Objective, Scope and Key terms – Ind AS 40

 Objective

The prime two objectives of the Ind AS 40 are as follows:

  • to prescribe the accounting treatment for investment property and
  • to prescribe the related disclosure requirements

Scope

  • This Standard shall be applied in the recognition, measurement and disclosure of investment property
  • This Standard does not apply to:
  • biological assets related to agricultural activity (Refer Ind AS 41and Ind AS 16); and
  • mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

Key terms

Fair value

  • The price that would be received to sell an asset or
  • paid to transfer a liability
  • in an orderly transaction
  • between market participants
  • at the measurement date.

Investment property

  • A property (land or a building—or part of a building—or both)
  • held (by the owner or by the lessee as a right of- use asset)
  • 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.

Owner-occupied property

  • A property held (by the owner or by the lessee as a right-of-use asset) for use
    • in the production or supply of goods or services or for administrative purposes.

Question:

Held (by the owner or by the lessee under finance lease) for use in the production or supply of goods or services or for administrative purposes is called 

a. Owner–Occupied Property

b. Investment Property

c. Business Property

d. Owner–Occupied Property or Investment property

Answer

a. One of the distinguishing characteristics of investment property (compared to owner-occupied property) is that it generates cash flows that are largely independent from other assets held by an entity. Owner-occupied property is accounted for under Ind AS-16, Property, Plant, and Equipment and held for use in the production or supply of goods or services or for administrative purposes as against investment property(accounted for under Ind AS-40) held for earning rentals or for capital appreciation or both.

Classification of property

  1. Investment property

Investment property is held to earn rentals or for capital appreciationor both

Therefore, an investment property generates cash flowslargely independently of the other assets held by an entity

This distinguishes investment property from owner-occupied property

  • Owner-occupied property

The production or supply of goods or services (or the use of property foradministrative purposes) generates cash flows that are attributable notonly to property, but also to other assets used in the production orsupply process

Ind AS 16 applies to owned owner-occupied propertyand Ind AS 116 applies to owner-occupied property held by a lesseeas a right-of-use asset

Examples of Investment property

  • Land held for long-term capital appreciation rather than for short term sale in the ordinary course of business
  • Land held for a currently undetermined future use. (If an entity has not determined that it will use the land as owner-occupied property or for short-term sale in the ordinary course of business, the land is regarded as held for capital appreciation.)
  • Abuilding owned by the entity (or a right-of-use asset relating to a building held by the entity) and leased out under one or more operating leases
  • Abuilding that is vacant but is held to be leased out under one or more operating leases
  • Property that is being constructed or developed for future use as investment property

Examples of items that are not Investment property  

  • Property intended for sale in the ordinary course of business orin the process of construction or development for such sale (see Ind AS 2, Inventories),
    • for example: property acquired exclusively with a view to subsequent disposal in the near future or for development and resale
  • Owner-occupied property (see Ind AS 16 and Ind AS 116), including (among other things) property held for future use as owner-occupied property, property held for future development and subsequent use as owner-occupied property, property occupied by employees (whether or not the employees pay rent at market rates) and owner-occupied property awaiting disposal
  • Property that is leased to another entity under a finance lease

What if a property is used for dual purpose?

  • Some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion that is held for use in the production or supply of goods or services or for administrative purposes
  • If these portions could be sold separately (or leased out separately under a finance lease), an entity accounts for the portions separately
  • If the portions could not be sold separately, the property is investment property only if an insignificant portion is held for use in the production or supply of goods or services or for administrative purposes

Question:

Entity Y acquires land. The land consists of two pieces that could be sold separately. The land will be used during more than one financial year. One piece is held for long-term capital appreciation and the other piece for constructing a new warehouse building. Whether the two pieces of land have to be treated separately for accounting purposes? Yes / No?

Answer:

Yes: Para 10 of Ind AS 40 says that “Some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion that is held for use in the production or supply of goods or services or for administrative purposes. If these portions could be sold separately (or leased out separately under a finance lease), an entity accounts for the portions separately.”

Here in this example, Entity Y has a land which consists of two pieces that could be sold separately the piece of land is a dual-use property and hence, they are accounted for separately. The portion of land to earn rentals or for capital appreciation will be accounted per Ind AS 40 and another portion for constructing a new warehouse building (which believed to be held for use in the production or supply of goods or services or for administrative purposes) should be accounted per Ind AS 16

Question:

Entity A owns a hotel resort, which includes a casino in a separate building that is part of the premises of the entire hotel resort. Its patrons would be largely limited to tourists and non-resident visitors only. The owner operates the hotel and other facilities on the hotel resorts, with the exception of the casino, which can be sold or leased out under a finance lease. The casino will be leased to an independent operator. Entity A has no further involvement in the casino. The casino operator will not be prepared to operate it without the existence of the hotel and other facilities. Entity A wants to classify the Hotels and Casino –both as Property Plant and Equipment. Is it permissible? Yes/No?

Answer

No: Para 10 of Ind AS 40 says that “Some properties comprise a portion that is held to earn rentals or for capital appreciation and another portion that is held for use in the production or supply of goods or services or for administrative purposes. If these portions could be sold separately (or leased out separately under a finance lease), an entity accounts for the portions separately.”

In this scenario, management should classify the hotel and other facilities as property plant and equipment and the casino as Investment Property as because the casino can be sold separately or leased out under a finance lease.

Example 1

Entity PQR built a residential property with the object of selling it. Traditionally, PQR has regularly developed property and then sold it instantly after completion. Toboost the chances of a sale, PQR chooses to let some of the flats as soon as they are ready for occupation. How would PQR map the property on the balance sheet?

Henceforth, PQR classifies the property as inventory. This corresponds to PQR’s core business and its strategy regarding property. These undertakings are carried out with the intention of increasing the chances of selling the property and not for the long-term generation of rental income. The property is also not held for the reason of capital appreciation. PQR’s purpose to sell the property under construction immediately after completion in the ordinary course of business has not changed. Consequently, the property under construction does not fulfil the definition of an investment property (IAS 40.9(a))

Question:

An entity provides a bed and breakfast services from a building it owns. The entity also provides its guests with other services including housekeeping, television and internet access. The daily room rental is inclusive of these services. Furthermore, upon request, the entity conducts tours of the surrounding area for its guests. Tour services are charged for separately. The entity should account for the building as:

(a) property, plant and equipment

(b) inventory

(c) investment property

(d) property, plant and equipment or investment property

Answer:

  • The arrangement between the entity and the bed and breakfast guests is for the provision of services, rather than the property being a passive investment .and hence, building should be treated as property, plant and equipment.

Ancillary services significant or not significant?

Insignificant ancillary services:

  • In some cases, an entity provides ancillary services to the occupants of a property it holds. An entity treats such a property as investment property if the services are insignificant to the arrangement as a whole
  • Example: when the owner of an office building provides security and maintenance services to the lessees who occupy the building, for an owner, it is classified as an investment property

Significant ancillary services:

  • In other cases, the services provided are significant
  • Example: If an entity owns and manages a hotel, services provided to guests are significant to the arrangement as a whole. Therefore, an owner managed hotel is an owner-occupied property, rather than an investment property

Difficult to identify significance of ancillary services?

  • At times, it may be difficult to determine whether ancillary services are so significant that a property does not qualify as investment property
  • Judgment is needed to determine whether a property qualifies as investment property
  • An entity develops criteria so that it can exercise that judgment consistently in accordance with the definition of investment property and with the related guidance of Ind AS 40

Judgment to identify if it attracts Business combination

  • Judgment is also needed to determine whether acquisition of investment property is the
  • acquisition of an asset or
  • a group of assets or
  • a business combination within the scope of Ind AS 103, Business Combinations.
  • Reference should be made to Ind AS 103 to determine whether it is a business combination
  • Determining whether a specific transaction meets the definition of a business combination as defined in Ind AS 103 and includes an investment property as defined in this Standard requires the separate application of both Standards

Different classification Standalone Vs. Consolidated

  • In some cases, an entity owns property that is leased to, and occupied by, its parent or another subsidiary
  • The property does not qualify as investment property in the consolidated financial statements, because the property is an owner-occupied from the perspective of the group
  • However, from the perspective of the entity that owns it, the property is an investment property if it meets the definition in paragraph 5 of Ind AS 40
  • Therefore, the lessor treats the property as an investment property in its Standalone financial statements

Question:

A building is owned by a subsidiary (lessor) to earn rentals under an operating lease from its parent (lessee). The parent manufactures its products in the rented building. The fair value of the building can be measured reliably. The building is:

  1. accounted for as an investment property by the subsidiary and as an item of property, plant and equipment by the group.
  2. accounted for as an item of property, plant and equipment by the subsidiary and an investment property by the group.
  3. accounted for as an investment property by both the subsidiary and the group.
  4. accounted for as an item of property, plant and equipment by both the subsidiary and the group

Answer

  • As per para 15 of Ind AS 40, the property does not qualify as investment property in the consolidated financial statements, because the property is owner-occupied from the perspective of the group. However, from the perspective of the entity that owns it, the property is an investment property if it meets the definition requirements therefore, the lessor/subsidiary treats the property as investment property in its individual financial statements. And it would be treated as PP&E by the group.

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