IAS 40 Investment Property — Summary, Worked Example & Practice Questions

The test is purpose, not bricks. Land or a building qualifies when the owner is holding it in order to collect rent from tenants, or in the expectation that its market value will rise, or for both of those reasons together. What disqualifies a property is being used in the entity's own operations, or being one of the items the entity trades in the normal run of its business.

• An office block let to unrelated tenants under operating leases — investment property.
• Land bought and held with no decided use, on the view that it will appreciate — investment property.
• A newly completed building standing empty while the owner looks for a tenant — still investment property, because the intention to let it is what drives the classification.
• A building the entity is constructing or redeveloping for future use as a let property — inside IAS 40 during the work.
• The entity's own head office, factory or depot — owner-occupied, so IAS 16 applies.
• Houses a developer has built and is trying to sell — trading stock, so IAS 2 applies.
• A property already being marketed for immediate sale in its present state, where a sale is highly probable — moves into IFRS 5.

Buildings used two ways at once cause most of the classification errors. Where the let portion and the occupied portion could be disposed of individually — or let on their own under a finance lease — the entity splits the building and puts each piece under the standard that fits it. Where no such split is possible in practice, the whole building goes into one category, and it only lands in IAS 40 if the slice the owner uses itself is trivial in the context of the property as a whole. A company letting eight floors of a ten-storey tower and running its head office from the other two, in a building whose floors cannot be sold or leased individually, is holding an item of property, plant and equipment: two floors out of ten is not a trivial share.

Services supplied alongside the letting raise the same question in a different form. A landlord who arranges security, cleaning of the common parts and routine maintenance is doing what any landlord does; those services are incidental to the letting and the property stays inside IAS 40. Once the services become the substance of the arrangement, the analysis flips — a hotel operated by its owner is a trading operation housed in a building, and the building is owner-occupied under IAS 16. Where the service element sits somewhere between the two, the entity has to judge how central it is, apply the same judgement consistently, and explain the criteria it used when the answer is not obvious.

Property let to another company in the same group is classified twice, and the two answers differ legitimately. In the owner's own separate financial statements the building is let to a party outside the reporting entity and earns rent, so it is investment property. In the consolidated financial statements the tenant and the landlord are the same reporting entity, the rent eliminates on consolidation, and what remains is a building the group works from — owner-occupied property under IAS 16.

Leased premises fit in too. Where an entity holds a right-of-use asset under IFRS 16 and sublets the space to tenants rather than using it, that right-of-use asset is investment property, and it is measured on whichever policy the entity has adopted for the rest of its investment portfolio. An entity that has chosen the fair value model therefore carries the leased interest at fair value as well, rather than running it down on the IFRS 16 cost basis.

An investment property is put on the balance sheet once the economic benefits attached to it are likely to flow to the entity and its cost can be measured dependably — the same two-part gate used elsewhere for tangible assets. On acquisition it is measured at cost, whatever measurement policy the entity intends to run afterwards.

Cost is the purchase price plus every expenditure that can be traced directly to bringing the property in. Professional and legal fees on the acquisition, surveyors' charges, agents' commission and property transfer taxes all sit inside the figure that goes into the ledger. For a property the entity builds itself, cost accumulates in the usual way until construction finishes, and borrowing costs are capitalised where IAS 23 requires it.

• In: purchase price, legal and professional fees on acquisition, transfer taxes and stamp duties, other directly attributable acquisition costs.
• Out: costs of getting an operation started that are not needed to bring the property to a condition where it can be let, losses run while occupancy is being built up, and materials, labour or other inputs wasted in abnormal amounts during construction.
• Out: general administrative overheads that would have been incurred anyway.

Later spending follows the same logic as day-one cost. Routine servicing, repairs and repainting are expensed as they arise; expenditure that replaces a component or genuinely enhances the property is added to its carrying amount, with the part being replaced taken out. Under the fair value model this matters less to the closing figure than it looks, because whatever is added is immediately caught up in the next remeasurement — but the additions still have to be recorded before the property is revalued, or the reported gain for the year will be overstated by the amount spent.

After initial recognition the entity picks one of two measurement bases and applies it to everything it classifies as investment property. This is a single accounting policy for the whole category, not a decision taken building by building — an entity cannot revalue the properties that have gone up and leave the rest sitting at depreciated cost. A change from one basis to the other is a change of accounting policy under IAS 8 and is only permissible where the new presentation gives more useful information, which in practice means moves away from fair value are very hard to justify.

Under the fair value model the property is remeasured to its fair value at each reporting date, determined on IFRS 13 principles from the perspective of market participants. Every movement in that value, up or down, is taken to profit or loss in the year the value moves. There is no depreciation, because the market price already reflects the ageing of the building, and there is no revaluation surplus in equity — the gain is ordinary reported profit. Nor is there an impairment test in the IAS 36 sense: a fall in value is simply the year's fair value loss. Candidates lose marks here more than anywhere else in the standard by routing an uplift into other comprehensive income out of habit.

Under the cost model the property is carried at cost, reduced by the depreciation charged to date and by any impairment, exactly as IAS 16 would require, with the land element not depreciated and the building element written off over its useful life. The entity that goes this way is not excused from working out fair value: it still has to determine it and disclose it in the notes, so the reader can see the market position even though the balance sheet does not show it. Property that has been reclassified as held for sale is dealt with under IFRS 5 instead.

The standard begins from the position that an entity can arrive at a dependable fair value for investment property, and that starting point can be displaced only in narrow circumstances: on first acquiring a property (or on a change of use bringing one into the category) where comparable market transactions are rare and no other dependable estimate is available. In that situation the fair value model is abandoned for that one property alone, which is measured on IAS 16 cost mechanics with a residual value of nil, and kept there until it is disposed of — even if dependable evidence of value appears later. Every other property in the portfolio stays at fair value, and the entity has to disclose the fact that its portfolio contains an exception, explain why fair value could not be established, and give a range for the value where it can.

A property moves into or out of the category when what the entity actually does with it changes — the owner starts working from it, the owner moves out and lets it, development for sale begins, or a property built as trading stock is retained and let instead. Management deciding on a different plan is not enough on its own; there has to be something observable that shows the switch has taken place. A board minute recording an intention to sell, with nothing yet done, does not reclassify anything.

Where the entity is on the cost model the transfer changes nothing in the numbers: the property carries across at the amount already in the books. The rules that follow apply where the fair value model is in use, and each direction of travel is treated differently.

• Out of investment property, because the owner has moved in or because redevelopment for sale has begun: the fair value on the date the use changes is the amount the property is taken across at, and that figure becomes its deemed cost under IAS 16 or IAS 2 from then on.
• Into investment property from owner-occupation: the property is remeasured under IAS 16 up to the date of the change, so any uplift over its carrying amount goes to a revaluation surplus in other comprehensive income and any shortfall goes to profit or loss, save that a reduction reversing a surplus already sitting in equity for that property is charged against the surplus first. Only the movements after that date run through profit or loss under IAS 40.
• Into investment property from inventory: the difference between the carrying amount of the stock and the property's fair value at the date of the change is taken to profit or loss, on the reasoning that the entity has effectively realised the item at market value.
• Where the entity finishes constructing or redeveloping a property that it will hold as an investment: the gap between fair value at completion and the accumulated construction cost is recognised in profit or loss.

It helps to see why the directions are not symmetrical. Coming out of the category, the property has already been marked to market through profit or loss, so the current fair value is simply the number the receiving standard starts from — nothing new is recognised. Going into the category, the property has been sitting on a cost basis that has never been trued up, and the standard that governed it up to that point decides how the catch-up is reported: IAS 16 sends a gain to equity, whereas inventory has no equivalent mechanism, so the catch-up goes through profit or loss like any other realisation of stock.

A property leaves the balance sheet when it is sold, when it is transferred into a lease that transfers control to the customer, or when it is permanently withdrawn from use with no further benefits expected. The gain or loss is the net proceeds less the carrying amount at that date, and it goes to profit or loss in the period of the disposal. Under the fair value model the amount deducted is the most recent fair value, so a property revalued at the reporting date and sold shortly afterwards at a similar price produces only a small figure on disposal — the value change was already reported in the prior year. Compensation from a third party for a property that was impaired, lost or given up is recognised in profit or loss when it becomes receivable, and is kept separate from the disposal itself.

The disclosures are what allow a reader to compare two landlords running different policies. Every entity states which model it applies, describes how it decided which properties belong in the category when the classification was finely balanced, and explains how the fair value figures were arrived at — including the extent to which an independent valuer with relevant qualifications and recent experience of that kind of property was involved.

• Rental income earned in the period, shown against the direct operating expenses of the properties that generated it, and separately the direct operating expenses of properties that produced no rent during the period.
• A reconciliation of the opening and closing carrying amounts, showing additions from purchase and from later expenditure, additions through business combinations, disposals, fair value movements for the year, transfers to and from the owner-occupied and inventory categories, and exchange differences on translation.
• Any restrictions on realising a property or on remitting the income and proceeds from it, together with the amounts involved, and any contractual commitments to buy, build, repair or improve.
• Under the cost model: depreciation methods and useful lives or rates, gross carrying amount and accumulated depreciation at both ends of the period, and the fair value of the portfolio — or, where that cannot be determined dependably, an explanation and a range if one can be given.

The fair value disclosure required of a cost-model entity is the point of the whole disclosure package. Without it two portfolios with identical market values would look unrelated in the accounts, purely because one owner chose to revalue and the other did not. With it, the reader can strip out the policy difference and compare the underlying assets.