IAS 40 Notes and class examples PDF

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FINANCIAL ACCOUNTING 300 IAS 40: INVESTMENT PROPERTY

DEPARTMENT OF ACCOUNTING

NOTES AND CLASS EXAMPLES

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L Kotze Material already covered in FRK201

The FRK300 scope for IAS 40 consists of the FRK201 scope (all work covered by FRK200), as well as the income tax implications for investment property. The work you covered in FRK201 will not be addressed in FRK300 lectures, although it may be tested at any time. It is assumed that you already know, understand, and can apply IAS 40 (except for a property interest and transfers which will be addressed in FRK705). The line items of an entity’s financial statements affected by IAS 40 Example Limited Statement of financial position as at ………..

R

Assets Non-current assets Property, plant and equipment Investment property Goodwill Other intangible assets Financial assets Deferred tax (if debit balance) Current assets Inventories Trade receivables Other current assets Cash and cash equivalents Current tax prepaid (if current tax was prepaid to SARS) Total assets Equity and liabilities Total equity Share capital Retained earnings/Accumulated loss Other components of equity Non-current liabilities Long-term borrowings Deferred tax (if credit balance) Long-term provisions Current liabilities Trade and other payables Short-term borrowings Short-term portion of long-term borrowings Current tax payable (if current tax owing to SARS) Short-term provisions Bank overdraft Total equity and liabilities

R

2 Example Limited Statement of changes in equity for the year ended on ……….. Share capital R

Revaluation surplus R

Retained earnings R

Balance at beginning of the year Total comprehensive income for the year Profit for the year Other comprehensive income for the year Transfer to retained earnings Balance at end of the year Example Limited Statement of profit or loss and other comprehensive income for the year ended ... R Revenue (if main business is to rent out investment properties) Cost of sales Gross profit Other income (if rental income is not a primary business activity; gains on disposal; net gain on fair value adjustment )

Distribution costs Administrative expenses Other expenses (depreciation, costs incurred related to investment property; loss on disposal; net loss on fair value adjustment )

Net finance costs Finance costs Other finance income Profit before tax Income tax expense (including current and deferred tax) Profit for the year Other comprehensive income Items that will not be reclassified to profit or loss: Revaluation surplus on property, plant and equipment Gross amount Income tax expense Mark-to-market reserve for equity instruments  Items that will be reclassified to profit or loss: Foreign currency translation reserve  Mark-to-market reserve on debt instruments  Total comprehensive income for the year  the tax effect for these items should also be presented. However, revaluations on land will be the only OCI item for which the tax effect is within the scope of FRK300. Note: The impact on the line items of the statement of cash flows will be addressed in the lecture material of IAS 7, Statement of Cash Flows, later in the year.

Scope (IAS 40.02 -.04) The scope paragraph is on awareness level which means that you must be aware of specific inclusions and exclusions in respect of IAS 40.

3 Revision of FRK201 knowledge Based on your FRK201 knowledge, can you answer the following questions?  How are investment property and owner-occupied property defined? (IAS 40.5)  What types of properties are investment properties? (IAS 40.8)  What types of properties are not investment properties? (IAS 40.9)  If a property has a dual use (e.g. portion is rented out and portion is used to supply services), can the property still be classified as investment property? (IAS 40.10)  If the property is rented out and the landlord provides security services as part of the rental agreement, can the property still be classified as investment property? (IAS 40.11)  When can investment property be recognised as an asset? (IAS 40.16)  Are day-to-day service costs included in the cost of the investment property? (IAS 40.18)  On initial recognition, at what amounts should the investment property be measured? (IAS 40.20)  What costs are included in/excluded from the cost of investment property? (IAS 40.21 -24)  If investment property is acquired in an exchange transaction, how is the cost of the investment property measured? (IAS 40.27 – 29)  What are the two accounting models that can be applied on subsequent measurement? (IAS 40.30)  If the investment property was accounted for in accordance with the cost model and during the year, management decided to use the fair value model, would this be a change in accounting policy? (IAS 40.31)  Can an entity change its accounting policy from the fair value model to the cost model? (IAS 40.31)  If the cost model is applied, why does the fair value still have to be determined? (IAS 40.79(e))  Must the fair value always be determined by an independent valuator who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the property being valued? (IAS 40.32)  Under what circumstances can an investment property be accounted for on the cost model when the accounting policy for investment property is to apply the fair value model? (IAS 40.53 – 55)  If the fair value model is applied, are fair value adjustments recognised in profit or loss or other comprehensive income? (IAS 40.35)  When must an investment property be derecognised? (IAS 40.66)  Are gains/losses on disposal recognised in profit or loss? (IAS 40.69)  If investment property is accounted for on the cost model, what information must be disclosed in the notes to the financial statements? (IAS 40.75 and 79)  If investment property is accounted for on the fair value model, what information must be disclosed in the notes to the financial statements? (IAS 40.75 and 76 – 78)

4 Difference between owned investment property and right-of-use asset You will have noted that throughout IAS 40, reference is made to “owned investment property” and property held by the lessee as a “right-of-use asset”. This distinction between investment property that is owned and investment property that is leased by a lessee from a lessor and then sub-leased by the lessee, came about as a result of the implementation of IFRS 16, Leases. In terms of IFRS 16, if a lease agreement is entered into between two parties, in terms of which the property is leased by the lessee from the lessor, the lessee is required to recognise a “right-of-use asset”. If such a leased property (represented by the “”right-ofuse asset” recognised by the lessee) is then leased out by the lessee to another party, i.e. it is sub-leased, then that right-of-use asset is an investment property. Note, however, this relates to sub-lease arrangements per IFRS 16, Leases, which is NOT within the FRK300 syllabus. FRK300 will thus only address investment property that is owned by the entity, i.e.: referred to in IAS 40 as “owned investment property”. Example 1 – building constructed; fair value model; cost model; journal entries; disclosure investment property note; no income tax PROP INVESTORS LIMITED (PIL) is a wholly owned subsidiary of Lansam Limited, and has a reporting date of 31 August. PIL is the property owning entity in the Lansam Group. Lansam Limited required additional factory space for its specialised manufacturing operations, and so at a directors’ meeting of PIL, approved the purchase by PIL of a vacant piece of land on which PIL would construct a factory building specialised to the needs of Lansam. The factory building will be rented out to Lansam Limited once it is completed. The land cost R450 000 to purchase on 2 January 20X9. The factory building’s costs of construction comprised the following:

Clearing and cleaning land in preparation for construction Building materials Labour costs Architects’ and civil engineers’ fees

R 50 000 1 025 000 450 000 25 400 1 550 400

Of this total amount, R950 400 was incurred up to 31 August 20X9 and the remainder during the period 1 September 20X9 to 31 October 20X9, when the construction of the building was completed. On 31 August 20X9, the fair value of the land and factory building under construction could not be reliably determined as comparable market transactions are infrequent for this type of specialised building and the rental agreement was still in the early stages of negotiation so no agreement on the rent amount had been reached. However, on completion, on 31 October 20X9, the fair value was determined to be R2,9 million and on 31 August 20X10, the fair value was R3,2 million. This fair value is based on the rental

5 income that will be earned in the future and has not been determined by an independent valuer who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the investment property being valued. The rental agreement was finalised and signed by both parties on 31 October 20X9. Ignore all tax implications. REQUIRED: 1.

Assume that Prop Investors Limited accounts for its investment property using the cost model of IAS 40, Investment Property. Buildings are depreciated over 20 years on the straight line basis. The residual value of the building is insignificant.

2.

Assume that Prop Investors Limited accounts for all of its investment property using the fair value model of IAS 40, Investment Property.

For both 1 and 2 above: a)

Prepare the journal entries to account for the above transactions for the year ended 31 August 20X9 and 20X10 in accordance with IAS 40, Investment Property. Closing journals and journal narrations are not required.

b)

Prepare the “Investment property” note for inclusion in the financial statements for the year ended 31 August 20X10 in accordance with IAS 40, Investment Property.

Suggested solution:

a)

Journal entries Cr R

Dr R 2 January 20X9 Investment property (SFP) Bank/Creditors/Loans (SFP )

450 000 450 000

2 January – 31 August 20X9 Investment property ( SFP) Bank/Creditors/Loans (SFP )

950 400 950 400

1 September – 31 October 20X9 Investment property (SFP) Bank/Creditors/Loans (SFP )

600 000 600 000

31 August 20X10 Depreciation (P/L) Accumulated depreciation – investment property (SFP) (1 550 400/20 years x 10/12)

64 600 64 600

6 b)

Prop Investors Limited Notes for the year ended 31 August 20X10

4.

Investment property

Carrying amount beginning of year Cost Accumulated depreciation Movements during year Additions - acquisitions - subsequent expenditure capitalised Depreciation Carrying amount end of year Cost Accumulated depreciation

20X10 R 1 400 400 1 400 400 535 400 600 000 (64 600) 1 935 800 2 000 400 (64 600)

20X9 R 1 400 400 450 000 950 400 1 400 400 1 400 400 -

The fair value of this investment property on 31 August 20X10 is R3,2 million. This fair value is based on the rental income that will be earned in the future and has not been determined by an independent valuator who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the investment property being valued.

NB: The information on 31/8/20X9 is required per IAS 40.79(e).

7

a)

Journal entries Cr R

Dr R 2 January 20X9 Investment property (SFP) Bank/Creditors/Loans (SFP )

450 000 450 000

2 January – 31 August 20X9 Investment property (SFP) Bank/Creditors/Loans (SFP)

950 400 950 400

1 September – 31 October 20X9 Investment property (SFP) Bank/Creditors/Loans (SFP )

600 000 600 000

31 October 20X9 Investment property (SFP) Fair value adjustments (P/L)

899 600 899 600

(2,9 mil – [450 000 + 1 550 400])

31 August 20X10 Investment property (SFP) Fair value adjustments (P/L)

300 000 300 000

(3,2 mil – 2,9 mil)

NB: IAS40.53: “…. If an entity determines that the fair value of an investment property under construction is not reliably determinable but expects the fair value of the property to be reliably determinable when construction is complete, it shall measure that investment property under construction at cost until either its fair value becomes reliably determinable or construction is completed (whichever is the earlier)…..”

8 b)

Prop Investors Limited Notes for the year ended 31 August 20X10

4.

Investment property

Carrying amount beginning of year Movements during year: Additions - acquisitions - subsequent expenditure capitalised Gain on fair value adjustment

At fair value 20X10 R 1 400 400

At cost price 20X9 R -

600 000 1 199 600

450 000 950 400 -

3 200 000

1 400 400

(899 600 + 300 000)

Carrying amount end of year

The fair value of this investment property on 31 August 20X10 is R3,2 million. This fair value is based on the rental income that will be earned in the future and has not been determined by an independent valuator who holds a recognised and relevant professional qualification and who has recent experience in the location and category of the investment property being valued. The investment property comprised land and a factory building that was being constructed but which was not yet complete on 31 August 20X9. On 31 August 20X9, the fair value could not be reliably determined as the factory building was incomplete and comparable market transactions are infrequent for this type of specialised building. A rental agreement was in the early stages of negotiation so no agreement had been reached on the rent amount. It was not possible to provide a range of estimates of fair value on 31 August 20X9. NB: The information on 31/8/20X9 is required per IAS40.78. If a fair value could still not be determined following its completion and the property is sold, the information per IAS 40.78(d) would also need to be disclosed. PART 2 Assume that Prop Investors Limited (PIL) had several other investment properties and that all of these investment properties are accounted for in accordance with the fair value model, since this is PIL’s accounting policy. If it is assumed that the fair value of this property under construction cannot be reliably measured on a continuous basis, then PIL shall measure ONLY this property under the cost model of IAS 16 and shall use this method until the property is disposed of. Its residual value shall also be assumed to be Rnil (IAS 40.53). In this case, this property shall be disclosed in the “Investment property” note as per 1(b) above whilst all of the other properties measured using the fair value model will follow the same disclosure provided per 2(b) above. Thus the “Investment property note” will have both forms of disclosure included in it. In addition to the disclosure already provided above, PIL will also have to comply with IAS 40.78 and disclose the information in respect of the property measured on the cost model.

9 Prop Investors Limited Notes for the year ended 31 August 20X10 4.1

Investment property – on cost model

Carrying amount beginning of year Cost Accumulated depreciation Movements during year Additions - acquisitions - subsequent expenditure capitalised Depreciation Carrying amount end of year Cost Accumulated depreciation

20X10 R 1 400 400 1 400 400 535 400 600 000 (64 600) 1 935 800 2 000 400 (64 600)

20X9 R 1 400 400 450 000 950 400 1 400 400 1 400 400 -

On 31 August 20X9 and 31 August 20X10, the fair value could not be reliably determined. The investment property comprises land and a specialised office building situated on lot 007, Waltloo, Pretoria. The fair value of this property cannot be reliably measured as the market for comparable properties is inactive and alternative methods of reliably measuring the fair value are not available. No fair value range can be determined. (IAS 40.78 (a) – (c)) NB: If this property had been disposed of during the year, the following information will have to be provided per IAS 40.78(d):  fact that it has been disposed of; and  carrying amount on date of disposal; and  gain or loss on disposal. 4.2

Investment property – on fair value model

Carrying amount beginning of year Movements during year: Additions - acquisitions - subsequent expenditure capitalised Fair value adjustments Carrying amount end of year

20X10 R 7 450 000

20X9 R 5 600 000

1 200 000 500 000

1 500 000 350 000

9 150 000

7 450 000

The fair value on 31 August 20X10 was based on a valuation by an independent valuer who holds a recognised and relevant professional qualification and has recent experience in the location and category of the investment properties being valued. The fair value on 31 August 20X9 was not based on a valuation by an independent valuer. (IAS 40.75(e)) Total carrying amount of investment property at the end of year

11 085 800

8 850 400

NB: The amounts used in 4.2 above have been assumed for illustrative purposes only.

10 Income tax implications The tax base of an investment property will be the amount that will be deductible for tax purposes in the future (provided that the economic benefits that will flow to the entity from this asset will be taxable) (IAS12.7). The tax base is affected by the expected manner of recovery. When the expected manner of recovery of an asset is through use, the tax base will be the future wear and tear deductions that will be claimed as the asset is used. If the asset is to be recovered through sale, the tax base will be the base cost of the asset as this is the amount that will be deducted when Capital Gains Tax is calculated upon the sale of the asset. IAS12.51 requires that the measurement of deferred tax liabilities (the % used to calculate it) shall reflect the tax consequences of the manner in which the entity expects, at the reporting date, to recover the carrying amounts of its assets. An asset can be recovered through use or through sale. The manner in which an entity recovers an asset may affect the tax rate to be used. For example, the standard tax rate will be applied when an asset is recovered through use, but when an asset is sold at an amount higher than its base cost, the Capital Gains Tax (CGT) rate will apply. The expected manner of recovery for investment property accounted for on the cost model is through use. Consequently, if this investment property consisted of land and a building, the tax base will be calculated as follows:  the tax base of the land will be zero as no tax allowances will be received for land. Therefore, the IAS12.15(b) exemption from the recognition of a deferred tax liability for all taxable temporary differences will apply.  The tax base of the building will be the allowances that will be received in future (if the economic benefits that will flow to the entity from this building will be taxable). These deferred tax consequences will reflect the tax consequences of the recovery of the carrying amount of this investment property through use and the standard tax rate will apply. In the deferred tax calculation the investment property will be split between land and buildings, eg: TB TD DT (28%) CA (Dr)/Cr R R R R Exempt 100 000 Land 100 000 (cost)

Building

100 000 (cost less accumulated depreciation)

IAS12.15(b)