Steve Collings addresses the confusion surrounding the accounting treatment for investment property under FRS 102.
FRS 102 deals with investment property in Section 16 Investment Property. There appears to be a lot of confusion surrounding the accounting for investment property under FRS 102 and hence this article will examine the accounting treatment for such properties and also clarify the changes that were made to Section 16 as a result of the Financial Reporting Council’s (FRC) triennial review.
Investment property is defined in the Glossary to FRS 102 as:
“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:
- use in the production or supply of goods or services or for administrative purposes, or
- sale in the ordinary course of business.”
Generally, where a property is used to earn rentals then it will fall under the definition of investment property. However, do also keep in mind that if the property is being held for capital appreciation purposes it will also meet the definition of investment property. Land which is held for long-term capital appreciation would also meet the definition of investment property.
FRS 102, paragraph 16.3 also states that a property interest which is held by a lessee under an operating lease may be classified and accounted for as investment property if, and only if, the property would otherwise meet the definition of an investment property and the lessee can measure the fair value of the property interest on an on-going basis. This classification alternative is an on a property-by-property basis.
Property which is held primarily for the provision of social benefits (FRS 102, paragraph 16.3A cites an example of social housing held by a public benefit entity) is not investment property. Such property is accounted for under the provisions of Section 17 Property, Plant and Equipment.
FRS 102 paragraph 16.4 deals with mixed-use property. This particular paragraph requires such property to be separated between the investment property part and the property, plant and equipment part. The investment property part is measured at fair value at each reporting date. However, if the fair value of the investment property portion of the property cannot be measured reliably, the entire property is accounted for under the provisions of Section 17.
Accounting treatment under FRS 102
FRS 102 uses the fair value accounting rules in the Companies Act 2006 to account for investment property.
Under previous UK GAAP, SSAP 19 Accounting for investment properties, investment property was accounted for under the alternative accounting rules. As a result, fair value gains and losses on investment property under FRS 102 are taken to the profit and loss account and not directly to a revaluation reserve.
There appears to be some confusion with this accounting treatment and some practitioners are still continuing to take fair value gains and losses directly to equity through a revaluation reserve which is incorrect under FRS 102. FRS 102, paragraph 16.7 sets out the subsequent measurement of investment property and requires changes in fair value to be recognised in profit or loss.
In addition, deferred tax also has to be brought into account in respect of investment property fair value gains and losses. Deferred tax is dealt with in Section 29 Income Tax and paragraph 29.16 states:
“Deferred tax relating to investment property that is measured at fair value in accordance with Section 16 Investment Property shall be measured using the tax rates and allowances that apply to sale of the asset, except for investment property that has a limited useful life and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the property over time.”
Therefore, where a client has a fair value gain on investment property, a deferred tax liability will arise, or there will be an increase to an existing deferred tax liability in respect of the investment property or a deferred tax asset in respect of that property will reduce.
It is also important to emphasise that any gains on investment property are non-distributable as the gain is not a realised gain. Some practitioners are ring-fencing such non-distributable profits in a ‘non-distributable reserve’ which is acceptable. The reserve used should not be referred to as a ‘revaluation reserve’ because these are used when, for example, an item of property plant and equipment is measured using the revaluation model in Section 17. Fair value gains on an investment property are recognised in profit and loss hence the use of a revaluation reserve is not appropriate.
Undue cost or effort exemptions
The FRC has removed the undue cost or effort exemptions in Section 16. The impact of this is that all investment property (with the exception of intra-group investment property, which is covered in the next section of this article) must be remeasured to fair value at each reporting date.
The FRC removed the undue cost or effort exemptions on the grounds that they were being incorrectly applied as accounting policy choices, which they were never intended to be.
The amendments arising from the triennial review are mandatory for accounting periods commencing on or after 1 January 2019. Early adoption is permissible, provided all the amendments are applied at the same time (with limited exceptions in respect of directors’ loans and gift aid payments).
Investment property within a group
As part of the triennial review amendments, paragraph 16.4A was inserted into FRS 102 (March 2018). This paragraph provides an accounting policy choice for groups only. When an entity rents investment property to another group entity, the entity accounts for the property either:
- at fair value through profit or loss in accordance with Section 16; or
- by transferring them to property, plant and equipment and applying the cost model (cost less depreciation less impairment losses) in accordance with Section 17.
If only part of a property is rented to another group entity and the remainder is used for other purposes, the accounting policy choice in FRS 102, paragraph 16.4A only applies to the component of the property which is rented to another group entity.
This amendment will apply mandatorily for accounting periods commencing on or after 1 January 2019. Early adoption is permissible provided all of the triennial review amendments are applied at the same time (with limited exceptions noted above).
Where a group wishes to take advantage of the accounting policy choice to transfer the investment property to property, plant and equipment and measure the investment property at cost, it will need to go back to the start date of the comparative period in which it implements the triennial review amendments (ie 1 January 2017 for a 31 December 2018 year-end) and freeze the valuation at that point. It will then account for the investment property under the cost model per Section 17 and restate the comparative year.
While many groups are likely to apply the cost model in Section 17 of FRS 102 (due to it being less arduous to apply), the balance sheet may not be as strong as there will no longer be any increases in fair value and, of course, depreciation will be being charged on the property.
Micro-entities reporting under FRS 105
Micro-entities which choose to apply FRS 105 must only apply the cost model for investment property. FRS 105 does not allow the use of the fair value accounting rules and so if a micro-entity does wish to remeasure investment property to fair value at each balance sheet date, it must use FRS 102.
A micro-entity reporting under FRS 105 should never have a revaluation reserve/fair value reserve on its balance sheet (even though it has been noted that at least one micro-entity has filed a set of accounts at Companies House with a revaluation reserve on the balance sheet!).
There does appear to be a lot of confusion surrounding the accounting treatment for investment property which has hopefully been cleared up through this article. The key points to note are:
- fair value gains and losses are taken to the profit and loss account;
- fair value gains can be ring-fenced in a non-distributable reserve;
- the cost model can only be used for intra-group investment property; and
- deferred tax is also brought into account under FRS 102 for such property.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.