2.1 Property interest held under a lease

Leases of property that meet the definition of investment property in IAS 40, as described at 2 above, are included in the scope of IFRS 16 (see Chapter 23).

Under IFRS 16, lessees apply a single model for most leases i.e. they do not need to classify leases as finance leases or as operating leases, unlike for lessors. IFRS 16 requires lessees to recognise most leases in their statement of financial position as lease liabilities with corresponding right-of-use assets.

An investment property held by a lessee as a right-of-use asset is recognised in accordance with IFRS 16. [IAS 40.19A]. IFRS 16 requires a lessee to measure right-of-use assets arising from leased property (whether the lessor provided finance leases or operating leases to the lessee) in accordance with the fair value model of IAS 40 if the leased property meets the definition of investment property and the lessee elects the fair value model in IAS 40 as an accounting policy (see 6 and 6.7 below). [IFRS 16.34].

When a lessee uses the fair value model to measure an investment property that is held as a right-of-use asset, it will measure the right-of-use asset, and not the underlying property, at fair value. [IAS 40.40A].

If the lessee elects to use the cost model to measure its investment property, the lessee should measure its right-of-use assets that meet the definition of investment property in IAS 40 using the cost model in IFRS 16 (see 7 below) unless such assets are held for sale in accordance with IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations (see 8 below). [IAS 40.56].

If the right-of-use assets meet the definition of investment property, these are presented in the statement of financial position as investment property (see Chapter 23 at 5.7). [IFRS 16.48]. In addition to the relevant disclosure requirements in IFRS 16 (see Chapter 23 at 5.8), a lessee also applies the disclosure requirements in IAS 40 for such right-of-use assets (see 12 below). [IFRS 16.56].

Subsequent to initial recognition, the IASB indicated that a lease liability should be accounted for in a manner similar to other financial liabilities (i.e. on amortised cost basis). [IFRS 16.BC182].

For further discussion on subsequent measurements of lease liabilities and right-of-use assets, see Chapter 23 at 5.3.

2.2 Land

Land is investment property if it is held to earn rentals or for capital appreciation or for both; or for a currently undetermined future use. This is in contrast to land that is held for sale in the ordinary course of business (typically in the shorter term) or held for the production or supply of goods and services or for administrative purposes. [IAS 40.7, 8].

If, on initial recognition, land is held for a currently undetermined future use, i.e. if an entity has not determined whether it will use the land as owner-occupied property or for sale in the ordinary course of business, it is deemed to be held for capital appreciation and must be classified as investment property. [IAS 40.8].

2.3 Property leased to others

Properties leased to third parties under one or more operating lease are generally investment properties, whether they are owned freehold by the reporting entity or are right-of-use assets relating to properties held by the reporting entity. This will also apply if the property is currently vacant while tenants are being sought. [IAS 40.8].

However, in our opinion, an exception should be made in those cases where, despite being leased out, properties have been held for sale in the ordinary course of business since their initial recognition (either by acquisition or change in use – see 9 below). Leasing of property prior to sale is a common practice in the real estate industry in order to minimise cash outflows whilst the entity seeks a buyer and because prospective buyers may view the existence of such lease contracts positively, especially those that wish to acquire property for investment purposes.

In those circumstances – and notwithstanding that they are leased to tenants under operating leases – they should be accounted for as inventory under IAS 2 – Inventories – as long as it remains the intention to hold such properties for short-term sale in the ordinary course of business. The rent received would be recorded in profit or loss and would not be treated as a reduction in the cost of inventory.

Property that is leased to a third party under a finance lease is not an investment property but is accounted for under IFRS 16 (see Chapter 23). [IAS 40.9].

2.4 Property held for own use (‘owner-occupied’)

As noted above, owner-occupied property, that is property held for use in the production or supply of goods or services or for administrative purposes, is specifically excluded from being treated as investment property and is subject to the provisions of IAS 16 and IFRS 16. Owner-occupied property includes:

• property that is going to be owner-occupied in the future (whether or not it has first to be redeveloped);
• property occupied by employees (whether or not they pay rent at market rates); and
• owner-occupied property awaiting disposal. [IAS 40.9].

Note that the treatment in the consolidated accounts can be different from the treatment by individual group entities. For example, it may be the case that a property owned by one group company is held for occupation by another group company. This will be owner-occupied from the perspective of the group as a whole but can be classified as an investment property in the accounts of the individual entity that owns it, provided it meets the definition of an investment property. [IAS 40.15]. This classification in the individual entity's financial statements will apply even if the rental is not at arm's length and the individual entity is not in a position to benefit from capital appreciation. The IASB concluded that the more significant factor is that the property itself will generate cash flows that are largely independent from other assets held by the entity. [IAS 40.7].

Associates and joint ventures are not part of the group. Therefore, a property owned by the group but occupied by an associate or a joint venture would be accounted for as investment property in the consolidated financial statements (provided, of course, it meets the investment property definition).

2.5 Investment property under construction

Property that is being constructed or developed for future use as investment property (‘investment property under construction’) is in the scope of IAS 40. [IAS 40.8].

The fair value of investment property under construction is further discussed in 6.3 below.

2.6 Property held or under construction for sale in the ordinary course of business

Property held, or being constructed, with the intention of sale in the ordinary course of business is not an investment property. This includes property acquired exclusively for sale in the near future or for development and resale (such property is accounted for as inventory under IAS 2 (see Chapter 22)). [IAS 40.9].

In practice, the classification between investment property and property intended for sale in the ordinary course of business is often a difficult judgement. There is only a fine line between:

• a property held for capital appreciation, and therefore classified as investment property; and
• a property intended for sale in the ordinary course of business, which would be classified as inventory.

For example, the owner will undertake activities to increase the property's value prior to sale or where there is uncertainty in obtaining permits required from relevant authorities prior to commencing construction activities. In the latter case, the property, e.g. land, may continue to appreciate in value during the period where there are no development activities – see 3.1 below.

As set out in 2.3 above, the receipt of rental income from a property would not necessarily be the deciding factor. Certainly, other than for land (see 2.2 above), IAS 40 provides no explicit ‘default’ classification when the future use of a property has not yet been determined.

However, this judgement is important because whilst IAS 40 allows property held as inventory to be reclassified as investment property when there is a change in use and an operating lease with a third party is entered into, it is more difficult to reclassify investment property as inventory (see 8, 9 and 9.1 below). Accordingly, an entity should develop criteria so that it can exercise that judgement consistently in accordance with the definition of investment property and with the related guidance in IAS 40. Such criteria are required to be disclosed when classification is difficult (see 12.1 below). [IAS 40.14].

2.7 Property with dual uses

A property may be used partly to derive rental income and partly as owner-occupied property. For example, an office could be sub-divided by the owner with some floors being rented to tenants whilst retaining others for own use.

IAS 40 states that if a property has both investment property and non-investment property uses, providing the parts of the property could be sold or leased out under a finance lease separately, they should be accounted for separately. [IAS 40.10].

However, to meet these requirements we consider that a property must actually be in a state and condition to enable it to be disposed of or leased out separately at the end of the reporting period. The fact that a property could be divided in future periods if the owner so chose is insufficient to conclude that the portions can be accounted for separately. Consequently, if a property requires sub-division before the portions could be disposed of separately, then those parts should not, in our view, be accounted for as separate portions and the entire property should be accounted for as either an investment property or as a non-investment property (e.g. as an owner-occupied property or as an inventory) until such sub-division occurs or unless sub-division is a non-substantive legal requirement.

In our view, an intention to lease out, or the action of leasing out a portion of a property under an operating lease is prima facie evidence that, if it so wished, the entity could also lease out the property under a finance lease – the difference between the two commonly being just the length of the lease. If, however, there is evidence that the property could not be leased out under a finance lease then IAS 40 could not be applied to that portion.

It also seems clear that ‘separately’ needs to be assessed both in terms of the physical separation (for example, mezzanine floors and partitioning walls) of the property and legal separation such as legally defined boundaries.

In many jurisdictions, properties that are physically sub-divided into different portions (for example, different floors) are registered in a land or property registry as one single property and need to be legally sub-divided before a portion can be leased out to a third party or disposed of. Often, these legal proceedings are undertaken only at or near the point of sale or the assignment of a lease on that portion of the property concerned. At the end of the reporting period the legal sub-division may not have occurred.

Accordingly, judgement is required to determine whether legal separation is a substantive requirement that will restrict the property being considered currently separable or whether it is a non-substantive requirement where the property is currently separable. For example:

• If the entity owning the property could not be prevented from legally sub-dividing the property then it is already in a condition to be sold separately and this would not prevent the portion of the property concerned being accounted for as investment property. This would be the case where, for example: the process of sub-dividing the property was entirely within the control of the entity and did not require permission from a third party (which would include the relevant authorities); or if permission from a third party was required, but this was no more than a formality.
• Conversely, if the entity was required to obtain the permission of third parties before legally sub-dividing the property, and such permission could realistically be withheld, the portions of the property concerned are not accounted for separately until such legal sub-division occurs.

Therefore, if the portion of the property concerned otherwise meets the definition of investment property at the end of the reporting period, judgement is required to assess the legal position of the property in determining whether it is appropriate to account for a portion separately under IAS 40. Criteria used in the assessment should be disclosed and applied consistently (see 12.1 below). [IAS 40.14].

In the event that no separation is possible, the property is an investment property only if an insignificant proportion is used for non-investment property purposes. [IAS 40.10].

The setting of a threshold to evaluate whether or not something is significant or insignificant depends on judgement and circumstances. In the extract below, PSP Swiss Property discloses its judgement about dealing with property that it partially uses, but other entities will need to make their own assessment.

2.8 Property with the provision of ancillary services

If the owner supplies ancillary services to the user of the investment property, the property will not qualify as an investment property unless these services are an insignificant component of the arrangement as a whole. For example, security and maintenance services are described by the standard as being insignificant. [IAS 40.11].

The crucial issue is the extent to which the owner retains significant exposure to the risks of running a business. The standard uses the example of a hotel. An owner-managed hotel, for example, would be precluded from being an investment property as the services provided to guests are a significant component of the commercial arrangements. [IAS 40.12‑13].

However, the nature of the asset in question is not the key factor; rather it is the nature of the owner's interest in the asset. If the owner's position is, in substance, that of a passive investor, any property may be treated as investment property. If, in contrast, the owner has outsourced day-to-day functions while retaining significant exposure to variation in the cash flows generated by the operations that are being executed in the building, a property should rather be treated as owner-occupied property. [IAS 40.13].

The standard refers to owner-managed hotels as being precluded from being investment property. Hotel properties that are leased on arm's length terms to hotel operators may, however, fall to be accounted for as investment property. This is more likely to be the case when:

• the payments under the lease are not significantly determined by the results of the hotel operator (see 2.9 below), rather they reflect the general market for such properties; and
• the nature of the owner's rights in the arrangements with the operator is not divergent from those usually expected under a property lease.

The standard acknowledges that this question of significance can require judgements to be made. It specifies that an entity should develop consistent criteria for use in such instances that reflect the provisions described above. These criteria must be disclosed in those cases where classification is difficult. [IAS 40.14].

See also 3.3 below where the question of classification of a property as a business or as an asset is considered.

2.9 Property where rentals are determined by reference to the operations in the property

It may also be inappropriate to consider a property as investment property if the owner is significantly exposed to the operation of the business in the property through a linkage between the rentals charged and the performance of the business.

A common example is the incidence of turnover- or profit-related rents in retail leases. If the turnover- or profit-related element is a very significant proportion of total rental then consideration should be given to whether the landlord is so exposed to the performance of the underlying retail business as to make classification of the property as investment property inappropriate. This will be a matter of judgement, including the consideration of any other facts and circumstances (for example, the length of the lease to the tenant).

2.10 Group of assets leased out under a single operating lease

It is sometimes the case in practice that a group of assets comprising land, buildings and ‘other assets’ is leased out by a lessor under a single lease contract in order to earn rentals. In such a case, the ‘other assets’ would generally comprise assets that relate to the manner in which the land and buildings are used under the lease. The issue that arises is under what circumstances the ‘other assets’ should be regarded by the lessor as part of an investment property rather than as a separate item of property, plant and equipment. This is illustrated in the following example:

3.1 Expenditure prior to planning permissions/zoning consents

In many jurisdictions, permissions from relevant authorities are required prior to development of new or existing property, and the ability to start physical construction of the development depends on these permissions.

Application for such permissions supports the entity's intention as to the use of the property and may be considered as a factor in classifying the asset. However, unless an entity is considering a number of possible uses of the asset at its initial recognition, the uncertainty in obtaining relevant permission would usually not affect the classification of the property which, as set out in 2 above, is mainly based on the entity's intention when the property is first acquired. Subsequent to initial recognition, assets might be reclassified into and from investment property (see 9 below).

The likelihood of obtaining such permissions, however, is relevant in recognition and measurement of any additional costs to the property. Developers typically incur significant costs prior to such permissions being granted and such permissions are rarely guaranteed. Therefore, in assessing whether such pre-permission expenditure can be capitalised – assuming it otherwise meets the criteria – a judgement must be made, at the date the expenditure is incurred, of whether there is sufficient probability that the relevant permissions will be granted. Conversely, if during the application and approval process of such permits it is no longer expected that necessary permits will be granted, capitalisation of pre-permission expenditure should cease and any related amounts that were previously capitalised should be written off (either under the fair value model in IAS 40 (see 6 below) or in accordance with IAS 36 – Impairment of Assets, if the cost model is applied (see 7.3 below)). Further, if the cost model is used, the carrying amount of any related property subject to development or redevelopment (or, if appropriate, the cash generating unit where such an asset belongs) should be tested for impairment, where applicable, in accordance with IAS 36 (see 7.3 below).

3.2 Other aspects of cost recognition

3.3 Acquisition of investment property or a business combination?

In its July 2011 meeting, the Interpretations Committee discussed a request seeking clarification on whether the acquisition of a single investment property, with lease agreements with multiple tenants over varying periods and associated processes, such as cleaning, maintenance and administrative services such as rent collection, constitutes a business as defined in IFRS 3 – Business Combinations.

The Interpretations Committee noted that the issue raises the question of whether there is any interaction between IAS 40 and IFRS 3. It discussed services that are ‘ancillary services’ (as discussed in paragraphs 11‑14 of IAS 40 – see 2.8 above) that are not so significant as to disqualify a property from being an investment property but could nonetheless be considered ‘processes’ (as discussed in paragraphs B7-B12 of IFRS 3) that could result in the acquired set of activities constituting a business.⁵

IAS 40 notes, in relation to the need to distinguish investment property from owner-occupied property, that where certain ancillary processes exist in connection with an investment property they are often insignificant to the overall arrangement (see 2.8 above). Consequently, it may be appropriate to conclude that, where such acquired processes are considered by IAS 40 to be insignificant, an investment property acquisition is within the scope of IAS 40 rather than IFRS 3. However, it should be noted that IAS 40 and IFRS 3 are not mutually exclusive and this determination is not the specific purpose of the standard's observation about ancillary services. [IAS 40.BC19‑20].

Consequently, the IASB issued the Annual Improvements to IFRSs 2011‑2013 Cycle on 12 December 2013 which amended IAS 40 to state explicitly that the judgement required to determine whether the acquisition of investment property is the acquisition of an asset or a group of assets – or a business combination within the scope of IFRS 3 – should only be made with reference to IFRS 3. [IAS 40.14A].

This clarified that the discussion about ‘ancillary services’ in paragraphs 7‑14 of IAS 40 (see 2.8 above) relates to whether or not property is owner-occupied property or investment property and not to determining whether or not a property is a business as defined in IFRS 3. Determining whether a specific transaction meets the definition of a business combination as defined in IFRS 3 and includes an investment property as defined in IAS 40 requires the separate application of both standards. [IAS 40.14A].

IFRS 3 establishes different accounting requirements for a business combination as opposed to the acquisition of an asset or a group of assets that does not constitute a business (see 4.1.1 below). Therefore, determining whether an acquired investment property is a business or not, could result in significantly different accounting outcomes, both at the date of acquisition (i.e. at initial recognition) and subsequently. If dealt with as an acquisition of a business, then the initial accounting for investment property is considerably more complex. For example, amongst other requirements:

• initial direct costs are expensed (IAS 40 requires these to be capitalised – see 4.1 below);
• the initial recognition exception for deferred taxation does not apply (IAS 12 – Income Taxes – does not allow deferred taxation to be provided on existing temporary differences for acquisitions that are not business combinations); and
• goodwill is recognised (often itself ‘created’ by the provision of deferred taxation).

Judging whether an acquisition is a business combination or not is therefore of considerable importance. [IAS 40.14A].

It will be a matter of judgement for preparers, but it may still be appropriate to conclude that, when applying the guidance in IFRS 3, if acquired processes are considered to be insignificant (whether by reference to guidance in IAS 40 or otherwise) an investment property acquisition is within the scope of IAS 40 rather than IFRS 3. This judgement will rest upon the facts and circumstances of each acquisition. If significant, disclosure of this judgement would be required by IAS 1 – Presentation of Financial Statements. [IAS 1.122].

The definition of a business (see 3.3.1 below) is applied regardless of whether the entity purchases a property directly or, in the case of consolidated financial statements, via the shares in another entity.

4.1 Attributable costs

IAS 40 requires an owned investment property to be measured initially at cost, which includes transaction costs. [IAS 40.20]. If a property is purchased, cost means purchase price and any directly attributable expenditure such as professional fees, property transfer taxes and other transaction costs. [IAS 40.21].

For investment property under construction (see 2.5 above), although there is no specific reference to IAS 16, we consider that the principles in IAS 16 must still be applied to the recognition of costs in IAS 40. This means that only those elements of cost that were allowed by IAS 16 could be capitalised and that capitalisation ceased when the asset has reached the condition necessary for it to be capable of operating in the manner intended by management. [IAS 16.16(b)]. These principles are set out in detail in Chapter 18 at 4.

For investment property held by a lessee as a right-of-use asset, see 4.5 below.

4.2 Start-up costs and self-built property

IAS 40 specifies that start-up costs (unless necessary to bring the property into working condition) and operating losses incurred before the investment property achieves the planned occupancy level, are not to be capitalised. [IAS 40.23(a), 23(b)].

IAS 40 therefore prohibits a practice of capitalising costs until a particular level of occupation or rental income is achieved because at the date of physical completion the asset would be capable of operating in the manner intended by management. This forestalls an argument, sometimes advanced in the past, that the asset being constructed was not simply the physical structure of the building but a fully tenanted investment property, and its cost correspondingly included not simply the construction period but also the letting period.

If a property is self-built by an entity, the same general principles apply as for an acquired property (see 4.1 above). However, IAS 40 prohibits capitalisation of abnormal amounts of wasted material, labour or other resources incurred in constructing or developing the property. [IAS 40.23(c)].

4.3 Deferred payments

If payment for a property is deferred, the cost to be recognised is the cash price equivalent (which in practice means the present value of the deferred payments due) at the recognition date. Any difference between the cash price and the total payments to be made is recognised as interest expense over the credit period. [IAS 40.24].

4.4 Reclassifications from property, plant and equipment (‘PP&E’) or from inventory

When an entity uses the cost model, transfers between investment property, owner-occupied property and inventories do not change the carrying amount of the property transferred and they do not change the cost of that property for measurement or disclosure purposes. [IAS 40.59].

The treatment of transfers of properties measured using the revaluation option in IAS 16 to investment property is set out in 9.2 below.

4.5 Initial measurement of property held under a lease

An investment property held by a lessee as a right-of-use asset should be measured initially at its cost in accordance with IFRS 16 (see Chapter 23 at 5.2.1). [IAS 40.29A]. The treatment of initial direct costs by a lessee applying IFRS 16 is discussed at 4.9.2 below.

4.6 Initial measurement of assets acquired in exchange transactions

The requirements of IAS 40 for investment properties acquired in exchange for non-monetary assets, or a combination of monetary and non-monetary assets, are the same as those of IAS 16. [IAS 40.27‑29]. These provisions are discussed in detail in Chapter 18 at 4.4.

4.7 Initial recognition of tenanted investment property subsequently measured using the cost model

During the development of the current IFRS 3 the IASB considered whether it would be appropriate for any favourable or unfavourable lease aspect of an investment property to be recognised separately.

The IASB concluded that this was not necessary for investment property that will be measured at fair value because the fair value of investment property takes into account rental income from leases and therefore the contractual terms of leases and other contracts in place.

However, a different position has been taken for investment property measured using the cost model. In this case the IASB observed that the cost model requires:

• the use of a depreciation or amortisation method that reflects the pattern in which the entity expects to consume the asset's future economic benefits; and
• each part of an item of property, plant and equipment that has a cost that is significant in relation to the total cost of the item to be depreciated separately.

Therefore, an acquirer of investment property in a business combination that is subsequently measured using the cost model will need to adjust the depreciation method for the investment property to reflect the timing of cash flows attributable to the underlying leases. [IFRS 3.BC148].

In effect, therefore, this requires that the favourable or unfavourable lease aspect of the investment property – measured with reference to market conditions at the date of the business combination – be separately identified in order that it may be subsequently depreciated or amortised, usually over the remaining lease term. Any such amount is not presented separately in the financial statements.

This approach has also been extended to acquisition of all property, i.e. including those acquired outside a business combination (see 7.1.2 below).

4.8 Borrowing costs

IAS 23 – Borrowing Costs – generally mandates capitalisation of borrowing costs in respect of qualifying assets. However, application of IAS 23 to borrowing costs directly attributable to the acquisition, construction or production of qualifying assets that are measured at fair value, such as investment property, is not required because it would not affect the measurement of the investment property in the statement of financial position; it would only affect presentation of interest expense and fair value gains and losses in the income statement. Nevertheless, IAS 23 does not prohibit capitalisation of eligible borrowing costs to such assets as a matter of accounting policy.

To the extent that entities choose to capitalise eligible borrowing costs in respect of such assets, in our view, the methods allowed by IAS 23 should be followed.

The treatment of borrowing costs is discussed further in Chapter 21.

4.9 Lease incentives and initial direct costs of leasing a property

In negotiating a new or renewed operating lease, the lessor may provide incentives for the lessee to enter into the agreement. The lessor or the lessee (or both) may also incur costs that are directly attributable to negotiating and arranging a lease. However, IAS 40 provides no specific guidance on accounting for lease incentives and initial costs of obtaining a lease.

4.10 Contingent costs

The terms of purchase of investment property may sometimes include a variable or contingent amount that cannot be determined at the date of acquisition. For example, the vendor may have the right to additional consideration from the purchaser in the event that a certain level of income is generated from the property; or its value reaches a certain level; or if certain legislative hurdles, such as the receipt of zoning or planning permission, are achieved.

A common issue is whether these liabilities should be accounted for as a financial liability or as a provision. This is important because remeasurement of a financial liability is taken to profit or loss, whilst changes in a provision could, by analogy to IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities – be recorded as an adjustment to the cost of the asset.

The Interpretations Committee took this question onto its agenda in January 2011,¹¹ but in May 2011 chose to defer further work on it until the IASB concluded on its discussions on the accounting for the liability for variable payments as part of the leases project.¹²

At its July 2013 meeting, the IASB considered this issue again and noted that the initial accounting for variable payments affects their subsequent accounting. Some IASB members expressed the view that the initial and subsequent accounting for variable payments for the purchase of assets are linked and should be addressed comprehensively. The IASB noted that accounting for variable payments is a topic that was discussed as part of the Leases and Conceptual Framework projects and decided that it would reconsider this issue after the proposals in the Exposure Draft – Leases (published in May 2013) had been redeliberated.¹³

The Interpretations Committee revisited this issue at its meetings in September 2015, November 2015 and March 2016. It determined that this issue is too broad for it to address within the confines of existing IFRSs. Consequently, the Interpretations Committee decided not to add this issue to its agenda and concluded that the IASB should address the accounting for variable payments comprehensively.¹⁴

As a result, in May 2016 the IASB tentatively decided to include ‘Variable and Contingent Consideration’ in its pipeline of future research projects and noted that it expected to begin work on projects in its research pipeline between 2017 and 2021.¹⁵ In February 2018, the IASB decided that the IASB staff should carry out work to determine how broad the research project should be.¹⁶ At the time of writing this is not listed as an active research project on the IASB's work plan.¹⁷

Until such time as the IASB implements any changes, in our view, the treatment as either a provision or as a financial liability is a matter of accounting policy choice. Of course, for investment property held at fair value, this policy choice primarily affects classification within the income statement.

It is important to note that this policy choice is not available for the contingent costs of acquiring investment property as part of a business combination. The treatment of contingent costs in these circumstances is described in Chapter 9 at 7.1.

For more related discussions see Chapter 17 at 4.5 and Chapter 18 at 4.1.9.

4.11 Income from tenanted property during development

An issue that can arise is whether rental and similar income generated by existing tenants in a property development may be capitalised and offset against the cost of developing that property.

IAS 16 requires that the income and related expenses of incidental operations are recognised in profit or loss and included in their respective classifications of income and expense (see Chapter 18 at 4.2). [IAS 16.21]. We consider that rental and similar income from existing tenants are incidental operations to the development.

In our view there should not be a measurement difference between the cost of a property development dealt with under IAS 40 and the cost of development dealt with under IAS 16. Therefore, rental and similar income generated by existing tenants in a property dealt with under IAS 40 and now intended for redevelopment should not be capitalised against the costs of the development. Rather rental and similar income should be recognised in profit or loss in accordance with the requirements of IFRS 16 (see Chapter 23), together with related expenses. For these purposes it is irrelevant whether the investment property is held at cost or fair value.

4.12 Payments by the vendor to the purchaser

On occasion, a transaction for the purchase of an investment property may include an additional element where the vendor repays fixed or variable amounts to the purchaser – perhaps described as representing a rental equivalent for a period of time.

The question then arises whether, in the accounts of the purchaser, these payments should be recorded as income (albeit perhaps recognised over a period of time) or as a deduction from the acquisition cost of the investment property on initial recognition.

In our view such amounts are an integral part of the acquisition transaction and should invariably be treated as a deduction from the acquisition cost of the investment property because the payment is an element of a transaction between a vendor and purchaser of the property, rather than a landlord and tenant. In the event that the repayments by the vendor are spread over time, the fair value of the right to receive those payments should be deducted from the cost of the investment property and an equivalent financial asset recognised. The financial asset would be accounted for in accordance with IFRS 9 – Financial Instruments – which may lead to it being classified as financial asset at amortised cost or at fair value through profit or loss (see Chapter 48 at 2.1).

5.1 Measurement by insurers and similar entities

There is an exception to the requirement that an entity must apply its chosen measurement policy to all of its investment properties. This is applicable to insurance companies and other entities that hold specified assets, including investment properties, whose fair value or return is directly linked to the return paid on specific liabilities (i.e. liabilities that are secured by such investment properties).

These entities are permitted to choose either the fair value or the cost model for all such properties without it affecting the choice available for all other investment properties that they may hold. [IAS 40.32A]. However, for an insurer or other entity that operates an internal property fund that issues notional units, with some units held by investors in linked contracts and others held by the entity, all properties within such a fund must be held on the same basis because the standard does not permit the entity to measure the property held by such a fund partly at cost and partly at fair value. [IAS 40.32B].

If an entity elected a model for those properties described above that is different from the model used for the rest of its investment properties, sales of investment properties between these pools of assets are to be recognised at fair value with any applicable cumulative change in fair value recognised in profit or loss. Consequently, if an investment property is sold from a pool in which the fair value model is used into a pool in which the cost model is used, the fair value of the property sold at the date of the sale becomes its deemed cost. [IAS 40.32C].

When IFRS 17 is adopted (see 13.1 below), paragraph 32B of IAS 40 (as discussed above) will be amended. The previous reference to ‘insurers and other entities [operating] an internal property fund that issues notional units’ will be replaced by ‘[s]ome entities operate, either internally or externally, an investment fund that provides investors with benefits determined by units in the fund.’ The revised paragraph will also refer to entities that issue insurance contracts with direct participation features, for which the underlying items include investment property, and will specify that for the purposes of applying paragraph 32A (as discussed above) and the amended paragraph 32B of IAS 40 only, insurance contracts include investment contracts with discretionary participation features.

The amended paragraph 32B of IAS 40 will clarify that an entity is not permitted to measure the property held by the fund (as described above) or property that is an underlying item partly at cost and partly at fair value.

An entity will apply the above consequential amendment when it applies IFRS 17 (see 13.1 below).

6.1 Estimating fair value

When estimating the fair value of the property in accordance with IFRS 13, the objective is to estimate the price that would be received to sell an investment property in an orderly transaction between market participants at the measurement date under current market conditions. [IFRS 13.2]. This objective applies regardless of the techniques and inputs used to measure fair value.

IAS 40 has certain requirements in addition to those in IFRS 13. In particular, IAS 40 requires that the fair value reflects, among other things, rental income from current leases and other assumptions that market participants would use when pricing investment property under current market conditions. [IAS 40.40]. For example, in a transaction to sell an investment property, it is likely that market participants would consider the existing lease agreements in place.

This is consistent with the general requirement in IFRS 13 that an entity should measure the fair value using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. [IFRS 13.22].

Extract 19.3 below describes Unibail-Rodamco's approach to valuations:

6.2 Inability to determine fair value of completed investment property

It is a rebuttable presumption that an entity can determine the fair value of a property reliably on a continuing basis, that is, on each subsequent occasion in which it records the investment property in its financial statements. [IAS 40.53].

The standard emphasises that it is only in exceptional cases and only on initial recognition (either by acquisition or change in use – see 9 below) that the entity will be able to conclude that it will not be able to reliably measure the investment property's fair value on a continuing basis. [IAS 40.53].

Additionally, entities are strongly discouraged from arguing that fair value cannot be reliably measured. It may be a possible argument when, and only when, the market for comparable properties is inactive (e.g. there are few recent transactions, price quotations are not current or observed transaction prices indicate that the seller was forced to sell) and alternative reliable measurements of fair value (for example, based on discounted cash flow projections) are not available. In such exceptional cases, the property should be measured using the cost model in IAS 16 for owned investment property, or cost model in accordance with IFRS 16 for investment property held by a lessee as a right-of-use asset (see Chapter 23 at 5.3.1), until its disposal and assumed to have a nil residual value. [IAS 40.53]. This means that an owned investment property has to be carried at cost and the building and its component parts depreciated over their useful lives (see 7 below). In these circumstances, IAS 16's revaluation model, under which assets may be revalued to fair value, is specifically ruled out. If this exceptional situation occurs, the cost model in IAS 16 or in IFRS 16 should continue to be applied until disposal of such property. [IAS 40.54]. This also means that if this exceptional situation occurs, investment property should continue to be measured at cost even if a reliable measure of fair value subsequently becomes available (such treatment is different for investment property under construction – see 6.3 below). Although an entity measures an individual property at cost for this reason, all other investment property must continue to be carried at fair value. [IAS 40.54].

The above exception is not permitted for investment property that has been previously measured using the fair value model. Once a property is initially recognised at its fair value, it must always be so recognised until disposed of or reclassified for owner-occupation or development for subsequent sale in the ordinary course of the business, even if comparable market transactions become less frequent or market prices become less easily available. [IAS 40.55].

6.3 The fair value of investment property under construction

Entities who wish to measure their completed investment property at fair value will also need to measure their investment property under construction at fair value (subject to fair value being reliably determinable). [IAS 40.33, 53].

Determining the fair value of investment property under construction will often be more judgemental than for completed property because:

• there are generally no observable transactions for investment property under construction. Where such assets are transacted, this is typically when they are in the very early stages of development or when they are nearly complete and substantially let; and
• additional assumptions must be made about the risks and costs of any incomplete construction.

In January 2009, the International Valuation Standards Board (‘IVSB’) released an Interim Position Statement – The Valuation of Investment Property under Construction under IAS 40. This Position Statement acknowledged that few investment properties under construction are transferred between market participants except as part of a sale of the owning entity or where the seller is either insolvent or facing insolvency and therefore unable to complete the project.

Despite this, the Position Statement set out that since the property is being developed for either income or capital appreciation, the cash flows associated with its construction and completion should normally be readily identifiable and capable of reliable estimation. Consequently, the IVSB considered that it would be rare for the fair value of an investment property under construction not to be capable of reliable determination.

However, this latter comment was excluded from the final Guidance Note – The Valuation of Investment Property under Construction which was issued by the IVSB in February 2010. The IVSB seems to have concluded that it was not its role to comment on this area, thus, no comment about the reliability of estimation was included.

It is worth noting that, in light of the requirements of IFRS 13, an entity will have to determine whether fair value can be reliably measured or not under the requirements in that standard. This is discussed in Chapter 14 at 2.4.1.

In any event, some entities do consider that not all of their investment property under construction can be reliably measured and have developed criteria to make that assessment, see Extract 19.3 above for an example.

There were persistent concerns that, in some situations, the fair value of investment property under construction could not be measured reliably. Where an entity that chooses the fair value model for its investment property determines that the fair value of an investment property under construction is not reliably measurable but it expects the fair value to be reliably measurable when construction is complete, the IASB decided to allow such investment property under construction to be measured at cost until such time as the fair value becomes reliably measurable or construction is completed (whichever comes earlier). [IAS 40.53].

IAS 40 also sets out the following:

• Once an entity becomes able to measure reliably the fair value of an investment property under construction that it has previously measured at cost (see 7 below), it should measure that property at its fair value. [IAS 40.53A].
• Once construction of such property is complete, it is presumed that fair value can be measured reliably. If this is not the case, and this will be only in exceptional situations, the property should be accounted for using the cost model in accordance with IAS 16 for owned investment property (see 7 below) or cost model in accordance with IFRS 16 for investment property held by a lessee as a right-of-use asset (see Chapter 23 at 5.3.1), together with the other requirements discussed in 6.2 above, i.e. use the cost model until disposal of the property (even if subsequently its fair value becomes reliably determinable) and assume that it has a nil residual value. [IAS 40.53A].
• The presumption that the fair value of investment property under construction can be measured reliably can be rebutted only on initial recognition. Therefore, an entity that has measured an item of investment property under construction at fair value may not subsequently conclude that the fair value of the completed investment property cannot be measured reliably. [IAS 40.53B].

6.4 Transaction costs incurred by the reporting entity on acquisition

An issue that arises in practice is whether transaction costs that have been incurred by the reporting entity on purchase of an investment property should be taken into account in determining the subsequent fair value of the property when applying the fair value model. This is illustrated in the following example:

IFRS 13 clarifies that ‘[t]he price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. Transaction costs shall be accounted for in accordance with other IFRSs. Transaction costs are not a characteristic of an asset or a liability; rather, they are specific to a transaction and will differ depending on how an entity enters into a transaction for the asset or liability.’ [IFRS 13.25]. See Chapter 14 at 9.1.2 for further discussion.

Likewise, when measuring the fair value of an investment property, it is not appropriate to add the acquisition-related transaction costs incurred by the purchaser to fair value, as these have no relevance to the fair value of the property. Therefore, some or all of the transaction costs incurred when acquiring the investment property that were capitalised in accordance with IAS 40 will effectively be expensed as part of the subsequent fair value gain or loss.

6.5 Fixtures and fittings subsumed within fair value

Fixtures and fittings such as lifts or air conditioning units are usually reflected within the fair value of the investment property rather than being accounted for separately. [IAS 40.50(a)]. In other cases, additional assets may be necessary in order that the property can be used for its specific purposes. The standard refers to furniture within a property that is being let as furnished offices, and argues that this should not be recognised as a separate asset if it has been included in the fair value of the investment property. [IAS 40.50(b)].

The entity may have other assets that have not been included within the valuation, in which case these will be recognised separately and accounted for in accordance with IAS 16.

6.6 Prepaid and accrued operating lease income

6.7 Valuation adjustment to the fair value of properties held under a lease

IAS 40 states that the fair value of investment property held by a lessee as a right-of-use asset will reflect expected cash flows, including variable lease payments that are expected to become payable. Accordingly, if a valuation obtained for a property is net of all payments expected to be made, it will be necessary to add back any recognised lease liability, to arrive at the carrying amount of the investment property using the fair value model. [IAS 40.50(d)].

Therefore, if the entity obtains a property valuation net of the valuer's estimate of the present value of future lease obligations (which is usual practice), to the extent that the lease obligations have already been accounted for in the statement of financial position as a lease obligation, an amount is to be added back to arrive at the fair value of the investment property for the purposes of the financial statements.

Where an entity subsequently measures its investment properties using the fair value model, there is no difference in accounting for investment property held by a lessee as right-of-use assets, i.e. whether the lessor provided a finance lease or an operating lease to the lessee (see also 2.1 above).

The valuation adjustment referred to above is achieved by adjusting for the lease liability recognised in the financial statements.

This is illustrated using the information in the following example:

An example of this in practice can be seen in Extract 19.5 above and in Extract 19.6 below:

6.8 Future capital expenditure and development value (‘highest and best use’)

It is common for the value of land to reflect its potential future use and the value of land may increase in the event that the owner obtains any required permissions for a change in the use of that land.

It may be, for example, that a permission to change from an industrial to residential use will increase the value of the property as a whole, notwithstanding that the existing industrial buildings are still in place. This increase in value is typically attributable to the land, rather than the buildings.

It is therefore important to note that IFRS 13 requires consideration of all relevant factors in determining whether the highest and best use of a property can be something other than its current use at the measurement date. IFRS 13 presumes that an entity's current use of an asset is generally its highest and best use unless market or other factors suggest that a different use of that asset by market participants would maximise its value. [IFRS 13.29]. IFRS 13 states:

‘A fair value measurement of a non-financial asset takes into account a market participant's ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use. The highest and best use of a non-financial asset takes into account the use of the asset that is physically possible, legally permissible and financially feasible, as follows:

1. A use that is physically possible takes into account the physical characteristics of the asset that market participants would take into account when pricing the asset (e.g. the location or size of a property).
2. A use that is legally permissible takes into account any legal restrictions on the use of the asset that market participants would take into account when pricing the asset (e.g. the zoning regulations applicable to a property).
3. A use that is financially feasible takes into account whether a use of the asset that is physically possible and legally permissible generates adequate income or cash flows (taking into account the costs of converting the asset to that use) to produce an investment return that market participants would require from an investment in that asset put to that use.’ [IFRS 13.27‑28].

Considerable judgement may then have to be applied in determining when an anticipated change is legally permissible. For example, if approval is required for rezoning land or for an alternative use of existing property interests, it may be necessary to assess whether such approval is a substantive legal requirement or not. See Chapter 14 at 10.1 for further discussion on determining highest and best use and the assessment of ‘legally permissible’.

If management determines that the highest and best use of an asset is something other than its current use, certain valuation matters must be considered. Appraisals that reflect the effect of a reasonably anticipated change in what is legally permissible should be carefully evaluated. If the appraised value assumes that a change in use can be obtained, the valuation must also reflect the cost associated with obtaining approval for the change in use and transforming the asset, as well as capture the risk that the approval might not be granted (that is, uncertainty regarding the probability and timing of the approval).

Expectations about future improvements or modifications to be made to the property to reflect its highest and best use may be considered in the appraisal, such as the renovation of the property or the conversion of an office into condominiums, but only if and when other market participants would also consider making these investments and reflect only the cash flows that market participants would take into account when assessing fair value.

See Chapter 14 at 10 for further discussion on application of IFRS 13 requirements to non-financial assets which includes determining highest and best use.

6.9 Negative present value

In some cases, an entity expects that the present value of its payments relating to an investment property (other than payments relating to recognised liabilities) will exceed the present value of the related cash receipts. An entity should apply IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – to determine whether a liability should be recognised and, if so, how that liability should be measured. [IAS 40.52].

6.10 Deferred taxation for property held by a ‘single asset’ entity

It is common in many jurisdictions for investment property to be bought and sold by transferring ownership of a separate legal entity formed to hold the asset (a ‘single asset’ entity) rather than the asset itself. In addition to the issue on initial recognition discussed in 4.1.2 above, this matter created diversity in practice when determining the expected manner of recovery of the asset for the purposes of IAS 12, i.e. whether or not the parent entity should reflect the fact that an asset held by a single asset entity is likely to be disposed of by selling the shares of the entity rather than the asset itself, and if so, whether the deferred taxation would be recognised with reference to the shares rather than the underlying property.

The Interpretations Committee clarified in its July 2014 meeting that IAS 12 requires the parent to recognise in its consolidated financial statements both the deferred tax related to the property inside the single asset entity and the deferred tax related to the shares of that single asset entity (the outside), if:

• tax law attributes separate tax bases to the asset inside and to the shares;
• in the case of deferred tax assets, the related deductible temporary differences can be utilised; and
• no specific exceptions in IAS 12 apply.¹⁹

Accordingly, in determining the expected manner of recovery of a property held by a single asset entity for the purposes of IAS 12, the parent entity should have regard to the asset itself. In line with this, it would not be appropriate to measure deferred taxation with reference to selling the shares of the single asset entity or include the related effects of tax in the valuation of the underlying property.

For further discussions on recognition of deferred taxes for investment property and for single asset entities, see Chapter 33 at 8.4.7 and 8.4.10, respectively.

7.1 Initial recognition

7.2 Incidence of use of the cost model

It appears less common for entities to measure investment property using the cost model than the fair value model.

In previous years, EY real estate financial statement surveys have consistently found that over 90% of the companies in those surveys used the fair value model. There also seems to be a general, although not universal, market consensus among existing IFRS reporters that the fair value model is the more appropriate. For example, in its latest Best Practices Recommendations issued in November 2016, the European Public Real Estate Association (‘EPRA’) recommends to its members that ‘Real estate companies should account for their property investments based upon the fair value model.’²⁰

Some IFRS reporters have moved from the cost model. For example, Klépierre adopted the cost model until the middle of 2016 when the fair value model was adopted. It made the following statement in its 2016 financial statements:

The use of the cost model (rather than the fair value model) removes the need to recognise gains from increases in the fair value of property within profit or loss. However, it is unlikely to insulate an entity from reporting falls in the fair value of investment property below the depreciated cost of the property – see 7.3 below.

7.3 Impairment

Investment property measured at cost is subject to the requirements of IAS 36 in respect of impairment. As set out in Chapter 20, IAS 36 requires a recoverable amount to be determined as the higher of (i) value in use and (ii) fair value less costs of disposal. [IAS 36.18].

Both value in use calculation and fair value calculation (where there is no price quoted for identical assets on an active market) are typically based on discounted cash flow models. The former will typically use entity specific cash flows, whilst the latter would generally use market expected cash flows. Both would use a market determined discount rate.

For a rental generating asset such as an investment property, the future cash flows to be taken into account in any projection would, in simple terms, be (i) the rental stream under the existing lease arrangements and (ii) an estimate of any rental stream thereafter.

The cash flows expected to be generated from the existing lease would be the same whether the basis was entity specific or market expected cash flows.

The estimate of any rental stream thereafter would also be the same unless the entity forecast it would outperform the market and achieve superior cash flows. This is unlikely to be an acceptable basis for a forecast as no entity can realistically expect to outperform the market for its whole portfolio or do so for more than the short term. Therefore, a forecast that cash flows from individual properties will outperform the market would have to be considered with scepticism.

Consequently, we would regard it as being a rare circumstance where the value in use of an individual investment property could be said to be higher than the fair value of that property. Indeed, in some circumstances – for example, where a fair value is partly dependent on a gain from planned future development (see 6.8 above) but where that expenditure is not to be allowed to be considered in a value in use calculation – value in use may be lower than fair value.

9.1 Transfers from investment property to inventory

Transfers to inventory are more difficult to deal with by way of the application of a general principle since IFRS 5 explicitly deals with investment property held for sale. IAS 40 allows a transfer to inventory only when there is a change in use as evidenced, for example, by the start of development with a view to subsequent sale. [IAS 40.57].

If an entity decides to dispose of an investment property without development with a view to sale, it is unlikely to be transferred to inventory as IFRS 5 is applied to property held for sale to the extent that the requirements therein are met (see 8 above).

The IASB is aware of this inconsistency in the application of IFRS 5 and IAS 2 to investment property and in 2010 it asked the Interpretations Committee to consider any necessary interpretation to resolve it. However, the Interpretations Committee decided to recommend proposals that indicated no change to existing practice.

Consequently, this means that, unless there is development with a view to sale, it may not be possible to reclassify investment property as inventory even if the entity holding that property changes its intentions and is no longer holding that property for rental or capital appreciation. Accordingly, when an entity decides to dispose of an investment property without development, it should continue to classify the property as an investment property until it is derecognised (see 10 below) and should not reclassify it as inventory. Similarly, if an entity begins to redevelop an existing investment property for continued future use as investment property, the property remains an investment property and is not reclassified as owner-occupied property during the redevelopment. [IAS 40.58].

9.2 Accounting treatment of transfers

When an entity uses the cost model for investment property, transfers between investment property, owner-occupied property and inventories do not change the carrying amount of the property transferred and they do not change the cost of that property for measurement or disclosure purposes. [IAS 40.59].

Transfers to and from investment property under the fair value model are accounted for as follows:

• Transfers from inventory: any difference between the fair value of the property at date of change in use and its previous carrying amount should be recognised in profit or loss. [IAS 40.63]. This treatment is consistent with the treatment of sales of inventories. [IAS 40.64].
• Transfers to inventory or owner-occupation: the cost for subsequent accounting for inventories under IAS 2, or for owner-occupied property under IAS 16 or IFRS 16, should be the property's fair value at the date of change in use. [IAS 40.60].
• Transfers from owner-occupation: IAS 16 will be applied for owned property and IFRS 16 for property held by a lessee as a right-of-use asset up to the date of change in use. At that date, any difference between the carrying amount under IAS 16 or IFRS 16 and the fair value should be treated in the same way as a revaluation under IAS 16. [IAS 40.61].

If the owner-occupied property had not previously been revalued, the transfer does not imply that the entity has now chosen a policy of revaluation for other property accounted for under IAS 16 in the same class. The treatment depends on whether it is a decrease or increase in value and whether the asset had previously been revalued or impaired in value.

The treatment required by IAS 40 is as follows. Up to the date when an owner-occupied property becomes an investment property carried at fair value, an entity depreciates the property (or the right-of use asset) and recognises any impairment losses that have occurred. The entity treats any difference at that date between the carrying amount of the property in accordance with IAS 16 or IFRS 16 and its fair value in the same way as a revaluation in accordance with IAS 16.

‘In other words:

1. any resulting decrease in the carrying amount of the property is recognised in profit or loss. However, to the extent that an amount is included in revaluation surplus for that property, the decrease is recognised in other comprehensive income and reduces the revaluation surplus within equity.
2. any resulting increase in the carrying amount is treated as follows:
   1. to the extent that the increase reverses a previous impairment loss for that property, the increase is recognised in profit or loss. The amount recognised in profit or loss does not exceed the amount needed to restore the carrying amount to the carrying amount that would have been determined (net of depreciation) had no impairment loss been recognised.
   2. any remaining part of the increase is recognised in other comprehensive income and increases the revaluation surplus within equity. On subsequent disposal of the investment property, the revaluation surplus included in equity may be transferred to retained earnings. The transfer from revaluation surplus to retained earnings is not made through profit or loss.’ [IAS 40.62].

IAS 40 also reconfirms that when an entity completes the construction or development of a self-constructed investment property that will be carried at fair value (i.e. no actual reclassification to investment property), any difference between the fair value of the property at that date and its previous carrying amount shall be recognised in profit or loss. [IAS 40.65].

10.1 Calculation of gain or loss on disposal

Gains and losses on retirement or disposal of investment property are calculated based on the difference between the net disposal proceeds (after deducting direct costs of disposal) and the carrying amount of the asset. [IAS 40.69]. IAS 40 does not give guidance on how to determine the carrying amount of the asset. Possible alternatives would include the use of (i) the carrying amount in the financial statements of the last full period of account, or (ii) the carrying amount in the latest interim financial statements, or (iii) the updated carrying amount at the date of disposal. In our view, this is a policy choice for an entity to make and is primarily a matter of income statement presentation to the extent that an entity presents gains and losses on disposal separately from gains and losses on revaluation. This choice is illustrated in Extract 19.3 above where Unibail-Rodamco uses the ‘full period of account’ approach.

Gains and losses on retirement or disposal of investment property are recognised in profit or loss, unless it is a sale and leaseback and IFRS 16 requires a different treatment, in the period of retirement or disposal (see also 12.4 below). [IAS 40.69]. Refer to Chapter 23 at 8 for a discussion of sale and leaseback under IFRS 16.

The amount of consideration to be included in the gain or loss arising from the derecognition of an investment property is determined in accordance with the requirements for determining the transaction price in paragraphs 47‑72 of IFRS 15. [IAS 40.70]. Under IFRS 15, an entity is required to consider the terms of the contract and its customary business practices in determining the transaction price. Transaction price is defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring the property to a buyer, excluding amounts collected on behalf of third parties (e.g. sales taxes). The consideration in a contract may include fixed amounts, variable amounts, or both. [IFRS 15.47].

In many cases, the transaction price may be readily determined if the entity receives payment when it transfers the property and the price is fixed. In other situations, it could be more challenging as it may be affected by the nature, timing and amounts of consideration.

Determining the transaction price is discussed in detail in Chapter 29 at 2.

Subsequent changes to the estimated amount of the consideration included in the gain or loss should be accounted for in accordance with the requirements for changes in the transaction price in IFRS 15. [IAS 40.70]. This is further discussed in Chapter 29 at 3.5.

If an entity retains any liabilities after disposing of an investment property these are measured and accounted for in accordance with IAS 37 or other relevant standards. [IAS 40.71]. Accounting for such liabilities depends on specific facts and circumstances as such a liability may represent a provision or a contingent liability under IAS 37, or a financial liability under IFRS 9, or a separate performance obligation or variable consideration under IFRS 15.

Retention of liabilities on sale of goods may indicate that the seller has continuing involvement to the extent usually associated with ownership. Under IFRS 15, retention of liabilities or the existence of continuing managerial involvement might indicate that control of goods has not passed to a buyer, but on their own do not affect whether an entity can recognise a sale and the associated profit from the transfer of the property. Instead, an entity might need to consider whether it represents an assurance-type or service-type warranty or consideration payable to a customer and whether variable consideration requirements would apply. See also related discussions in Chapter 29 at 2.2.1.B.

10.2 Sale prior to completion of construction

It should be noted that property that is subject to sale prior to completion of construction, if not previously classified as investment property, is likely to be property intended for sale in the ordinary course of business (see 2.6 above) and is therefore not likely to be investment property. Accordingly, the requirements in IFRS 15 should be followed.

If, however, the property subject to sale prior to completion of construction is previously classified as investment property, guidance in IAS 40 would be followed – see discussions in 10 and 10.1 above. Any consequent construction services to be provided by the seller would likely be subjected to the requirements of IFRS 15.

For further discussion of IFRS 15, see Chapters 27 to 32.

10.3 Replacement of parts of investment property

When an entity that applies the fair value model wishes to capitalise a replacement part (provided it meets the criteria at 3 above), the question arises of how to deal with the cost of the new part and the carrying value of the original. The basic principle in IAS 40 is that the entity derecognises the carrying value of the replaced part. However, the problem frequently encountered is that even if the cost of the old part is known, its carrying value – at fair value – is usually by no means clear. It is possible also that the fair value may already reflect the loss in value of the part to be replaced, because the valuation reflected the fact that an acquirer would reduce the price accordingly. [IAS 40.68].

As all fair value changes are taken to profit or loss, the standard concludes that it is not necessary to identify separately the elements that relate to replacements from other fair value movements. Therefore, if it is not practical to identify the amount by which fair value should be reduced for the part replaced, the cost of the replacement is added to the carrying amount of the asset and the fair value of the investment property as a whole is reassessed. The standard notes that this is the treatment that would be applied to additions that did not involve replacing any existing part of the property. [IAS 40.68].

If the investment property is carried under the cost model, then the entity should derecognise the carrying amount of the original part. A replaced part may not have been depreciated separately, in which case, if it is not practicable to determine the carrying amount of the replaced part, the standard allows the entity to use the cost of the replacement as an indication of an appropriate carrying value. This does not mean that the entity has to apply depreciated replacement cost, rather that it can use the cost of the replacement as an indication of the original cost of the replaced part in order to reconstruct a suitable carrying amount for the replaced part. [IAS 40.68].

10.4 Compensation from third parties

IAS 40 applies the same rules as IAS 16 to the treatment of compensation from third parties if property has been impaired, lost or given up (see Chapter 18 at 5.7). It stresses that impairments or losses of investment property, related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets are separate economic events that have to be accounted for separately. [IAS 40.73].

Impairment of investment property will be recorded automatically if the fair value model is used; but if the property is accounted for using the cost model, it is to be calculated in accordance with IAS 36 (see Chapter 20). If the entity no longer owns the asset, for example because it has been destroyed or subject to a compulsory purchase order, it will be derecognised (see 10 above). Compensation from third parties (for example, from an insurance company) for property that was impaired, lost or given up is recognised in profit or loss when it becomes receivable. The cost of any replacement asset is accounted for wholly on its own merits according to the recognition rules covered in 3 above. [IAS 40.72, 73].

12.1 Disclosures under both fair value and cost models

Whichever model is chosen, fair value or cost, IAS 40 requires all entities to disclose the fair value of their investment property. Therefore, the following disclosures are required in both instances:

• whether the entity applies the cost model or the fair value model;
• when classification is difficult, the criteria it uses to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business;
• the extent to which the fair value of investment property (as measured or disclosed in the financial statements) is 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 property being valued. If there has been no such valuation, that fact shall be disclosed (e.g. a statement that the fair value of investment property is based on internal appraisals rather than on a valuation by an independent valuer as described above);
• the amounts recognised in profit or loss for:
  • rental income from investment property;
  • direct operating expenses (including repairs and maintenance) arising from investment property that generated rental income during the period (see 12.1.3 below);
  • direct operating expenses (including repairs and maintenance) arising from investment property that did not generate rental income during the period (see 12.1.3 below); and
  • the cumulative change in fair value recognised in profit or loss on sale of an investment property from a pool of assets in which the cost model is used into a pool in which the fair value model is used (see 5.1 above);
• the existence and amounts of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal; and
• contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements. [IAS 40.75].

12.2 Additional disclosures for the fair value model

A reconciliation between the carrying amounts of investment property at the start and end of the period must be given showing the following:

• additions, disclosing separately those additions resulting from acquisitions and those resulting from subsequent expenditure recognised in the carrying amount of an asset;
• additions resulting from acquisitions through business combinations;
• assets classified as held for sale or included in a disposal group classified as held for sale in accordance with IFRS 5 and other disposals;
• net gains or losses from fair value adjustments;
• the net exchange differences arising on the translation of the financial statements into a different presentation currency, and on translation of a foreign operation into the presentation currency of the reporting entity;
• transfers to and from inventories and owner-occupied property; and
• other changes. [IAS 40.76].

When a valuation obtained for investment property is adjusted significantly for the purpose of the financial statements, for example to avoid double-counting of assets or liabilities that are recognised separately (see 6.1.4 above), the entity must disclose a reconciliation between the valuation obtained and the adjusted valuation included in the financial statements, showing separately the aggregate amount of any recognised lease liabilities that have been added back, and any other significant adjustments. [IAS 40.77]. Extracts 19.5 and 19.6 above provide examples of such disclosure.

12.3 Additional disclosures for the cost model

If investment property is measured using the cost model, the following disclosures are required by IAS 40 in addition to those at 12.1 above:

• the depreciation methods used;
• the useful lives or the depreciation rates used;
• the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period;
• a reconciliation of the carrying amount of investment property at the beginning and end of the period, showing the following:
  • additions, disclosing separately those additions resulting from acquisitions and those resulting from subsequent expenditure recognised as an asset;
  • additions resulting from acquisitions through business combinations;
  • assets classified as held for sale or included in a disposal group classified as held for sale in accordance with IFRS 5 and other disposals;
  • depreciation;
  • the amount of impairment losses recognised, and the amount of impairment losses reversed, during the period in accordance with IAS 36 (see Chapter 20);
  • the net exchange differences arising on the translation of the financial statements into a different presentation currency, and on translation of a foreign operation into the presentation currency of the reporting entity;
  • transfers to and from inventories and owner-occupied property; and
  • other changes;
• the fair value of investment property. In the exceptional cases when an entity cannot measure the fair value of the investment property reliably (see 6.2 above), it shall disclose:
  • a description of the investment property;
  • an explanation of why fair value cannot be measured reliably; and
  • if possible, the range of estimates within which fair value is highly likely to lie. [IAS 40.79].

12.4 Presentation of sales proceeds

IAS 16 allows an entity that, in the course of its ordinary activities, routinely sells items of property, plant and equipment that it has held for rental to transfer such assets to inventories at their carrying amount when they cease to be rented and become held for sale. The proceeds from the sale of such assets are then recognised as revenue (see Chapter 18 at 7.2).

However, investment property, by definition, is held to earn rentals or for capital appreciation rather than for sale in the ordinary course of business. Consequently, we consider that this IAS 16 accounting treatment may not be applied by analogy to IAS 40 and proceeds from the sale of investment property may not be presented as revenue.

Despite this, however, it may be appropriate to present separately the material gains or losses on retirement or disposal of investment property elsewhere in the financial statements, either as part of the income statement or in the notes. [IAS 1.97]. For example, Unibail-Rodamco has chosen to present proceeds from disposal of investment properties, together with the carrying amount derecognised and the net gain/loss on disposal on the face of its statement of comprehensive income (see Extract 19.15 above).

13.1 New standard for insurance contracts: IFRS 17

In May 2017, the IASB issued IFRS 17. Once effective, IFRS 17 will replace IFRS 4 – Insurance Contracts.

As part of the consequential amendments arising from IFRS 17, the subsequent measurement requirements in IAS 40 will be amended as indicated in 5.1 above. IFRS 17 and its consequential amendments to other standards are effective for annual periods beginning on or after 1 January 2021, with adjusted comparative figures required. Early application is permitted provided that both IFRS 9 and IFRS 15 have already been applied, or are applied for the first time, at the date on which IFRS 17 is first applied. Mandatory application of IFRS 9 (subject to the proposed deferral of mandatory effective date – see discussion below) and IFRS 15 were effective from 1 January 2018.

In June 2019, the IASB issued an Exposure Draft (‘ED’) containing proposed amendments to IFRS 17 responding to concerns and implementation challenges raised by stakeholders. This ED includes the IASB's proposal to defer the mandatory effective date of IFRS 17 by one year, so that entities will be required to apply IFRS 17 for annual periods beginning on or after 1 January 2022.²⁴ In the view of the Board, this allows entities to deal with the uncertainty arising from its decision to explore potential changes to the standard.²⁵

The IASB also proposes to extend the fixed expiry date of the temporary exemption in IFRS 4 from applying IFRS 9 by one year. Insurance entities eligible for the exemption will be required to apply IFRS 9 for annual periods beginning on or after 1 January 2022.²⁶ As a result, such entities will be able to adopt IFRS 17 and IFRS 9 at the same time.²⁷

For those entities early adopting IFRS 17 and for the detailed discussions and requirements of this new standard, see Chapter 56.