Property, plant and equipment to investment property
An item of owner-occupied property is transferred to investment property when owner-occupation ceases.
[IAS 40 para 7(c)].
Example – Change in use of an existing asset Background
Entity A owns an office building that it has previously used for its own administrative purposes. The building has been classified as PPE.
During the year, management moved the workforce to a new building and leased the old building to a third party.
Should the building be reclassified to investment property?
Solution
Yes. The building should be reclassified to investment property when management moves to the new building and owner-occupation ceases. The change represents a change in use of the property, and so no restatement of the comparative amounts should be made. [IAS 40 para 60]. The fact that different
accounting treatment is applied to the same property in the current and prior years is appropriate, because the building was used for different purposes in the two years.
Inventory to investment property
Property held as inventory is transferred to investment property on commencement of an operating lease with a third party.
A property under construction previously classified as inventory is not transferred to investment property when the intention to sell changes. The inventory will be transferred to investment property when, and only when,
there is a change in use evidenced by commencement of an operating lease to another party. [IAS 40A para 57(d)].
Impact of amendment to IAS 40 on transfer of investment property
IAS 40 was amended to clarify that, in order to transfer to or from investment property, there must be a change in use. To conclude that a property has changed use, there should be an assessment of whether the investment property definition is met. This change must be supported by evidence. The IASB confirmed that a change in intention, in isolation, is not enough to support a transfer.
The amendment also clarifies that the examples illustrating a change in use in paragraph 57 of IAS 40 are non-exhaustive.
The amendment is effective for annual periods beginning on or after 1 January 2018. Earlier application is permitted.
Example – Property under construction 1 Background
Entity A, a property developer with a history of developing properties for sale immediately after completion, constructs a residential apartment block for sale. The entity decides to lease out individual apartments when construction is completed, to increase the possibility of selling the entire property after completion. The tenants move in before the property in its entirety is completed and sold.
How should entity A account for the property?
Solution
Entity A should continue to classify the property as inventory, because this is consistent with the entity’s principal activities and its strategy for the property, even after the commencement of leases. The leases are intended to increase the possibility of selling the property, rather than to earn rental income on a continuing basis, and the property is not held for capital appreciation.
The entity’s intention to sell the property immediately after completion has not changed, because the property continues to be held exclusively with a view to sale in the ordinary course of business; it does not therefore meet the definition of investment property. [IAS 40 para 9(a)].
Example – Property under construction 2 Background
Entity C, a property developer with a history of developing properties for sale immediately after completion, constructs a residential property for sale. However, since property prices are at a multi-year low, entity C decides not to pursue the plan to sell the property after completion and to reconsider the decision to sell at a later stage when the market improves.
The intended change in use is evidenced by a formal decision of the board and a change in entity C’s business plan. Entity C intends to rent the property out to third parties on longer lease terms. However, at year end, no lease contract has been signed.
How should entity C account for the property?
Solution
Entity C should continue to classify the property as inventory. Paragraph 57 of IAS 40 precludes the transfer of such a property to investment property until there is evidence of an actual change in use (for example, by the commencement of an operating lease with a tenant). [IAS 40 para 57(c)]. In the context of the
amendment to IAS 40 noted above, all relevant facts and circumstances should be considered when determining whether evidence exists of a change in use of the property. However, the intention to rent out
the building after completion – with no lease contract yet in place – might indicate a change in the intended use but is, in itself, not sufficient to qualify for a change in classification.
4.1. Overview of guidance
Owners of investment property lease out property to tenants. Guidance on lessor accounting is contained in IAS 17. Accounting for lease incentives is covered by SIC 15.
Impact of IFRS 16
In 2016, the IASB issued IFRS 16 which supersedes IAS 17, SIC 15, SIC 27 and IFRIC 4. For lessors, the accounting remains largely unchanged; however, the accounting for lessees will change significantly, with almost all leases being recognised on the balance sheet. Whilst the impact of the new standard on real estate lessors is not expected to be significant, the impact on tenants might, in turn, influence lease negotiations and market behaviour.
4.2. Definition of a lease
A lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments. [IAS 17 para 4]. A lease might be in place even if the
arrangement does not take the legal form of a lease but bears the characteristics of a lease.
Impact of IFRS 16
Under IFRS 16, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A contract contains a lease if fulfilment depends on an identified asset and it conveys the right to control the use of that identified asset throughout the period of use. It is likely that the vast majority of real estate contracts that meet the definition of a lease under IAS 17 will also meet the definition of a lease under IFRS 16.
Leases are distinguished from service contracts. A lease contract provides the lessee with the right to use an asset, whereas a service contract provides the customer with a service that does not oblige the seller to make an asset available to the customer.
In the context of real estate entities, a contract between the entity and a tenant for the right to use a real estate asset will almost always meet the definition of a lease. The entity might also enter into separate contracts with the tenant for the provision of other items, such as maintenance, cleaning and security. These will likely meet the definition of a service. In some instances, such services might be part of the lease agreement.
The extent of ancillary services provided to customers might have an impact on the classification of the property (see section 2.2.2).
Impact of IFRS 16
IFRS 16 requires a lessor to account for the lease and non-lease components of a contract separately. [IFRS 16 para 12]. The lessor should also assess whether there are separate lease components in the lease (for example, lease of property, furniture and electrical equipment). [IFRS 16 para B12].
Non-lease components in a rent contract might be the provision of building maintenance services, elevator services or concierge services.
4. Rental income: accounting
by lessors
The allocation of the consideration between lease and non-lease components is performed in accordance with IFRS 15. [IFRS 16 para 17]. The lessor should allocate the transaction price to each component on the basis of relative stand-alone selling prices. This is achieved as follows:
At contract inception, the lessor determines the stand-alone selling price of each component.
The stand-alone selling price is the price at which an entity would sell the service separately to a customer.
IFRS 15 provides further guidance on how to estimate the stand-alone selling price in paragraphs 76–80.
The lessor allocates the consideration in proportion to the stand-alone selling prices.
The non-lease components would then need to be accounted for in accordance with the relevant standard. For example, security or cleaning services would be accounted for in accordance with IFRS 15. The lease
components would be accounted for in accordance with IFRS 16.