Steve Collings looks at some of the main issues accountants face when it comes to the accounting aspects of property valuations under FRS 102, and tackles queries raised around fair values and revaluation amounts.
There are two sections in FRS 102 which deal with properties: Section 16 Investment Property and Section 17 Property, Plant and Equipment.
The glossary to FRS 102 (March 2018) defines ‘investment property’ 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.’
In the basic sense of the definition, if a property earns rentals for the entity it will meet the definition of an investment property and hence must be accounted for as such.
The Financial Reporting Council (FRC) have removed the undue cost or effort exemptions that were in FRS 102 (September 2015) as part of the triennial review amendments, including those which were in Section 16. Therefore, all properties which meet the definition of investment property under FRS 102 (March 2018) are accounted for under Section 16 and must be remeasured to fair value at each balance sheet date with fair value gains and losses going through profit and loss. There is an option available to groups which is discussed later.
Seemingly, some practitioners have continued accounting for investment property under the old UK GAAP accounting treatment (ie taking fair value gains directly to a revaluation reserve).
This is wrong under FRS 102 because the standard applies the fair value accounting rules in the Companies Act 2006 (as opposed to the alternative accounting rules) for investment property gains and losses and hence such gains and losses are reported via the profit and loss account.
Where the practitioner has applied the incorrect accounting treatment and the error is material, then it would need to be corrected by way of a prior year adjustment in accordance with FRS 102, Section 10 Accounting Policies, Estimates and Errors.
Also, don’t forget that deferred tax must be brought into account which is also presented in profit and loss, hence for a fair value gain on an investment property the entries are:
|Dr Investment property||£X|
|Cr Fair value adjustments (profit and loss account)||£X|
|Being fair value gain on investment property|
|Dr Deferred tax (profit and loss account)||£X|
|Cr Deferred tax provision||£X|
|Being deferred tax liability arising on fair value gain|
FRS 102, paragraph 29.16 requires deferred tax relating to investment property measured at fair value to be measured using the tax rates and allowances that apply to the sale of the property (there is an exception in paragraph 29.16 relating to investment property which has a limited useful life).
If it is assumed that the client has no plans to sell the asset for the foreseeable future, deferred tax is calculated using the tax rates and laws which have been enacted or substantively enacted by the balance sheet date, hence we can use 17% (indexation allowance may also be available depending on when the asset was purchased) as this will be the corporation tax rate which will apply for the corporation tax year starting 1 April 2020.
Fair value gains on investment property are not distributable because they are unrealised gains (the gain cannot be readily convertible into cash). The gain, net of deferred tax, ends up in retained earnings or they can be presented in a separate component of equity in the balance sheet to ring-fence them from reserves which are distributable. There is nothing in company law which requires such gains to be presented separately in the equity section of the balance sheet, but it is often a good idea to do this to prevent them being inappropriately distributed.
Where fair value gains are presented as a separate component of equity, some professional bodies are advising against calling the reserve a ‘Fair value reserve’ which is what some automated accounts production software systems are referring to the reserve as by default. Instead, they are advising member firms to call it a ‘Non-distributable reserve’ so you may need to rename the reserve accordingly. Regardless of what the reserve itself is called in the financial statements, the crucial point to emphasise to the directors is that the gains are not distributable.
Intra-group investment property
The FRC included an accounting policy choice for investment property which is rented out to another group entity in FRS 102 (March 2018). This is likely to prove to be attractive for groups and formed part of the triennial review amendments.
The triennial review amendments apply mandatorily for accounting periods commencing on or after 1 January 2019 and early application is permissible provided all of the triennial review amendments are applied at the same time.
The only exception to this rule relates to the amendments in respect of directors’ loans and gift aid payment, which can be early applied separately without having to early adopt the rest of the triennial review amendments.
Please note, if you apply the triennial review amendments earlier than the mandatory 'effective from' date you must disclose this fact, although small entities are encouraged to disclose this fact) (FRS 102 (March 2018), para 1.18).
FRS 102 (March 2018), para 16.4A allows an entity which rents investment property to another group entity to account for those properties either at fair value through profit and loss or by transferring them to Section 17 and applying the cost model (cost less depreciation less impairment).
Where this accounting policy choice is adopted, it will require retrospective application as illustrated in the following example:
Topco Limited has an investment property which it rents out to another group member. The company is preparing its financial statements to 31 March 2019 and wishes to apply the accounting policy to measure the intra-group investment property under the cost model. The group is medium-sized and is required to prepare consolidated financial statements.
A transitional provision is contained in FRS 102, para 1.19(a) which allows the entity to:
Topco wishes to take the fair value at the date of transition as deemed cost. As a consequence, the investment property is not being carried on a cost basis and is being measured under the alternative accounting rules. Therefore, any fair value uplift existing at the date of transition is transferred to a revaluation reserve from either retained earnings or the non-distributable reserve.
Topco then restates the comparatives and accounts for the intra-group investment property under the cost model in Section 17.
Topco must also make the historical cost comparable disclosures to comply with Schedule 1 to The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410), para 34. In addition, it must also disclose the fact that it has early adopted the triennial review amendments. If it were a small entity, it would be encouraged to disclose that it has early adopted the triennial review amendments.
Revaluation of owner-occupied property
Owner-occupied property is accounted for under FRS 102, Section 17.
Section 17 allows an entity to use the revaluation model for assets, but where the entity does apply the revaluation model to an asset it must revalue all assets within that asset class. The entity cannot just revalue those assets in the class which have increased in value; they must also revalue those which may have decreased in value.
When the revaluation model in FRS 102 Section 17 is applied, the entity is applying the alternative accounting rules in the Companies Act 2006 (not the fair value accounting rules which are applied for investment property). This means the entity must present a revaluation reserve in the balance sheet.
In addition, deferred tax is also brought into account. Hence, for a revaluation gain:
|Dr Property, plant and equipment||£X|
|Cr Revaluation reserve||£X|
|Being revaluation gain on freehold building at the year end|
|Dr Revaluation reserve||£X|
|Cr Deferred tax provision||£X|
|Being deferred tax on revaluation gain|
When an asset suffers a revaluation loss, the carrying amount of the asset is reduced and the corresponding debit is taken to the revaluation reserve to the extent of a surplus in respect of that asset. You cannot offset losses of one asset against gains of another and vice versa. Once the surplus in the revaluation reserve in respect of that asset has been used up, any further losses are recognised in profit and loss.
Gains on revaluations are generally recognised in other comprehensive income via the revaluation reserve. The exception to this would be where the gain reverses a previous revaluation decrease in respect of the same asset which has been recognised in profit or loss. In such cases, the gain is taken to profit or loss to the extent of the previously recognised loss with any resulting excess being recognised in the revaluation reserve.
Do not forget to account for the deferred tax consequences as well.
Frequency of revaluations
FRS 102 para 17.15B requires an entity to carry out a revaluation exercise with sufficient regularity such as to ensure that the asset’s carrying amount in the balance sheet does not differ materially from its fair value at the balance sheet date.
There are no specific timeframes referred to in FRS 102 as there was in previous FRS 15 Tangible fixed assets and hence professional judgment must be applied in this respect.
The treatment of properties within the financial statements under FRS 102 does seem to continue to present challenges – particularly investment property.
This article has looked at some of the main issues which practitioners face when it comes to the accounting aspects of property valuations under FRS 102. In addition, the FRC has also produced some helpful factsheets, one of which covers the issue of fair value measurement for property.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.