In my previous blog post on investment properties I started to consider subsequent measurement of investment properties under FRS 102 and had noted the following:
SSAP 19 requires investments properties to be carried at open market value with no depreciation whilst FRS 102 refers to fair value (with no depreciation) although this change in wording is not expected to lead to many differences at all in practice. For an unquoted asset the price of a recent transaction for an identical asset or a valuation technique provides evidence of fair value. Both open market value and fair value should be accounted for on an on-going basis (ie. at the end of each period).
A key difference in FRS 102 is that in certain situations, a depreciated cost model can be used instead of the fair value approach.
It was also noted that the transitional options available for investment properties would allow certain values to be used as deemed cost and deemed cost would only be allowable under the depreciated cost model.
I would like to pick up on two points here:
The definition of fair value is cross referenced to paragraph 11.27 in FRS 102 which lists out a hierarchy of calculating fair values:
The key point to note is that this is a hierarchy so checking the local property market should be considered prior to using rental yields as a valuation technique. Care will need to be taken here as many accountants and clients will prefer the rental yields valuation technique from a cost perspective! This hierarchy is considered in more detail in David Smith's blog post 'Royal babies and the FRS 102 fair value anarchists'.
FRS 102 doesn't insist on the involvement of a professionally qualified valuer who has recent experience in the location and class of the property, but must disclose the extent to which such a valuation is used. If there has been no such valuation, then this fact should be disclosed together with the methods and significant assumptions applied in determining the valuation technique (eg. the director performed the valuation looking at the local property market over the last 12 months which has seen an X% increase in prices).
Depreciated cost model
FRS 102 allows an entity to use a depreciated cost model when the fair value of the property cannot be measured without undue cost or effort (16.1). The FRC's Staff Education Note 4 on investment properties notes that changes in fair value can normally be obtained so the use of undue cost or effort is unlikely.
The real question here is what exactly constitutes 'undue cost or effort'. The ICAEW issued Technical Release 13/14 AAF (issues for auditors) at the back end of 2014 and in the case of an investment property it states the following should be considered:
- whether management has obtained a reliable fair value or equivalent previously and why management believe that this is no longer possible (ie. consider how they ensured compliance with SSAP 19 in previous years if it was an investment property);
- materiality of the investment property;
- context of the investment property in relation to the business / operation as a whole and any changes therein (ie. are they set up purely to invest in property or is it ancillary to their business?);
- users of the financial statements and extent of their interest in the fair value of the investment property and their understanding therein (eg. is there external finance supporting the business and is this property secured on that finance?);
- management's rationale for concluding that cost or effort is undue; and
- alternatives available and permitted under the framework.
Although this has come from a Technical release for auditors it would appear to be a pretty good starting place for those who are involved in accounts compilation as well. This is going to need to be considered on an entity by entity basis and a blanket approach does not seem suitable.
If you are able to prove that fair valuing the asset would cause undue cost and effort then section 16 cannot be applied and the property is accounted for under section 17 instead, on tangible fixed assets (or PPE). As such these would be held at cost (less impairment) and depreciated over their useful economic life. This would not be deemed to be a change in accounting policy but is a change in circumstances. As such if it was previously included in investment property then the comparatives are not restated and the change in circumstance is dealt with by transferring the carrying amount of the investment property into tangible fixed assets at its 'cost'.
Does the above apply in the not for profit sector?
For those working in the not for profit sector then they may fall into the category of a 'public benefit entity' (PBE). Under FRS 102, the definition is an entity whose primary objective is to provide goods or services for the general public, community or social benefit and where any equity is provided with a view to supporting the entity's primary objectives rather than with a view to providing a financial return to equity providers, shareholders or members. When dealing with a 'PBE' which holds properties primarily for the provision of social benefits such as social housing then these should not be classified as investment properties but they should be treated as property, plant and equipment (PPE)(16.3A).
We now know when we can use the depreciated cost model for investment properties and the types of issues to watch out for. Just take care when using the 'undue cost of effort' clause to ensure it truly applies to that entity.
My next blog post on investment properties will consider the fair value model and how to account for gains and losses.