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In our previous blog, we discussed subsequent measurement of Property Plant & Equipment (PPE), Intangible Asset and Investment Property. In this blog we’ll discuss some special cases related to classification of a property as Investment Property under IAS 40. We’ll understand how to evaluate and classify the property as investment property and how it is differentiated from PPE. This understanding is important for the student of Diploma IFRS as IAS 40 requires an entity to identify the investment property separately from PPE and present and classify the same on the face of the balance sheet.
The characteristics of certain properties (investment property) differ sufficiently from the characteristics of owner-occupied property and hence the classification of certain properties as ‘investment properties’ for financial reporting purposes is required. This is because, in particular, the IASB believes that it is the current value of such properties and changes to those values that are more relevant to users of financial statement than its historical cost.
This blog specifically covers the definition and the meaning of investment property. Recognition, measurement (initial and subsequent) and derecognition principles related to investment property are covered in previous blogs along with PPE and Intangible assets. These topics are vital when preparing for IFRS certification exams, especially for students appearing for DipIFR by ACCA.
Definition of Investment Property:
- Property (being land or a building or a part of building or both)
- Held to earn rentals or for capital appreciation or for both
-
And not for own use i.e. not for
1. production supply of goods or for administrative purpose or
2. Sale in ordinary course of business
Classification is mandatory if the criteria under IAS 40 is met
Investment property is a property held to earn rentals or for capital appreciation or for both. Therefore, an investment property generates cash flow largely independently of the other assets held by an entity. This distinguishes investment property from owner-occupied property. The production or supply of goods or services or administrative properties generates cash flows that are attributable not only to property, but also to other assets used in the production or supply process.
In some cases where property is held for dual purposes i.e. both for own use and for rental / capital appreciation purposes, question arises with respect to its classification as per IFRS 16 Leases and IAS 40.
Special Cases
1. Accounting for dual purpose properties – which are capable of separation
Property – Land or Building
Portion 1 – used as:
Owner Occupied
Portion 2 – used for:
Portion 1 to be accounted for as
Portion 2 to be accounted for as:
Investment property – IAS 40
Properties capable of separation means, two or more portions of a property which are used for different purposes, are capable of being sold or leased out under finance lease, separately from each other
Example 1 – property capable of separation
Alpha Ltd owns a building having 15 floors of which it uses 5 floors for its office; the remaining 10 floors are leased to tenants under operating leases. According to law, the company could sell legal title to the 10 floors while retaining legal title to the other 5 floors.
Alpha Ltd owns a building having 15 floors of which it uses 5 floors for its office; the remaining 10 floors are leased to tenants under operating leases. According to law, the company could sell legal title to the 10 floors while retaining legal title to the other 5 floors.
In the given scenario, the remaining 10 floors should be classified as investment property since they are able to split the title between the floors.
2. Accounting for dual purpose properties – which are NOT capable of separation (1 of 2)
Property – Land or Building
Portion 1 – used as:
Owner occupied (is more than insignificant)Portion 2 – used for:
Such properties to be accounted for:
Properties NOT capable of separation means, two or more portions of a property which are used for different purposes, are NOT capable of being sold or leased out under finance lease, separately from each other.
Example 2 – property not capable of separation
Beta Ltd uses 35% of the office floor space of the building as its head office. It leases the remaining 65% to tenants, but it is unable to sell the tenant’s space or to enter into finance leases related solely to it.
Therefore, the Beta should not classify the property as an investment property as the 35% of the floor space used by the company is significant.
3. Accounting for dual purpose properties – which are NOT capable of separation (2 of 2)
Property – Land or Building
Portion 1 – used as:
Owner occupied (is insignificant)
Portion 2 – used for:
Account for entire property as Investment property under IAS 40
4. Rental properties with ancillary services:
In some cases, an entity provides ancillary services to the occupants of a property it holds and earns service income along with the rental income. Classification and accounting for such properties either as investment property or PPE depends on “proportion of service income” vis-à-vis “total income from property”. The proportion of service income will indicate whether the main objective to hold property is to earn rentals or to undertake business to deliver services using the property. Accounting of such properties will be as below:
A. Proportion of Income from property
Services Income (Insignificant)
Rental Income
Account for entire property as Investment property under IAS 40
B. Proportion of Income from property
Service Income, more than insignificant
(as compared to total income from property)
Rental Income
Account for entire property as PPE under IAS 16
Example 3
The owner of an office building provides security and maintenance services to the lessees who occupy the building. In such a case, since the services provided are insignificant, the property would be treated as investment property.
If an entity owns and manages a hotel, services provided to guests are significant to the arrangement. In such a case, an owner-managed hotel is owner-occupied property, rather than investment property.
5. Multipurpose facility
Hotels
Owner managed
Managed by third party
Treated as owner occupied and accounted under IAS 16 as PPE
Entity is passive investor
Entity is actively managing the business/ significant exposure to operating cash flows
Investment property under IAS 40
Owner occupied property IAS 16
Example 4
An entity owns a hotel, which includes a health and fitness centre, housed in a separate building that is part of the premises of the entire hotel. The owner operates the hotel and other facilities on the hotel with the exception of the health and fitness centre, which can be sold or leased out under a finance lease. The health and fitness centre will be leased to an independent operator. The entity has no further involvement in the health and fitness centre. In this scenario, management should classify the hotel and other facilities as property, plant and equipment in accordance with IAS 16 and the health and fitness centre as investment property under IAS 40.
If the health and fitness centre could not be sold or leased out separately on a finance lease, then because the owner-occupied portion is not insignificant, the whole property would be treated as an owner-occupied property.
Summary
We hope this blog helps to understand the definition and classification of Investment Property under IAS-40. Thank you for reading this article. Stay tuned for more simplified insights on IFRS standards, financial reporting, and accounting certifications.
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