Section 16 – Investment Property
Section 16 deals with the accounting for investment property. It only applies to investment property whose fair value can be measured reliably without undue cost or effort. If this is not the case then the property falls within the scope of section 17, property, plant and equipment. If it cannot be measured without undue cost then the depreciated cost model applies.
What is new?
Section 16.7 states that investment property whose fair value can be measured reliably without undue cost or effort shall be measured at fair value at each reporting date with changes in fair value recognised in the profit and loss account.
This contrasts with the position under old GAAP (SSAP 19) where changes in the open market value was recognised in the statement of recognised gains and losses (STRGL) and then accounted for as a movement in the revaluation reserve, unless a deficit was permanent in nature (or it was a reversal) in which case, it was recognised in the profit and loss account (note the treatment for insurance companies and pension funds differed from this under SSAP 19).
SSAP 19 did not address situations where there was undue cost or effort to value the investment property as there was a presumption that all investment property could be measured at open market value. However, where open market value was able to be determined under old GAAP it would be expected that fair value would be able to be measured under Section 16 so it is likely that fair value will have to be used and only in exceptional circumstances would an entity be able to move from a fair value model to a cost model.
Old GAAP (SSAP 19) did not allow a property leased to another member of a group entity to be classified as investment property. Section 16 does not prevent such a property from being classified as investment property if it meets the definition of investment property. This will result in a difference as under FRS 102 such property can then be classified as an investment property. This may also mean that it can be classified as investment property even if the group entity is not charged.
Section 16 does not explicitly address assets under construction, however, it does in Section 16.5 deal with how self-constructed investment property should be accounted for on initial recognition. Therefore, if an asset under construction meets the investment property definition it is likely it can be accounted for as an investment property under Section 16 of FRS 102. This contrasts with old GAAP (SSAP 19) which only applied to assets which were completed and thereby, by definition, assets under construction fell under the scope of the tangible fixed standard (FRS 15).
Section 16.4 deals with mixed use property; for the relevant section of the property that meets the definition of an investment property, this section should be accounted for under Section 16 if it can be done so without undue cost or efforts. This compares with SSAP 19, which was silent on the matter and as a result there was diversity in practice.
Section 16.3 gives the option on a property by property basis as to whether property interests held under operating leases (which meet the definition of investment property and the leasee can measure the fair value of the property interest) are to be classified under investment properties under the fair value model. Under SSAP 19, there was as no option, if it met the definition it had to be accounted for at open market value.
SSAP 19 required investment property held on a lease with an unexpired term of 20 years or less to be depreciated over the remaining term which differs from Section 16 as Section 16 does allow such a property to be depreciated.
Section 16.3A deals with properties held by a public benefit entity and states that properties held by such entities should be accounted for under Section 17 – property, plant and equipment and not investment property. SSAP 19 did not deal with this and therefore there was diversity in practice.
What is different?
Old GAAP requires the investment property to be valued at open market value whereas Section 16 requires fair value. Open market value should in reality equate to fair value therefore there should be no changes in value.
Fair value required to be measured at each reporting date compared to at least every 5 years under SSAP 19 (old GAAP).
Section 16.10 requires similar disclosures to old GAAP but in addition requires companies to disclose:
- The methods and significant assumptions applied in determining the fair value of investment properties.
- The existence and amounts of restrictions on the reliability of investment property or the remittance of income and proceeds of disposal.
- Contractual obligations to purchase construct or develop investment property or for repairs, maintenance or enhancement.
- A reconciliation between carrying amounts at beginning and end of the period to include:
– showing transfer to property plant and equipment where the fair value cannot be measured without undue cost or effort.
– Net fair value adjustments posted to the profit and loss account
Other standards impacting investment property where differences arise:
Section 29 – Income tax – Section 29 requires deferred tax to be recognised on the difference between the fair value to be included in the financial statements and the base cost for tax purposes. The tax rate used is the tax rate enacted at the balance sheet date for capital disposals. This is a transition adjustment which will need to be posted.
Section 11 – Basic financial instruments – details the fair value hierarchy to be used in the valuation process.
Section 35 – Transition to FRS 102 – Section 35.10 deals with transition exemptions. An exemption is available to allow a first time adopter to elect to use a previous GAAP revaluation of an investment property at or before the date of transition as its deemed cost or alternatively to using fair value as deemed cost.
What are the key points?
Investment property is defined in Section 16.2 as property (land or buildings, or part of a building or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both, rather than for:
- Use in production or supply of goods or service or for administrative purposes; or
- Sale in ordinary course of business
- Investment property is measured at fair value unless it cannot be measured without undue cost or effort;
- Movement in fair value to be recognised in the profit and loss account in the period that it occurred;
- Where it cannot be measured due to undue cost or effort the property then comes within the scope of Section 17, Property, plant and equipment (PPE) and is transferred into PPE at the valuation shown in investment property prior to the time of transfer (where it no longer meets the condition of investment property or it cannot be measured without undue cost or effort);
- Fair value not necessarily required to be performed by an external valuation specialist, however, they need to be suitably qualified and disclosure is required if not performed by a professional valuer;
- If an entity can no longer reliably measure an investment property at fair value without undue cost or effort, then the property should be transferred to property, plant and equipment (Section 16.9);
- Deferred tax to be accounted for at the CGT rate;
- Reconciliation to be provided giving full details of transfers to and from investment property and any fair value adjustments;
- Contractual obligations and restrictions of disposal to be disclosed; and
- Property leased to other group companies which meets the definition of investment property and can be reliably estimated without undue cost needs to be fair valued.
What do accountants need to do?
Get to grips with the new accounting standard and review all investment properties at the time of transition.
Review their client portfolio to assess the companies impacted by the changes and discuss with their clients to determine the impact on a case by case basis.
Recognise and advise companies of the volatility fair valuing investment properties on a yearly basis will have on their clients’ profit (any unrealised profit may not be seen as distributable as it has not been realised) to include the requirement to recognise deferred tax.
Advise clients to assess if property leased to other group companies should be accounted for as investment property.
What do companies need to do?
Understand the differences between old GAAP and section 16 of FRS 102.
Quantify the effect on distributable profits as a result of the transition adjustments required to adopt this standard e.g. the need to post the fair value movements and the related deferred tax which will ultimately impact the profit line.
Consider whether covenants on loans will be affected as a result of the new requirements.
Where property is leased to other group companies, assess whether this will now need to be fair valued.