte, 2008). Conclusion This paper highlighted the different aspects of investment property such that the relevant standard covering the investment property is discussed. The objective and scope of IAS 40 has been described along with the appropriate recognition, measurement criteria and disclosures are made. Comparison of IFRS and GAAP has been evaluated in brevity. An illustrated example from the financial statements of Ahold Inc. for the year 2009 has been reproduced. Generally IAS 40 has provided two models which are fair value and cost models to be used for valuing investment property. Since investment property has not been recognized by GAAP as yet, therefore, the implementation of this concept across the world is still in its struggling stage. However, it can be expected that with the increasing convergence of accounting standards, this issue would be taken into consideration by GAAP as well. References Ahold Inc., 2009. Notes to the Consolidated Financial Statements. [Online] Available at http://www.annualreport2009.ahold.com/financials/financial_statements/notes_to_the_consolidated_financial_statements/test12.htm?page=3 [Accessed on 19 April 2012]. Deloitte, 2008, IFRSs and US GAAP A pocket comparison, [Online], Available at: http://www.iasplus.com/dttpubs/0809ifrsusgaap.pdf [Accessed on 19 April 2012]. Deloitte, 2012, Summaries of International Financial Reporting Standards, IAS40 Investment Property, [Online] Available at http://www.iasplus.com/en/standards/standard39 [Accessed on 19 April 2012]. Grant Thornton, 2007. Comparison between U.S. GAAP and International Financial Reporting Standards. [Online] Available at:http://www.grantthornton.com/staticfiles/GTCom/files/AboutUs/Assurance_thought_leadership/Grant_Thornton_U%20S%20_GAAP_v_IFRS_Comparison.pdf[Accessed 19 April 2012]. International Accounting Standards Board, 2008, International Financial Reporting Standards (IFRSs®) 2008: Including International Accounting Standards (IASs®) and Interpretations as approved at 1 January 2008, “The consolidated text of International Financial Reporting Standards as approved on 1 January 2008”. London, International Accounting Standards Board. Thomson One Banker database, 2012, [Online] Available from: http://banker.thomsonib.com [Accessed on 5th April 2012]. Read More