International Accounting Standard 40 - Investment Properties - REAL ESTATE INVESTMENT
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What is the objective of nic-40?
The objective of IAS 40 is to prescribe the accounting treatment for investment property and its associated disclosure requirements.
What is the range of the nic-40?
- IAS 40 should be applied in the recognition, measurement and disclosure of investment property.
- IAS 40 deals with the measurement, in a lessee's financial statements, of investment property held under a finance lease and with the measurement, in a lessor's financial statements, of investment property leased under an operating lease.
- IAS 40 does not apply to biological assets attached to land and related to agricultural activity IAS 41.
Utility Definitions
- Investment Properties are property (land or a building, in whole or in part, or both) held (by the owner or by a lessee under a finance lease) to earn rentals or capital gains, or both, rather than for:
(a) its use in the production or supply of goods or services or for administrative purposes; or for
(b) its sale in the ordinary course of business.
- Owner-occupied properties are properties held (by the owner or by a lessee who has agreed to a financial lease) for use in the production or supply of goods or services, or for administrative purposes.
- Fair value It is the amount for which an asset can be exchanged between an interested and duly informed buyer and seller who carry out a free transaction.
- Cost It is the amount of cash or cash equivalents paid, or the fair value of the consideration given, to purchase an asset at the time of its acquisition or construction by the company.
- Book value is the amount for which an asset is recognized on the balance sheet.
TheInvestment property is held to earn rentals, capital gains or both. Therefore, investment property generates cash flows independently of other assets owned by the enterprise. This distinguishes investment property from owner-occupied property. The production or supply of goods or services (or the use of property for administrative purposes) generates cash flows that are not attributable merely to the property but to other assets used in the production or supply process. IAS 16 Property, Plant and Equipment, applies to owner-occupied properties.
Investment Property Examples
(a) Land held for long-term capital gains and not for short-term sale in the ordinary course of business operations;
(b) Land held for an undetermined future use (if the business has not determined whether the land will be used as owner-occupied property or sold in the short term, in the ordinary course of business operations, such land is considered to be held for capital gain);
(c) A building owned by the reporting company (or a building obtained through a finance lease) and leased by the reporting company through one or more operating leases; and
(d) A building that is vacant and will be leased through one or more operating leases.
Examples of items that are not investment property and therefore do not fall within the scope of IAS 40
(a) property held for sale in the ordinary course of business, or under construction or development with a view to such sale (see IAS 2 Inventories), for example, property acquired solely for disposal in the near future or for development and resale;
(b) properties that are being constructed or improved on behalf of others (see IAS 11 Construction Contracts);
(c) owner-occupied property (see IAS 16 Property, Plant and Equipment), including (among others) property held for future use as owner-occupied, property held for future construction or development and subsequent use as owner-occupied, employee-occupied property (whether or not rented at market value) and owner-occupied property awaiting disposal; and
(d) properties that are being constructed or improved for future use as investment property. IAS 16 applies to such properties until construction or development is completed, at which time they become investment property and are therefore subject to this Standard. However, this Standard does apply to existing investment property that is being further improved for future use as investment property (see paragraph 52).
Certain properties include a portion held to earn rentals or capital gains and a portion used in the production or supply of goods or services, or for administrative purposes. If these portions can be sold separately (or placed separately under a finance lease), the company accounts for them separately as well. If these portions cannot be sold separately, the property qualifies as investment property only if only a minor portion is used for the production or supply of goods or services, or for administrative purposes.
In certain cases, the company provides ancillary services to the occupants of a company's property. The company will treat such property as investment property if the services are an insignificant component of the contract. An example might be the security and maintenance services provided by the owner of a building to the tenants occupying the building.
In other cases, the services provided are a more significant component. For example, if a company owns and operates a hotel, the services provided to guests are a significant component of the contract taken as a whole. Therefore, an owner-managed hotel is an owner-occupied property and not an investment property.
It may be difficult to determine whether ancillary services are significant enough to cause the property to not qualify as investment property. For example, a hotel owner sometimes transfers certain responsibilities to third parties under a management agreement. The terms of such an agreement can vary widely. At one end of the spectrum of possibilities, the owner's position may be essentially that of a passive investor. At the other end of the spectrum, the owner may simply have outsourced certain day-to-day management functions to third parties, but retained significant exposure to variations in the cash flows generated by the hotel's operations.
Judgment is required in determining whether a property qualifies as investment property. An enterprise shall develop criteria for exercising such judgment in a consistent manner, in accordance with the definition of investment property and the related guidance in paragraphs 5 through 11. Paragraph 66(a) requires an enterprise to disclose such criteria when classification is difficult.
Under IAS 17 Leases, a lessee shall not capitalise property held under an operating lease arrangement. Therefore, a lessee shall not treat its investment in such property as investment property.
In some cases, an enterprise owns property that it leases to and is occupied by the parent or another subsidiary in the same group. This property cannot be classified as investment property in the consolidated financial statements that include both enterprises because it is owner-occupied property from the perspective of the group as a whole. However, from the perspective of the individual enterprise that owns it, the property is investment property if it meets the definition in paragraph 4. Therefore, the lessor will treat the property as investment property in its individual financial statements.
Initial measurement of investment properties
An investment property should be initially measured at cost. Costs associated with the transaction should be included in the initial measurement.
The cost of acquiring an investment property comprises its purchase price and any directly attributable expenditures. Directly attributable expenditures include, for example, professional fees for legal services, property transfer taxes and other costs associated with the transaction.
The cost of an investment property constructed by the enterprise itself is its cost at the date the construction or development is completed. Until that date, the enterprise shall apply IAS 16 Property, Plant and Equipment. From that date, the property becomes investment property and the provisions of this Standard apply to it (see paragraphs 51(e) and 59 below).
The cost of an investment property is not increased by start-up costs (unless necessary to bring the property into a usable condition), initial operating losses incurred before the investment property reaches the expected level of occupancy, or abnormal amounts of waste, labor or other resources incurred in the construction or development of the property.
If payment for an investment property is deferred, its cost is equivalent to the cash price. The difference between this amount and the total payments will be recognized as an interest expense over the credit period.
Key Differences Between Investment Property and Property of Plant and Equipment
| Criterion | Investment Property | Property, Plant and Equipment |
|---|---|---|
| Main purpose | Obtain income from rental or appreciation. | Use in the production of goods/services or for administrative purposes. |
| Use in operational activity | It is not used directly in production or in the provision of services. | It is used directly in the company's daily operations. |
| Typical examples | Office building leased to third parties, land for appreciation. | Factory, machinery, office equipment used for commercial activities. |
| Accounting treatment | Fair value valuation (if that method is chosen). | Valuation at cost and depreciation over its useful life. |
| Sale | It is generally not intended for sale. | You can sell it, but that is not its primary purpose (it is an operating asset). |
| Valuation in financial statements | It can be recorded at its market value, reflecting the revaluation. | It is recorded at cost less accumulated depreciation. |
Subsequent disbursements
A subsequent expenditure relating to an investment property that has been recognised should be added to the carrying amount of the investment property when it is probable that some future economic benefit, in addition to the standard yield originally assessed for the existing property, will flow to the enterprise. All other subsequent expenditures should be recognised as an expense in the period in which they are incurred.
The appropriate accounting treatment for expenditure incurred subsequent to the acquisition of an investment property depends on the circumstances that were taken into account in the initial recognition and measurement of the investment in question. For example, where the carrying amount of an investment property already reflects a loss of future economic benefits, subsequent expenditure to restore the expected future economic benefits of the asset will be capitalised. This is also the case where the purchase price of an asset reflects the obligation of the enterprise to incur expenditure that is necessary, in the future, to bring the asset into working condition. An example of this might be the acquisition of a building that requires restoration. In such circumstances, the subsequent expenditure will be added to the carrying amount.
Measurement after initial recognition
This Standard requires all companies to determine the fair value of their investment property for measurement (fair value model) or disclosure (cost model) purposes. Companies are encouraged, but not required, to determine the fair value of their investment property based on a valuation performed by an independent expert who has recognized professional ability and recent experience in the locality and type of investment property being valued.
Fair value model
After initial recognition, a company that elects the fair value model must measure all of its investment properties at their fair value.
Gains or losses arising from a change in the fair value of an investment property should be included in net profit or loss in the period in which they arise.
The fair value of an investment property is usually its market value.. Fair value is measured as the most probable price that can be obtained in the market at the balance sheet date., according to the definition of fair value. It is the best price that can reasonably be obtained by the seller and the most advantageous price that is reasonably possible for the buyer. This form of estimate specifically excludes an over or underprice due to special arrangements or circumstances, such as atypical financing, sale and leaseback arrangements, special consideration or concessions earned by any situation associated with the sale.
The company must determine the fair value without any deduction for costs associated with the transaction that it may incur due to the sale or other form of dispossession.
The fair value of an investment property should reflect the actual state and conditions of the market at the balance sheet date, and not at any earlier or later date.
The estimated fair value is specific to a given date.
The fair value of an investment property reflects, among other things, the rental income that could be earned from leases under current conditions, as well as reasonable and defensible assumptions that represent the market view that experienced and interested parties might make about the income that could be earned from future leases in light of current market conditions.
The definition of fair value refers to “interested and informed parties”
The definition of fair value refers to an unrestricted transaction.
The best evidence of fair value is normally given by current prices in an active market, for similar properties in the same location and condition, and subject to leases or other agreements, related to the property, that are similar.
In rare cases, when an enterprise first acquires an investment property (or when an existing property is first converted to investment property, after construction or development is completed, or after a change in use) there is clear evidence that the variation in the range of fair value estimates will be so large and the probabilities of the different possible outcomes so difficult to assess that the usefulness of a single fair value estimate is invalidated. This may indicate that the fair value of the property cannot be determined reliably on a continuous basis.
If an office is rented furnished, the fair value of the office generally includes the fair value of the furniture, because rental income is derived from the furnished office. When furniture is included in the fair value of investment property, the company should not recognize such furniture as a separate asset.
Inability to determine fair value reliably
There is a rebuttable presumption that companies will be able to determine, reliably and on an ongoing basis, the fair value of an investment property. However, in rare cases, when an company first acquires an investment property (or when an existing property first becomes an investment property after completion of construction or development, or after a change in use) there is clear evidence that the company will not be able to determine, reliably and on an ongoing basis, the fair value of the investment property.
This arises when, and only when, similar transactions in the market are not frequent and other means of estimating fair value (for example, based on discounted cash flow projections) are not available. In such cases, an enterprise should measure the investment property using the benchmark treatment provided for in IAS 16 Property, Plant and Equipment. The residual value of the investment property should be assumed to be zero. The enterprise should continue to apply IAS 16 until the investment property is disposed of.
If an enterprise has previously measured an investment property at fair value, it should continue to measure it at fair value until it is disposed of (or until the property is owner-occupied, or the enterprise begins converting the property to sale in the ordinary course of business) even if comparable market transactions become infrequent or market prices become unavailable.
Cost model
After initial recognition, a company that chooses the cost model must measure all its investment property using the benchmark treatment in IAS 16 Property, Plant and Equipment, that is, at cost less accumulated depreciation and any accumulated impairment losses.
Transfers
Transfers to or from investment property should be made when, and only when, there is a change in use, as evidenced by:
(a) the commencement of owner-occupancy, in the case of a transfer of an investment property to an owner-occupied facility;
(b) the commencement of a development with the intention of selling, in the case of a transfer of an investment property to inventory;
(c) the end of owner-occupancy, in the case of a transfer from an owner-occupied facility to an investment property;
(d) the commencement of a leasing transaction to a third party, in the case of a transfer of inventories to investment properties; or
(e) the completion of construction or development, in the case of a transfer from property under construction or development (covered by IAS 16 Property, Plant and Equipment) to investment property.
For the transfer of investment property, carried at fair value, to owner-occupied property or to inventory, the cost of the property for subsequent accounting purposes, whether IAS 16 or IAS 2 is used, should be the fair value at the date of the change in use.
If an owner-occupied property becomes an investment property, which is recorded at fair value, the company must apply IAS 16 until the date of the change in use. The company must treat any difference at that date between the property's carrying amount under IAS 16 and its fair value in the same way as it would record a revaluation using IAS 16.
When a company completes the construction or development of an investment property that is built by the company and will be recorded at fair value, any difference between the fair value of the property at that date and its previous carrying amount should be recognized as profit or loss for the period.
Disappropriations
An investment property should be derecognized (removed from the balance sheet) when the company disposes of it or when the investment property is permanently withdrawn from use and no future economic benefits are expected from its disposal.
Consideration receivable arising from the disposal of an investment property shall be initially recognised at fair value. In particular, if payment for an investment property is deferred, the consideration received shall be initially recognised at its cash price.
Information to be disclosed
Fair value model and cost model
The disclosures presented below apply in addition to those mentioned in IAS 17, Leases. Under IAS 17, an owner of investment property shall include disclosures applicable to the lessor in respect of operating leases. Under IAS 17, an enterprise that has investment property subject to finance leases shall include disclosures applicable to the lessee and disclosures applicable to the lessor in respect of any operating leases granted by the enterprise.
A company must disclose:
(a) The criteria developed by the enterprise to distinguish investment property from owner-occupied property and property held for sale in the ordinary course of business operations;
(b) The significant methods and assumptions applied in determining the fair value of investment properties, including a statement as to whether the fair value determination was made on the basis of market evidence or whether more account was taken of other factors (which should be disclosed by the company) in light of the nature of the properties and the lack of comparable market data;
(c) The extent to which the fair value of investment property (as measured or disclosed in the financial statements) is based on a valuation made by a qualified appraiser who has recognised professional ability and recent experience in the locality and category of the investment property being valued; alternatively, if there has been no such valuation, that fact shall also be disclosed;
(d) The figures included in the income statement for:
(i) Income derived from rentals from investment properties;
(ii) Direct operating expenses (including repairs and maintenance) related to investment properties that generated rental income during the period; and
(iii) Direct operating expenses (including repairs and maintenance) related to investment properties that did not generate rental income during the period;
(e) The existence and amount of restrictions on the sale of investment property or on the remittance of profits and proceeds from its dispossession; and
(f) Significant contractual obligations for the acquisition, construction or development of investment properties, or for repairs, maintenance or improvements.
Fair value model
A company applying the fair value model must also present a reconciliation of the carrying amounts of investment properties at the beginning and end of the period, including the following (comparative information is not required):
(a) Additions, disclosing separately those arising from acquisitions and those relating to subsequent capitalized expenditures;
(b) Additions resulting from acquisitions through business combinations;
(c) Disappropriations;
(d) Net gains or losses from fair value adjustments;
(e) Net exchange differences arising from the translation of the financial statements of a foreign entity;
(f) Transfers of investment property to and from inventory or owner-occupied property; and
(g) Other movements.
- In the exceptional case where an enterprise measures its investment property using the benchmark treatment in IAS 16 Property, Plant and Equipment (because of the lack of a reliable fair value, see paragraph 47), the reconciliation required under the preceding paragraph must disclose the amounts relating to that investment property separately from the amounts relating to other investment property. In addition, the enterprise must disclose:
(a) A description of the investment properties;
(b) An explanation of why the fair value cannot be measured reliably;
(c) If possible, the range of estimates within which the fair value is likely to lie; and
(d) When it has investment properties not recorded in books at fair value:
(i) The fact that the company has disposed of investment properties not recorded in books at their fair value;
(ii) The carrying amount of such investment properties at the time of their sale; and
(iii) The amount of the gain or loss recognized.
Cost model
The company that applies the cost model must also disclose:
(a) the depreciation methods used;
(b) the useful lives or depreciation rates used;
(c) the gross carrying amount and accumulated depreciation (increased by accumulated impairment losses) at the beginning and end of the period;
(d) a reconciliation of the carrying amounts of investment property at the beginning and end of the period, including the following (comparative information is not required):
(i) additions, presenting separately those arising from acquisitions and those referring to subsequent capitalized disbursements;
(ii) additions resulting from acquisitions through business combinations;
(iii) disappropriations;
(iv) depreciation;
(v) the amount of the loss recognised on impairment of assets, and the amount of impairment losses on assets that have reversed during the period in accordance with IAS 36 Impairment of Assets;
(vi) net exchange differences arising from the translation of the financial statements of a foreign entity;
(vii) transfers of investment properties to and from inventories or owner-occupied properties; and
(viii) other movements; and
(e) the fair value of investment property, when a business cannot determine the fair value of investment property reliably, the company should provide the following information;
(i) a description of the investment properties;
(ii) an explanation of why the fair value could not be determined reliably; and
(iii) if possible, the range of estimates within which the fair value is likely to lie.
How long is NIC-40 valid?
This International Accounting Standard (IAS 40) is effective for annual financial statements covering periods beginning on or after 1 January 2001. Earlier application is encouraged. If an enterprise applies this Standard for periods beginning before 1 January 2001, it must disclose that fact.
This Standard supersedes IAS 25 Accounting for Financial Investments, in relation to investment property.
How is IAS 40 applied in Mexico?
According to IAS 40, investment properties are those that:
- They are held for rental income or for appreciation in value or a combination of both.
- They are not used in the production or supply of goods or services or in the administrative activities of the company.
In Mexico, NIF C-18 also establishes that an investment property is one that is acquired for the purpose of generating income through its rental or for its revaluation.
Under IFRS C-18, the option of using either the cost method or the fair value method for measuring investment property is permitted, as is IAS 40. However, IFRS C-18 makes an important distinction:
- Fair value method: If this method is chosen, changes in fair value must be recognized in the income statement (not in equity).
- Cost method: If this method is chosen, investment properties are recorded at historical cost less accumulated depreciation.
This treatment is similar to that of IAS 40, but with greater flexibility in the use of each method.
Transition from Investment Property to Property of Plant and Equipment and Vice Versa
- IAS 40 states that if an investment property is no longer used for the purpose of generating rental income and is instead used for the operations of the company (for example, the company starts using the property for its own activity), it must be reclassified from investment property to property of plant and equipment.
- Similarly, if a property of plant and equipment begins to be rented or is held for the purpose of appreciation, it is reclassified as investment property.
In Mexico, this practice is also applied under NIF C-18, with the same reclassification treatment.
Depreciation and Useful Life
- Investment properties measured by the cost method must be depreciated over their useful life, as is done with fixed assets under NIF C-6.
- If the fair value method is used, depreciation is not applied, since the value is adjusted to market value and not to historical cost.
Impact on Financial Statements
- Fair value method: Changes in the fair value of investment properties are recognized directly in the income statement. This reflects increases or decreases in the value of the asset as operating income or losses.
- cost method: Property is stated on the balance sheet at cost less accumulated depreciation, and income is generated by leasing.
Tax Considerations in Mexico
It is important to note that although investment properties are handled differently in accounting terms, tax authorities in Mexico, such as the Tax Administration Service (SAT), may have their own rules for the tax treatment of income from investment properties, which could include considerations regarding the deduction of expenses, amortization, and the treatment of capital gains from the sale of property.
