Investment Property

Question 1

Relco Inc. has moved out out of the 5 floor building they occupied and is now renting out the building. The building was previously classified under the cost method in PPE. Relco knows the fair value of the building is significantly higher than the cost and would like to begin recording the building at the fair value in the investment property section of the Handbook. What is the accounting for the change in use to the building from PPE to investment property?

Answer 1

The building will move from PPE to investment property and if the fair value model is now going to be used in the Investment Property Handbook Section, the difference between CV under IAS 16 (PPE) and FV at the time the company switches the use of the building, would go through OCI (assuming credit), rather than the P & L.\n\nOn a go-ahead basis, any increases or decreases in the fair value will go through the regular income statement.

Question 2

Wackal Inc (WI) is in the business of building homes for resale. Last year, the company built 20 houses at a cost of $2.6 million and at year end the sales values of the homes was $2.3 million. At the beginning of the current year, the company decided that they would not sell the homes in the foreseeable future and instead rent them out using long term leases. By year end, the market value of the 20 homes was $2.5 million. WI uses IFRS to prepare its financial statements. \tWhat is the gain or loss that the company will recognize in its current year financial statements, in connection with the homes, assuming that it does not wish to use the cost model to measure the homes?

Answer 2

Last year the homes would have been treated as inventory and measured at the lower of cost and NRV. Given that the sales value of the homes of $2.3 million was below cost at year end, the homes would have been written down to $2.3 million at the end of last year. During the current year the company decided not to sell the homes in the foreseeable future and instead to rent them out using long term leases. Accordingly, these homes would have become ?investment property? in the current year and as investment property, the homes can be valued using the cost model or fair value model. As the company does not wish to use the cost model they would use the fair value model.\n\nUnder the fair value model, the homes would be valued at the fair value at the end of the current year which is $2.5 million and the difference between the value of the homes on the financial statements at the end of last year (i.e. $2.3 million) and the value at the end of this year (i.e. $2.5 million) would be recognized in income. That is, with investment property, any change in the value over the course of the year is recognized in income.

Question 3

ABC a company involved in the restaurant business, owns a building that is 30,000 square meters. ABC does not use the cost model to value the building. The building was purchased during the year for $75 per square meter. By year end, the market value of the building had increased to $85 per square meter. The first two floors of the building which make up 40% of the area of the building is used by the company to operate one of its restaurants; the remaining 3 floors are leased to residential tenants. Following year end a developer who would like to convert the apartments to condominiums, has approached ABC to purchase the top three floors for $85 per square meter. Under IFRS, what is the (a) carrying value of the building at year end; (b) the amount to include in P&L for the year; and (c) the amount to include in OCI for the year?

Answer 3

Since it is possible to sell the top three floors without selling the bottom 2 floors, we can separate the investment property (top 3 floors) from the owner occupied property (bottom 2 floors). Accordingly, we can account for the first 2 floors as property, plant and equipment under IAS 16, and the top 3 floors as investment property under IAS 40. The evidence for this is that the developer is interested in purchasing just the top 3 floors.\n\nThe company has chosen not to use the cost model, so the full building will be accounted for at fair value. The fair value of the building based on 30,000 square meters at $85 per square meter is <strong>$2,550,000</strong>.\n\nThe capital appreciation for the top 3 floors (investment property), would be credited to income. The top 3 floors account for 18,000 meters (i.e. 30,000 meters for the whole building x 60% of the building area). The value of the building per square foot has increased by $10 per square meter. Hence the income statement gain is 18,000 X $10 = <strong>$180,000.</strong>\n\nFor the 1st 2 floors (PPE), the capital appreciation will be recognized in other comprehensive income, and will not impact the income statement. The bottom 2 floors account for 12,000 meters (i.e. 30,000 meters for the whole building x 40% of the building area). The value of the building per square foot has increased by $10 per square meter. Hence the gain that would be recognized in other comprehensive income is 12,000 X $10 = <strong>$120,000.</strong>

Question 4

ABC Inc. purchased 20% of the shares of DEF Inc. for $1 million and is using the equity method. During the year equity income from DEF was $200,000 and DEF paid out total dividends of $50,000. What is the carrying value of the investment in DEF in ABC Inc.’s year end financial statements?

Answer 4

The investment would be valued based upon the purchase price of $1 million plus equity income for the year less dividends from DEF. if total dividends of $50,000 are paid out by DEF then ABC would havebeen entitled to$10,000 of dividends (i.e. 20% X $50,000). The carrying value at year end is therefore $1,190,000 (i.e. $1,000,000 + $200,000 - $10,000).

Question 5

What is the definition of an investment property?

Answer 5

Investment property is land or building, used to earn rental income or for capital appreciation or both.

Question 6

How do you classify a building if part of the building is owner occupied and part is rented out?

Answer 6

If portions could be sold separately/leased out separately under a finance lease, the building would be accounted for separately, part as investment property and part as PPE. If portions could not be sold separately, property is investment property only if an insignificant portion is owner occupied.

Question 7

Temblant Inc. owned a building that was rented out. The building has 10 floors. Temblant then decided to move into the building and occupy the first 4 floors. How should the building be accounted for on their balance sheet (IFRS)?

Answer 7

The owner occupied portion is 4 floors out of 10, which is not an insignificant portion. Therefore, provided the portions could be sold separately/leased out separately under a finance lease, the first 4 floors would be treated as PPE and the remaining 6 floors would be treated as investment property. Otherwise, the whole building would be treated as PPE.

Question 8

How should investment property be measured upon initial recognition?

Answer 8

It should be measured at cost with direct transaction costs included in the initial measurement.

Question 9

After initial recognition, what are the 2 measurement models for investment property?

Answer 9

The 2 models are the fair value model and the cost model.

Question 10

In which case must the fair value model be used?

Answer 10

The only time no choice exists is when a property interest held by a lessee under an operating lease is classified as an investment property - in which case fair value model must be used.

Question 11

Do all investment property have to be classified using the same measurement model?

Answer 11

For the most part yes, as whichever model is chosen must be applied to all investment property, unless the company has no choice but to use the cost model for a particular property due to the inability to measure fair value reliably.

Question 12

If the cost model is used to value an investment property, what accounting standard is followed?

Answer 12

The investment property would be accounted for in accordance with the PPE standard - IAS 16.

Question 13

If the cost model is used for investment property, does the company still have to determine the fair value of the property and if yes why?

Answer 13

Even if the cost model is used, one would still need to determine fair value as the company must still disclose fair value, unless it is not possible to determine reliably, in which case one would need to explain why this is the case.

Question 14

When using the fair value model for investment property, where do the changes in fair value go (i.e. in which financial statement)?

Answer 14

Gains or losses arising from a change in the fair value of the property, <u>are recognized in profit or loss</u> for the period.

Question 15

Is depreciation taken if the fair value model is used for investment property?

Answer 15

No - unlike PPE when depreciation is taken if the revaluation model is used, there is no depreciation taken if the fair value model is used for investment property.

Question 16

According to the Handbook, can one normally determine the fair value of an investment property?

Answer 16

There is a rebuttable presumption that the entity can reliably determine fair value on a continuing basis. Only in <u>exceptional cases</u>, is cost used for an individual property because FV not reliably determinable, per the Handbook.

Question 17

A company is using the fair value method for its investment properties. There is however one property for which fair value can not be determined reliably and for that property the cost model is being used. In calculating depreciation for that property can the company assume that there is a positive residual value?

Answer 17

No - if the cost model is used for that property, the residual value is assumed to be zero.

Question 18

Can one change from using the fair value model for investment property to the cost model say it becomes very difficult over time to determine fair value?

Answer 18

No - If investment property initially measured at fair value, must continue to use fair value until disposal <u>even if</u> comparable market transactions become less frequent or market prices become less readily available.

Question 19

Build-a-lot Ltd. constructs large condominiums. Most of the condominiums are grade A condos, which are very upscale, but the company has recently constructed some grade B, lower scale condos. They are currently constructing a large condo and it is now year end and they have not decided if this condo will be a grade A or grade B property. Can the company account for the property under construction at fair value at year end?

Answer 19

It is often very difficult to determine fair value during construction. Also, the fact that at year end they are unsure if the condo will be a grade A or B property, would also make it difficult to determine fair value reliably at this stage. Once the fair value is determinable the company can use fair value.

Question 20

Remaxx Corp recently decided to move into a building they owned which was previously being rented out. They will now be occupying 100% of the building. The building was being treated as investment property and carried on their books at fair value, . How will the accounting treatment change?

Answer 20

There is a change in use, as Remaxx has commenced owner-occupation of the building, so the building will now be classified as PPE, and will be valued at the time of the change in use at fair value (i.e. the deemed cost of the building under the PPE HB Section will be based on the fair value of the building on the date of the change in use). On a go ahead basis, the building will be accounted for in accordance with the PPE section and can be valued using the cost method or revaluation method.

Question 21

Stanco Ltd. has just decided to sell a building that they were renting out to a tenant. The building was being treated as investment property and carried on their books at fair value, . Will the accounting treatment have to change in light of the decision to sell the building?

Answer 21

Nothing will happen from an accounting standpoint, as the building will remain as investment property. In order for the building to move into inventory, they will need to commence developing the building with a view to selling it. Management intention alone does not provide evidenceof a change in use. The building would then move into inventory at its fair value at the date of the change in use.

Question 22

Sadalion Ltd. was in the business of buying and selling houses. They recorded the houses as inventory. They are now entering into an operating lease with another party for a number of houses. What is the accounting impact of the change in use?

Answer 22

The houses will move from the Inventory HB Section to Investment Property HB Section and if the fair value model is used under the Investment Property HB Section, the difference between CV under IAS 2 (inventory) and FV would be recognized in profit or loss.

Question 23

Why is it highly unlikely that an entity would be able to change their accounting policy from the fair value model to the cost model for investment properties?

Answer 23

It is highly unlikely because to make an accounting policy change, the change must result in the financial statements providing reliable and more relevant information. It would be unlikely that moving from the fair value model to the cost model would provide more relevant information.