The Main Objective of Investment Property - Term Paper Example

CORPORATE ACCOUNTING MUTTRAH LLC Contents Introduction 3 Objectives 3 Recognition Criteria of IAS 40 4 Differences between measurement of investment at recognition and measurement of investment after recognition 5 Critical evaluation of two models allowed by IAS 40 for treatment of after recognition 7 Treatment of the properties making references to the relevant IFRS principle 9 Treatment of Transfer and De Recognition 10 Disclosures required by IAS 40 under different models 10 Conclusion 11 References 12 Introduction IAS 40 Investment property is applicable for accounting of property which includes land and building that are used for earning in rentals or earning through the appreciation of capital. IAS 40 Investment property is mainly measured at cost. The two models that are used for measurement in the accounting treatment of IAS 40 are cost model and fair model. It is applicable for leasing out the property under operating lease, land or property valued, maintained and constructed for undetermined use in the future. IAS 40 can be classified under the following heads that is property held under an operating lease, for partial own use that is if the owner of the property uses property for its own use or for earning rentals or for appreciation in capital in such a way that it can be either leased or sold out. The property becomes insignificant if the property is not sold out. IAS 40 can also be classified as ancillary services to the owner of the property, the importance of the ancillary services can be valued by the importance of the service that is provided to the occupant. IAS 40 can be classified as the intra company rentals as the property that is rented to either the parent company or subsidiary company or the fellow subsidiary is not considered as an Investment property according to IAS 40. Therefore this type of property can be qualified as an Investment property in a separate entity. Objectives The main objective of IAS 40 Investment property is to provide an accounting treatment for investment in property and also the related disclosures. It generally includes: classifying the lease as a financial or an operating lease, recognizing the income derived from leasing of the property, the accounting treatment and disclosures made for calculating operating and financial lease. The main objective of formulating a separate accounting treatment and introducing a separate accounting standard is that the features of the investment property differs significantly from the features of the property occupied by the owner and the values related to its features are very important for the users of the financial statement analysis. Its objective can be described as a standard prescribed to identify whether the investment property acquisition relating to an asset is the acquisition of an asset or a combination of asset or a combination of business and its judgment. Investment property can be recognized as an asset when an asset is used for providing economic benefits in the future which will flow in the organization, the cost associated to investment property can be reliably measured. Measurement of investment property should be done at cost incurred initially and the transaction cost should be included in the initial measurement of cost. The objective of IAS 40 can be described as the standard which has been set in order to identify that whether the acquisition of the investment property is considered as an acquisition of an asset , a combination of business or a consolidation of assets (Ball, 2006). Recognition Criteria of IAS 40 Recognition criteria of IAS 40 identifies that an asset can be considered as an investment property only when the asset which is related to the investment property provides economic benefit in the future which will flow in the enterprise. Its cost can be measured reliably. Purchase of an investment property includes cost which comprises of purchase price and the expenditures that are related to providing of professional fees for availing legal services, the tax incurred in the transfer of property and other related transaction cost. The premium if paid for availing a lease is considered as a minimum payment of lease (Nicholls and Opal, 2005). The cost incurred for the investment property is not influenced by the start up cost, the operating losses that are incurred prior to the achievement of planned occupancy by the investment property. The abnormal waste of labor and raw material is incurred in the development and improvement of the property. An investment property is eliminated from the financial position statement when the investment property is withdrawn from its use and it is not possible of generating any future economic benefit resulting from its disposal. The amount of gain or losses derived from the non utilization of investment property can be ascertained by the difference between the carrying amount of the asset and the net disposal items which can be regarded as an item for profit or loss during the period of its disposal or during the retirement period. Treatment 2: In our case study of Muttrah LLC, the company which have a factory and it is no longer required and its activity have been declined and it is expecting to sale at a price of Rials 25,000, the factory have to recognize its asset in the factory its investment property or the asset will not be included in the financial statement as it is not possible of generating income in the future. IAS provides an option to select either the fair value model or the cost model. Fair value model helps in the initial measurement of an investment property and the fair value model changes which is identified in the profit or loss. The cost model is used when the investment property is calculated after the depreciation of cost. The organization adopting cost model reveals the fair value of the investment property (Smith, 2012). Differences between measurement of investment at recognition and measurement of investment after recognition Measurement of investment at recognition can be defined as the measurement of investment property which is measured at an initial cost and it should include the transaction cost. The cost included in the purchase of an investment property includes the expenditure incurred from the professional fees charged for the legal services that is being provided, the taxes incurred in the transfer of property and the cost involved in transaction. Treatment 1: In the case study of Muttrah LLC the company has constructed and developed a hotel for AL Seeb LLC at the cost of Rials 5, 00,000. The hotel which is completed this year and the cost plus 20% will be received by the year end. Here the company can apply measurement of investment at cost as it includes the construction and development of the hotel. The cost of the investment property is not influenced by the start up cost, the operating losses that are calculated before the investment property reaches the occupancy, the amount of waste or abnormal losses that is incurred for the construction and development of the property. The premium if paid for the lease can be treated as the minimum payment of lease. More than one investment property can be acquired in lieu of a monetary or non monetary asset or the combination of both. The entity specific operation is generally affected by that transaction which reflects the cash flows after tax. The fair value of the asset given up is measured is generally used for the measurement of cost and the asset that is received must be very clear and evident (Banerjee, 2009). Measurement of investment after recognition helps in the determination of the fair value of the investment property either for measurement or for disclosure, it also states that any changes in the accounting policies should be adopted only when its changes will affect the financial statement and will provide more relevant and reliable information of the changes and impact of transaction. An organization should either select the fair value model or the cost model for application in the investment property that will directly provide a return from the fair value or a return from the asset that includes the investment property. Critical evaluation of two models allowed by IAS 40 for treatment of after recognition Fair value model Fair value model can be described as the organization if after the initial cost recognition shall measure its entire asset in fair value if it wants to adopt fair value of property investment. The loss or gain resulted from the change in the fair value provides the profit or loss for the period in which it is undertaken. The organization identifies the fair value without making any changes in the fair value. The fair value price of an investment property is that price in which the product is exchanged between the parties willing for the investment and situated at an arm length (Brown, 2013). Fair value is generally very time specific as the condition of the market varies and keep on changing. As a result the amount determined under fair value may be correct or incorrect for a specific time period if the assumption is made at some other time. Fair value of an investment property is generally concerned with the rental income that is derived from the current leases which is affected by the number of assumptions served to the wiling parties that would determine the income from rent generated in the current condition of the market (Carmichael and Graham, 2012). It also calculates the cash outflows that are expected from the property. Some of these Outflows are considered as a liability by the organization whereas others are not shown in the financial statement. The fair value does not consider the future capital expenditure and also the future benefits derived from these expenditures. Fair value is different from that of the value in use which has been explained in IAS 36 of Impairment of Assets it estimates the knowledge of the willingness of the buyers and the sellers. Treatment 4: In the case study of Muttrah LLC , the company that has a old building which was constructed 5 years back at a cost of Rials 45,000 . Building is leased to one college for Rials 5000 per year under operating lease agreement. Here the fair value is the rental income of Rials 5000 per year is earned by Muttrah LLC in lease it is connected with the fair value. As the fair value of investment property is concerned with the rental income. Fair value establishes the similarity between assets and the investment property, tax benefit and burden of the current owner, legal restrictions and burden of the current owner. Cost Model After the initial recognition the organization that selects the cost model should identify its investment property and it should be held for sale and the construction and development of the property have been completed, transfer to the investment property, transfer from investment property to inventories. When an organization selects the cost model of investment property the transfer that is carried out do not change the amount involved during the transfer of property (Deegan, 2009). Treatment 5: Company has constructed and developed a residential complex at the cost of Rials 9, 00,000 two years ago. Complex is still vacant but the company is searching for the tenant, as the cost model deals with those property or asset whose construction and development have completed. The company’s construction and development is over but it is in search of a tenant. Treatment of the properties making references to the relevant IFRS principle Recognition and de recognition of assets and liabilities Investment property can be recognized as an asset when it earns future economic benefit related to the property which will flow in the organization and de-recognition is referred to the transfer the rights of the asset for the inflow of cash. Treatment 3: The Company has an old building which was constructed 5 years back at a cost of Rials 45,000. Building is leased to one college for Rials 5000 per year under operating lease agreement. The company will earn benefit of Rials 5000 per year which flow in the organization (Dworsky, 2009). Measurement of how profit affects the organization. Treatment 3 is applicable as its measures the profit or loss that is sold at Rials 50,000 but no rental is expected from it. Distinction between equity and liabilities which will identify the company’s owned asset and the liabilities that the company has to pay to the outsiders Profit or loss and other comprehensive income: Profit and the loss in giving rent to the Lease. The asset wills yields return and will provide future economic benefit. Treatment 3 is also applicable here as it provides no rental presently but it will provide a return of Rials 50,000. Presentation and disclosure: The disclosure which reveals the use of an asset, demand and value of the asset or property under the IAS 40 of the Investment property. Treatment of Transfer and De Recognition When a property that is occupied by the owner is considered as a standard treatment it is regarded as the investment property. The measurement of the property is calculated when the property is changed from the depreciated cost of the asset to its fair value. The income statement generally excludes the cumulative increase in the fair value before the property is considered as an investment property. This treatment defines the comparison between the entities which was revalued previously under the alternative treatment allowed I IAS 16 and also included those entity which considered IAS 16 as the standard for measurement. Treatment 5 is applied as the company has determined the fair value of the residential complex (Kimmel, Weygandt and Kieso, 2010). De recognition can be defined as that part of the investment property that has been acquired in the course of replacement. The standard defines it as the process of de recognition of the assets from the simple to more complex securitization process. Disclosures required by IAS 40 under different models Fair value model reflects the state of the actual market and its impact on the balance sheet. The evidences are provided at a current price in the active market in case of the same location condition of the property, and same lease agreement. The organization may refer to the current prices for the properties which are generally of different state of nature. Treatment 4 is applicable here as the company is getting a rent of around Rials 5000 per year under the operating lease agreement (Weil, Schipper and Francis, 2012). Cost Model defines when an organization wants to sell the investment property without its reconstruction and development and it is not reclassified as an investment property but it is disposed as an investment property. Treatment 5 is applicable as the company is in search of the tenant. Conclusion IAS 40 investment property covers a wide area which covers the capital that is subjected to appreciation, the property which is utilized for earning rentals. IAS 40 mainly deals with that entity which is subjected to operating lease. When the interest of the property is earned by the lease through operating lease, the property can be regarded as an investment property. A property will be regarded as investment property when the interest of the property is held in lease under the operating lease. Recognition can also be considered as a basis of classification, as the assets are to be recognized in such a way that it benefits the Organization providing future economic benefit. Initial measurement of the cost that includes the start up cost, initial losses that the company undergoes during its operation, abnormal wastes are to be avoided. References Ball, R., 2006. International Financial Reporting Standards (IFRS): Pros and cons for investors. 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Financial accounting: An introduction to concepts, methods and uses. Boston: Cengage Learning. Read More