Background
Current Indian GAAP provides limited guidance on accounting for investment properties under AS 13 Accounting for Investments. In order to converge the Indian Accounting Standards (Ind AS) with those under the International Financial Reporting Standards (IFRS), Ind AS 40 has been issued. Ind AS 40 will become applicable as and when Ind AS are notified.
Scope and definitions
Ind AS 40 provides guidance with respect to recognition, measurement and disclosure of investment property. It also provides detailed guidance on transfer to/from and disposals of investment property. Ind AS 40 specifically excludes below mentioned assets from its scope, as the relevant guidance relating to these assets is covered under other accounting standards:
• Biological assets (Ind AS 41 – Agriculture)
• Mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources. This standard could be applied to measurement in lessee’s or lessor’s financial statements depending on certain specified conditions.
But Ind AS 40 does not deal with matters covered under Ind AS 17 – Leases like classification of leases, recognition of lease income, accounting for sale and leaseback transactions etc. Definitions Investment property is property (land or a building— 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:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business. Thus the classification depends on the use of the property. Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes. Recognition Investment property is recognised as an asset only when both the following conditions are met:
• It is probable that the future economic benefits that are associated with the investment property will flow to the entity; and
• the cost of the investment property can be measured reliably. The above criteria are applied to all properties irrespective of whether the costs are incurred towards the property in the initial phase or subsequent phases. Measurement Initial measurement An investment property shall be measured initially at cost. Transaction costs which are directly attributable for preparing the asset for its intended use will form part of its initial cost. For example, property taxes, legal fees etc.
The principles are same as would be applied to determine the cost of asset under Ind AS 16 Property, Plant and Equipment (PPE). Maintaining consistency with Ind AS 16, abnormal amounts of inefficiencies incurred and initial operating losses incurred will not form part of the cost of the asset and will be expensed off as incurred. In case of acquisition of investment property on deferred payment terms, the investment property would be recognised, based on its current cash price equivalent. The difference between the current cash price equivalent and the deferred payment terms would be recognised as finance cost over the term of the deferred payment term.
Borrowing costs directly attributable to the acquisition, construction or development of an investment property that is a qualifying asset shall be capitalised in accordance with Ind AS 23 Borrowing Costs. The initial cost of a property interest held under a lease and classified as an investment property shall be as prescribed for a finance lease under paragraph 20 of Ind AS 17, i.e., the asset shall be recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount shall be recognised as a liability as prescribed under Ind AS 17.
Subsequent measurement
Unlike IAS 40 which permits both cost and fair value model after initial recognition, Ind AS 40 does not provide such an accounting policy choice after initial recognition under Ind AS 40. Ind AS 40 permits application of only the cost model.
The cost model is similar to that prescribed under Ind AS 16 for Property, Plant and Equipment i.e. at cost less accumulated depreciation less accumulated impairment losses. Only if the asset is classified as held for sale, the same would be valued in accordance with Ind AS 105 Non-current Assets Held for Sale and Discontinued Operations i.e. at fair value. While initial recognition and subsequent measurement is at cost, an entity is required to disclose the fair value of the investment property.
Fair value determination
Fair value is the price at which the investment property could be exchanged between knowledgeable, willing parties in an arm’s length transaction. It should reflect the market conditions at the end of the reporting period and does not consider any transaction costs it may incur on sale or disposal. It also does not reflect future capital expenditure that will improve or enhance the value of the property.
It is best evidenced by current prices in an active market for similar properties in the same location and subject to similar terms of the contract. If information pertaining to similar term contracts is not available, then the value of such properties should be adjusted to reflect the differences in the contracts.
Transfers
Although an entity’s business model plays a key role in the initial classification of property, the subsequent reclassification of property is based on an actual change in use rather than on changes in an entity’s intentions. Transfers to and from investment property can be made only when there is change in use which has to be evidenced by:
• commencement of owner-occupation, for a transfer from investment property to owner-occupied property;
• commencement of development with a view to sell, for a transfer from investment property to inventories;
• end of owner-occupation, for a transfer from owner-occupied property to investment property; or
• commencement of an operating lease to another party, for a transfer from inventories to investment property.
As such, the subsequent reclassification is based on actual change in use and not just the intentions of the entity.
For example, Company S owns a site that is an investment property. S decides to modernise the site and sell it. The investment property is transferred to inventory at the date of commencement of the redevelopment of the site that evidences the change in use. However, a decision to dispose of an investment property without redevelopment does not result in it being reclassified as inventory. The property continues to be classified as investment property until the time of disposal unless it is classified as held for sale.
Let us take another example where Company G which previously classified a property as an investment property has now decided to use the property as its administrative headquarters due to an expansion of its business, and commences redevelopment for own use in February 2013 (e.g. builders are on site carrying out the construction work on G’s behalf). In this case, the redevelopment of the property for future use for administrative purposes effectively constitutes owner occupation. Therefore, G should reclassify the property to owner occupied property on commencement of the redevelopment in February 2013.
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. In other words, transfers happen at the carrying amount. For example, if an investment property of Rs. 100,000 depreciated @ 10% SLM is transferred to inventory at the end of 3 years, the same will be transferred to inventory at Rs. 70,000 i.e., the carrying amount of investment property at the end of 3 years.
Disposals
The investment property shall be derecognised i.e. eliminated from the financial statements on disposal, providing an asset under finance lease or when it is permanently withdrawn from use and no future economic benefits are expected from its disposal. The criteria and guidance given in Ind AS 18 Revenue would be applied to determine the date of disposal, whereas Ind AS 17 would be applied in case the disposal is by way of finance lease or sale and leaseback.
Gains or losses resulting from difference in net sales proceeds and the carrying value of investment property will be recognised in profit or loss in the period in which the property is disposed or retired. In case the sales proceeds are deferred, the consideration receivable will have to be discounted to its present value and the difference would be recognised as finance income over the period of credit.
Practical issues
Classification issues
Determining what is or what is not investment property may raise practical issues, some examples of which are given below:
Subsequent cost
Subsequent costs of day-to-day servicing and maintaining a property are expensed as incurred and cannot be capitalised. But where statutory/fregulatory approvals are required to be obtained and any expenses incurred during the period required to get such approvals shall be capitalised as the property cannot be put to intended use till such time that the approvals are obtained.
Equipments and furnishings
Equipments and furniture and fittings that are physically attached to the building will be considered as integral part of the building and will not be accounted for separately. For example, lifts, escalators, air conditioning units etc., will all be considered as part of investment property. In case of movable property, the same would get accounted separately as PPE in accordance with Ind AS 16. In such cases, care must be taken while disclosing the fair value of the investment property, so that it does not include the fair value of moveable property that has been accounted for separately, otherwise it will be misleading.
Inventory vs. Investment Property
The entity’s intention regarding the property is a primary criteria for classification. Property held for short-term sale would be classified as inventory whereas the one held for long-term purposes would generally get classified under investment property. For example, if a builder acquires bare land with intention to construct buildings and sell them, the land would be classified as inventory because it is an asset held in the process of production for sale. However, if the company has brought land with no specific use in mind, then it gets classified as investment property. (Eg: Financial institution acquires a property as full and final settlement of loan given and is uncertain about its intention). In case a developer of the property holds a completed developed property and intends to rent the same, he could classify the same as investment property instead of classifying it as inventory.
Consolidated and separate financial statements
A property may also get classified differently in consolidated and separate financial statements of an entity. For example, when a holding company leases building to its subsidiary which uses the same as its administrative office, the property could be classified as investment property in the books of the holding company but would be classified as PPE in the Consolidated Financial Statements (CFS).
Dual-use property
Wherein a property could be used for dual purposes, say for own use and other for renting out, a portion of dual property can be classified as investment property, only if the portion could be sold separately. When a portion of the property can not be sold separately, the entire property is classified as investment property only if the portion of the property held for own use is insignificant. For example, Company X owns an office block and uses 3 floors as its own office; the remaining 12 floors are leased out to tenants on operating lease. Under the local laws, X could sell legal title to the 12 floors, while retaining legal title to the other 3 floors. In this case, the 12 floors would be classified as investment property.
Ancillary services
In case where the owner of the property provides ancillary services, the key factor in determining whether the same should be classified as investment property is its relative insignificance to the entire arrangement.
But in case of hotels, ancillary services would be considered as significant part and an owner-managed hotel would be regarded as owner-occupied property instead of investment property, as the property is used to a significant extent for the supply of goods and services. In case where the owner of the hotel is just a passive investor and the management function and provision of services is carried out by a third party and the owner is not exposed to variations in cash flow from the operations of the hotel, the same will be treated as investment property. As such, judgment is required in determining the classification of the property in case of different scenarios. An entity should assess on a case-to-case basis whether the arrangement is more like an example of owner-managed hotel (not investment property) or an example of office building with security services provided by the owner (investment property).
Even in case of classification of business centres, some of them which provide high level services such as secretarial support, teleconferencing and other computer facilities and where tenants sign relatively short term leases, the facilities provided are more in the nature of owner-managed hotel and hence should not be classified as investment property. In other cases where the owner provides just the basic furnishing and users are required to sign up for a minimum period, the same could be treated as investment property.
Disclosures
An entity is required to disclose the following:
• accounting policy for measurement.
• 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 methods and significant assumptions applied in determining the fair value of investment property.
• the extent to which FV is based on valuation by professional independent valuer; if not, such fact should be disclosed.
• amounts recognised in profit or loss for rental income, direct operating expenses that generated as well as those that did not generate rental income.
• the existence and amounts of restrictions on the realisability 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 enhancements.
• Depreciation method and useful life or rate of depreciation.
• Gross carrying amount and accumulated depreciation at beginning and end of reporting period.
• Reconciliation of carrying amount of investment property at the beginning and end of the period.
• Impairment losses recognised or reversed.
• Exchange differences.
• Transfers to and from inventories and owner-occupied property.
• Assets classified as held for sale.
• Other changes.
Conclusion
This accounting standard prescribes accounting for investment property and the related disclosure requirements. It gives detailed guidance on the classification, recognition and measurement of investment properties. The guidance requires the measurement of the investment property using the cost model similar to measurement of PPE under Ind AS 16. It also gives guidance on transfers to and from investment property and states that these can be made only when there has been a change in the use of the property.
Judgment would be required on case to case basis to classify the property as investment property especially in cases of ancillary use or dual-use of the property.
