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3. Property held by a subsidiary of XYZ Inc., a real estate firm, in the ordinary course of its business
4. Property held by XYZ Inc. for the use in production
5. A hotel owned by ABC Inc., a subsidiary of XYZ Inc., and for which ABC Inc. provides security services for its guests’ belongings
Required
Advise XYZ Inc. and its subsidiaries as to which of the aforementioned properties would qualify under IAS 40 as investment properties. If they do not
qualify thus, how should they be treated under IFRS?
Solution
Properties described under items 1., 2., and 5. would qualify as investment properties under IAS 40. With respect to item 5., it is to be noted that IAS 40
requires that when the ancillary services are provided by the entity and they are considered a relatively insignificant component of the arrangement, then
the property is considered an investment property.
These properties qualify as investment properties because they are being held for rental or for capital appreciation as opposed to actively managed
properties that are used in the production of goods.
Property described in item 3. is to be treated as “inventory” under IAS 2.
Property described in item 4. is treated as a long-lived asset under IAS 16.
Investment property shall be recognized as an asset when and only when
• It is probable that future economic benefits will flow to the entity.
• The cost of the investment property can be measured reliably.
Recognition principles are similar to those contained in IAS 16.
RECOGNITION
MEASUREMENT
Measurement at Recognition
An investment property shall be measured initially at cost, including transaction charges. Again, the principles for determining cost are similar to those contained in
IAS 16, in particular for replacement and subsequent expenditure.
However, property held under an operating lease shall be measured initially using the principles contained in IAS 17, Leases—at the lower of the fair value and the
present value of the minimum lease payments. A key matter here is that the item accounted for at fair value is not the property itself but the lease interest.
Measurement after Recognition
An entity shall select either the cost model or the fair value model for all of its investment property. There are, however, two exceptions. If an entity elects to classify
property held under an operating lease as investment property, then it must select the fair value model for all of its investment property. The second exception is if the
entity has investment property backing liabilities that pay a return linked to the fair value of the assets; if so, regardless of which model is selected for measuring such
investment property, the entity continues to have a choice of models for its other investment property.
Fair Value Model
If the fair model value is selected, after initial recognition, investment property shall be measured at fair value. Fair value is the amount for which an asset could be
exchanged between knowledgeable, willing parties in an arm’s-length transaction.
Any gains or losses arising from changes in fair value shall be recognized in the income statement. This is quite a radical divergence from previous practices but is
consistent with other Standards wherein assets are held in part for capital appreciation. The issue is that any gain on such remeasurement is unrealized, and, in many
jurisdictions, the retained earnings of an entity are considered distributable (although some jurisdictions have legal definitions of distributable reserves). Consequently,
many entities then transfer an amount from retained earnings to a capital reserve that may be treated as distributable only upon disposal of the related asset.
When applying the fair value model, the fair values should reflect the market conditions at the end of the reporting period. Valuations, therefore, carried out at dates
too far removed from the end of the reporting period could reflect market conditions that are markedly different from those at the end of the reporting period and would
be unacceptable. In addition, care needs to be taken as equipment, such as elevators, air conditioning, and the like, may be recognized as separate assets. Valuations
usually include such assets, which should not be double counted.