Many (if not all) accountants are aware that UK GAAP in its current form is set for significant change and it is likely that the Financial Reporting Council (FRC) will announce this year that the new ‘Financial Reporting Standard applicable in the UK and Republic of Ireland’ (FRS 102) will be implemented for accounting periods commencing on or after 1 January 2015 following the comment period which closed on 30 April 2012, explains Steve Collings.
There are some notable differences between current UK GAAP and the new FRS 102 which have been discussed in previous articles. There is one significant change in the new FRS 102 that has caused an element of controversy among accountants, which is the proposed accounting treatment for investment property.
Many clients (including those that report under the FRSSE (effective April 2008)) hold investment property on the balance sheet. Those companies that are not eligible to use the FRSSE (effective April 2008) will account for investment property under SSAP 19 Accounting for Investment Properties.
Under SSAP 19 (and the FRSSE (effective April 2008)), reporting entities that hold investment properties are required to carry such properties at their open market value (SSAP 19 para 6). Any changes in market value are taken to the revaluation reserve within the statement of total recognised gains and losses, unless a deficit (or the reversal of a deficit) on an individual investment property is expected to be permanent. In such cases, permanent diminutions in value are taken to the profit and loss account in the period the diminution in value occurs. The revaluation of investment property accords with the alternative accounting rules which require such amounts to be taken to the revaluation reserve.
Under the draft FRS 102, any changes in the fair value of investment property are taken directly to profit or loss as illustrated in the following example which compares the accounting treatment currently in SSAP 19 and the accounting treatment in the proposed FRS 102:
Example
Company A Limited has a property on its balance sheet that meets the recognition criteria of an investment property, both in SSAP 19 and paragraph 16.2 of FRS 102. On 1 January 2014 the carrying value of this property was £300,000 and on 31 December 2014 and independent valuation was carried out which revealed the open market value of this property was now £310,000.
SSAP 19 treatment
Under the provisions in SSAP 19 there will be a debit to the investment property of £10,000 to uplift the investment property’s carrying value from £300,000 to £310,000. The credit will be reported in the statement of total recognised gains and losses through the revaluation reserve account, hence no impact on the profit and loss account in this example.
FRS 102 treatment
The revaluation of the investment property accords with the fair value accounting rules and will be reported in profit or loss as follows:
DR carrying value of investment property £10,000
CR profit and loss £10,000
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In the example above, under the proposed FRS 102, we will see a direct impact on the profit and loss account because paragraph 16.7 in FRS 102 requires changes in fair value to be recognised in profit or loss. However, what is important to emphasise is that the revaluation gain will not be a realised profit available for distribution to shareholders. The staff guidance on investment property acknowledges that reporting entities could choose to transfer gains and losses arising from the fluctuation of open market values for investment property to a non-distributable reserve.
The treatment that is proposed in FRS 102 is consistent with international accounting standards; specifically IAS 40 Investment Property. The reason that IAS 40 and FRS 102 does not require the use of a revaluation reserve account is because investment property is not depreciated, nor subjected to an annual impairment test. Instead all valuation changes are reported within profit or loss for the period. Many accountants appear to disagree with this treatment with some accusing the proposed treatment as destroying the function of the profit and loss account by reporting unrealised gains. Again, it is important to emphasise that revaluation gains on investment property that go through profit and loss (should the treatment in FRS 102 be introduced), will not be distributable because the fair value of the investment property is not readily convertible to cash.
If a client chose to transfer gains and losses on remeasurement of investment property to a non-distributable reserve the presentation issues in the balance sheet would appear to be unchanged.
Deferred tax issues
The draft FRS 102 at paragraph 29.16 requires deferred tax to be recognised on the revaluation of property and this follows the principles contained in IAS 12 Income Taxes. The exception to this provision is for depreciable investment property held within a business model whose objective is to consume substantially all of the economic benefits embodied in the investment property over time. In contrast, FRS 19 Deferred Tax does not normally recognise deferred tax on the revaluation of assets.
Using an example, this is how deferred tax on the revaluation of an investment property would be calculated under the proposed FRS 102 requirements:
Example
Company B Limited has a year-end of 31 December 2015. On this date it had an investment property with a carrying value of £100,000 and an independent valuation confirmed the open market value of this property was £110,000.
The entries in the books of Company B Ltd under para 16.7 of FRS 102, will be:
DR investment property £10,000
CR profit or loss £10,000
Deferred tax on this revaluation would then be recognised as the adjustment to fair value affects profit. Assuming Company B Ltd will pay tax at 22% in that financial year, the deferred tax to be recognised will be (£10,000 x 22%) £2,200 and such entries will be:
DR deferred tax expense £2,200
CR deferred tax liability £2,200
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Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.