Investment property (IAS 40) - Cost vs fair value model and ...

Learning Outcomes

After reading this article, you will be able to explain what investment property is under IAS 40, describe its initial recognition and measurement, compare the cost and fair value models for subsequent measurement, and account for transfers to and from investment property. You will also know how gains, losses, and depreciation are handled for each model, and understand the exam treatment of property reclassification.

ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand and apply the core principles related to investment property as set out in IAS 40. This article covers:

• The definition and examples of investment property as per IAS 40
• The rules for initial recognition and measurement at cost
• The choice between cost and fair value models for subsequent measurement
• The accounting for changes in fair value, depreciation, and gains/losses under each model
• The requirements and mechanics of transfers between investment property and property, plant and equipment or owner-occupied property
• Recognition of gains and losses on transfer between categories

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. How should investment property be measured initially?
   1. At fair value
   2. At cost
   3. At revalued amount
   4. At net realisable value
2. Which statement best describes the treatment of fair value gains on investment property measured under the fair value model?
   1. Recorded in revaluation surplus
   2. Taken directly to retained earnings
   3. Recognised in profit or loss
   4. Recognised in other comprehensive income

3. True or False? If an owner-occupied building is transferred to investment property (fair value model), any difference between carrying amount and fair value at the transfer date is recognised in profit or loss.

4. What happens to depreciation when an investment property is held under the fair value model?

5. When can a property be transferred from investment property to property, plant and equipment?

Introduction

IAS 40 Investment Property sets out the accounting requirements for properties held to earn rental income, for capital appreciation, or both. These are distinct from properties used by the company itself or those held for sale in the ordinary course of business. Understanding how to apply the cost and fair value models, and the correct treatment of transfers, is essential for preparing accurate financial statements and for success in the ACCA FR exam.

Key Term: investment property
Property (land or building, or part thereof) held by the owner (or lessee under a finance lease) to earn rentals or for capital appreciation, or both, rather than for: (i) use in the production or supply of goods or services or for administrative purposes, or (ii) sale in the ordinary course of business.

Initial Recognition and Measurement

Investment property is recognised as an asset when, and only when, it is probable that future economic benefits will flow to the entity and the cost can be measured reliably. Initial measurement is always at cost, which includes the purchase price and any directly attributable expenditure (such as legal fees and property transfer taxes), but excludes costs like start-up expenses and abnormal losses.

Key Term: cost model (IAS 40)
A model where investment property is carried after initial recognition at cost less accumulated depreciation and any accumulated impairment losses, accounting as if it were property, plant and equipment under IAS 16.

Key Term: fair value model (IAS 40)
A model under which, after initial recognition, investment property is carried at a fair value remeasured each reporting date, with changes in fair value recognised in profit or loss.

Subsequent Measurement: Cost Versus Fair Value Model

After initial recognition, entities must choose either the cost model or the fair value model for all investment property. This decision is made at a portfolio level and consistently applied.

Cost Model

• The investment property is carried at cost less accumulated depreciation and impairment, according to IAS 16 rules.
• Depreciation is charged annually over the property's useful life.
• Any gain or loss from sale is shown in profit or loss.

Fair Value Model

• The investment property is revalued to fair value at each reporting date.
• All changes in fair value are recognised immediately in profit or loss.
• No depreciation is charged on properties measured at fair value.
• Fair value is determined by reference to an active market, or using valuation techniques if no market is available.

Worked Example 1.1

A company purchases an office building for $2,000,000 to rent to tenants. At the year-end, the fair value is estimated to be $2,200,000. The company adopts the fair value model. What is the impact on profit or loss and on the statement of financial position?

Answer:
The property is initially measured at cost: $2,000,000. At the reporting date, it is revalued to $2,200,000.

• The fair value gain of $200,000 ($2,200,000 - $2,000,000) is recognised in profit or loss for the period.
• The statement of financial position shows investment property at $2,200,000. No depreciation is charged.

Exam Warning

A common mistake in the exam is to treat gains or losses in fair value under the fair value model as other comprehensive income. Under IAS 40, all fair value changes go directly to profit or loss, NOT to OCI or revaluation surplus.

Depreciation and Gains/Losses

• Under the cost model, annual depreciation and impairment review are required, similar to IAS 16.
• Under the fair value model, do not depreciate. Any gain/loss is simply the movement in fair value.

Transfers Into and Out of Investment Property

Transfers to or from investment property can only be made when there is a demonstrable change in use, such as:

• Commencement of owner-occupation (from investment property to PPE)
• End of owner-occupation and start of renting to third parties (from PPE to investment property)
• Start or end of development for subsequent sale (to or from inventories)

On transfer:

• If switching to the fair value model, the property is revalued on the date of the transfer.
• If transferring from PPE (IAS 16) to investment property held at fair value: revalue as per IAS 16, recognise any revaluation gain in other comprehensive income (revaluation surplus), then transfer at fair value under IAS 40. Any further increase upon transfer is recorded in profit or loss only if it reverses a previous impairment.
• If transferring from investment property held at fair value to PPE: use fair value as deemed cost under IAS 16 from transfer date.
• If transferring to or from inventory (IAS 2), use fair value at the date of reclassification as the new carrying amount.

Worked Example 1.2

On 1 July 20X9, Meggie Co stops using a warehouse for its own operations and begins leasing it to a third party. The carrying amount at that date is $950,000, and the fair value is $1,050,000. Meggie Co uses the fair value model. How is the transfer accounted for?

Answer:
The company reclassifies the warehouse to investment property on 1 July 20X9. It is revalued to $1,050,000.

• The gain of $100,000 ($1,050,000 - $950,000) is treated under IAS 16 as a revaluation surplus (other comprehensive income) before the transfer.
• Thereafter, all fair value movements are recognised in profit or loss.

Key Term: transfer of property (IAS 40)
The change of a property’s classification (e.g. from PPE to investment property, or vice versa), which must be triggered by a change in use evidenced by events, not by management intention alone.

Transfers Between Cost and Fair Value Models

Entities cannot switch between models for individual properties; the model must be applied consistently to all investment properties, except on the initial adoption of IAS 40 or when required by a new accounting standard.

• Change from cost model to fair value: remeasure all properties at fair value, recognise the revaluation difference in profit or loss.
• Change from fair value model to cost: use fair value as the new deemed cost.

Transfers to/from Investment Property: Summary Table

Summary

• Investment property is initially measured at cost.
• Choice of cost or fair value model for subsequent measurement applies to all investment property.
• Under the cost model, depreciate and impair as per IAS 16.
• Under the fair value model, measure at FV each year; changes go to profit or loss. No depreciation.
• Transfers are only permitted when there is clear evidence of a change in use and must follow specific rules for remeasurement and recognition of gains or losses.
• Gains from fair value changes are never recognised in OCI under IAS 40.

Key Point Checklist

This article has covered the following key knowledge points:

• Define investment property per IAS 40
• Explain initial recognition and measurement at cost
• Compare and contrast the cost and fair value models for subsequent measurement
• Distinguish how gains, losses, and depreciation are treated under each model
• Identify when and how transfers to and from investment property are permitted
• Recognise how to account for remeasurement and transfers, including in exam questions

Key Terms and Concepts

• investment property
• cost model (IAS 40)
• fair value model (IAS 40)
• transfer of property (IAS 40)