IAS 40 defines investment properties as fixed assets that are held to earn rentals and for capital appreciation. Investment properties are not employed in normal activities such as in manufacturing or housing the business’ operations.
Fixed assets that are not investment properties
Fixed assets qualify to be classified as investment properties if they are held to earn rental income or to appreciate in value rather than for use or consumption in generating revenues or in earning profits.
Assets that are held for use in normal activities do not fall within the scope of IAS 40, rather they fall within the scope of IAS 16 or other relevant IAS or IFRS (International Financial Reporting Standard). The following are some assets that fall outside the scope IAS 40:
- Property held for sale in the normal course of business are covered by IAS 2 which is on inventory
- Property under construction or being developed for a customer is covered by IAS 11 which is on long-term contracts and works in progress
- Fixed assets such as plant, equipment, and properties that are used or occupied by the owner fall under IAS 16
- Properties leased under a finance lease are covered by IAS 17
Accounting models
Under IAS 40 investment properties should be valued either using the cost model or the fair value model. If a business elects to use any of these two models it must apply the chosen method to all of its investment properties and it must do so consistently. These models are discussed in the section below.
Cost model
The cost model applies the same principles as ones used to value ordinary fixed assets under IAS 16. Under IAS 16 the cost of fixed assets is made up of the purchase price plus any other costs incurred in bringing the fixed asset to the present location and condition.
If the company buys a finished property development it must value the property at the full price plus any incidental necessary costs that it incurred such as legal fees, borrowing costs if the property is being bought from borrowed money, stamp duties, and registry fees.
If the company is developing the property from scratch then the cost will include the cost of the land, building cost, other direct costs of building, unavoidable in-directs costs such as fees paid to surveyors or consultants, and an element of the business overheads.
Fair value model
The fair value is the higher of the recoverable amount and the value in use. The recoverable amount is what the business will sell the property for in an open market and the value in use is the net present value of all the net future rental incomes and operating costs plus the present value of the expected terminal value of the property.
When businesses use the fair value method they must recognise annual changes in the fair value in the profit and loss account. An increase will be shown as profit and a decrease will be shown as a loss on the profit and loss account. This treatment is different from the one used is for Property, Plant, and Equipment under IAS 16 where increases or decreases in value go to a revaluation reserve.
If a business uses the cost model it must also disclose the fair value of the property investment as a note to accounts. A business can elect to change from the cost model to fair value method when valuing investment properties in the interest of fair reporting; however, IAS 40 does not permit a reporting entity to revert from the fair value to the cost model.
Munya Mtetwa - Munya is an ACCA and IFA qualified accountant with over ten years financial management and accounting experience acquired in a plethora of ...
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