REDEFINING INVESTMENT PROPERTY

Accountancy SA,  Mar 2005  by Toit, Morne du,  van Wyk, Anton

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Introduction

In line with its project on Improvements to International Accounting Standards, the International Accounting Standards Board's (lASB's) main objective was a limited revision of the IAS 40.

The Standard had already incorporated most of the problem areas previously identified by the IASB, including the evolutionary step forward to allow the measurement of Investment Property - a non-monetary asset - at fair value. There were however some issues that were not resolved during the previous round of changes.

In the previous Standard (IAS 40 (2000) Investment Properties) one of the issues specifically discussed in the basis for conclusions was the treatment of long-term operating leases. As proposed in E64, and the previous Standard, it was not permitted for a lessee to treat interest in property held under an operating lease as investment property, even if the lessee acquired its interest in exchange for a large upfront payment or the lease had a very long term (IAS 40 (2000), B10).

This created problems in countries where it is common practice to make large upfront payments to acquire long-term interests in properties (sometimes known as leasehold interests) because it may be impossible to obtain outright ownership of land and buildings, and where property Ownership' in these markets is invariably transferred by selling rights under these operating leases. Some lessees were of the opinion that this leasehold interest is, in economic substance, virtually indistinguishable from rights acquired on buying property (IAS 40 (2000), B11).

At that point the Board concluded, for various reasons listed in the Basis for Conclusions on IAS 40 (2000), that the Standard on investment property should not deal with property held under an operating lease.

It is mainly this issue that was addressed during the Board's limited review of IAS 40 in its project on improvements. They did not reconsider the fundamental approach to the accounting for investment property contained in IAS 40. There were also some significant changes that have been incorporated into the standard as a result of amendments that the Board made to IAS 16 Property, Plant and Equipment as part of the improvements project. These will be discussed later in the article.

The Main Change

The main change to IAS 40 was the incorporation of some property interests held by a lessee under an operating lease into the definition and treatment of investment properties. From the effective date of the standard - annual periods beginning on or after 1 January 2005 - or earlier application if an entity so wishes, it can classify and account for property interests held by a lessee under an operating lease as investment property provided that:

* The rest of the definition of investment property is met;

* The operating lease is accounted for as if it were a finance lease in accordance with IAS 17 Leases; and

* The lessee uses the fair value model set out in this Standard for assets recognised.

The treatment above is available on a property-by-property basis, in other words the entity does not have to treat all property interests under operating leases as investment properties - it can choose which leasehold interests it wants to treat in this manner.

In terms of paragraph 34 all interests held by a lessee under an operating lease and classified as investment property will be treated in accordance with the fair value model i.e. the cost model is not an option. This in turn implies that the entity will then, when classifying any leasehold interests as investment property, have to apply the fair value model for all other investment properties.

Measurement

At initial recognition

According to paragraph 25, the cost of the property interest held under a lease and classified as an investment property will be as prescribed by paragraph 20oflAS 17, i.e. the asset will be recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount will be recognised as a liability in accordance with that same paragraph.

It is important to note that the item accounted for at fair value is the property interest held under the lease and not the underlying property.

Subsequent to initial recognition

It is clear from the above that, after recognition, the fair value model will apply to easehold interests.

Paragraph 33 of the Standard requires these interests to be re-measured, if necessary to fair value. According to paragraph 41, in a lease negotiated at market rates, the fair value of an interest in a leased property at acquisition, net of all expected lease payments (including those relating to recognised liabilities), should be zero. This fair value does not change regardless of whether, for accounting purposes, a leased asset and liability are recognised at fair value or at the present value of minimum lease payments, in accordance with paragraph 20 of IAS 17. Thus, re-measuring a leased asset from cost in accordance with paragraph 25 to fair value in accordance with paragraph 33 should not give rise to any initial gain or loss, unless fair value is measured at different times. This could occur when an election to apply the fair value model is made after initial recognition.