Leased investment property

Leased investment property

It is mandatory rather than optional for landlords to apply IAS 40 to account for leased investment property, requiring landlords to disclose fair value information for all leased investment property.

A company applies IAS 40 to account for a right-of-use asset if the underlying asset would otherwise meet the definition of investment property. (IAS 40.2, IAS 40.30, IFRS 16.48, IFRS 16.56)

Under IAS 40, a company chooses as its accounting policy either the fair value model or the cost model for measuring its investment property. The company applies the policy to all of its investment property – i.e. it applies the same policy to owned and leased investment property. However, in either case the company complies with the disclosure requirements of IAS 40 – including disclosures of the fair value of the investment property. (IFRS 16.34, IFRS 16.56, IAS 40.30)

Leased investment propertyIf a lessor enters into an operating lease of investment property, then it continues to recognise the investment property. In contrast, if a lessor enters into a finance lease of investment property, then it derecognises the investment property and instead recognises a net investment in the lease, which is accounted for under IFRS 16.

An intermediate lessor classifies a sub-lease as a finance lease or an operating lease with reference to its right-of-use asset under the head lease rather than the underlying asset – see Sub-lease. (IFRS 16.B58)

Food for thought – How does the accounting for leased investment properties differ under IFRS 16?

IFRS 16 contains important guidance for investment property companies that hold leasehold interests, as is common in the UK, Hong Kong, some parts of the Middle East and elsewhere. There are two key differences from the previous requirements in IAS 17 and IAS 40.

  • The election becomes a requirement: Previously, a company could elect on a property-by-property basis to recognise investment property held under an operating lease on-balance sheet. Now, all leasehold property will be on-balance sheet, and treated as investment property if the definition of investment property is met.
  • There is a choice of valuation basis: Previously, if a company elected to recognise investment property held under an operating lease on-balance sheet, then it was required to apply the fair value model to all of its investment property. Now, a company has a free choice over whether to apply the cost or fair value model to its investment property.

This new guidance may also affect companies that do not think of themselves as investment property companies. For example, a company that is managing a portfolio of leasehold properties following a restructuring or change in business model – e.g. a retailer or bank that has reduced its number of stores/branches as its business moves online – will need to assess whether each property meets the definition of investment property. If so, then the company will be required to prepare a valuation of the property, either for inclusion in its statement of financial position or for disclosure, depending on its accounting policy choice.

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Food for thought – Are there special rules for accounting for right-of-use investment property?

No. A right-of-use asset classified as investment property is measured:

  • on initial recognition: under IFRS 16 – i.e. at the present value of the future lease payments, adjusted for any lease payments made on or before lease commencement (e.g. initial direct costs); and
  • on subsequent measurement: under IAS 40 – i.e. under either the cost model or the fair value model, consistent with the landlord’s accounting policy for other investment property (subject to very limited exceptions when fair value cannot be measured reliably).

After initial recognition, the general IAS 40 guidance on transfers and redevelopment, for example, applies equally to owned and leased investment property.

Food for thought – How does a landlord apply the fair value model to a right-of-use asset?

A landlord that applies the fair value model for investment property applies that model to owned and leased Leased investment propertyinvestment property. In the case of leased investment property, the landlord measures the fair value of its right to use the underlying asset, not the underlying asset itself.

When measuring the fair value of leased investment property, a company needs to consider rental income from current leases. In addition, care is needed to ensure that the landlord’s obligation to make payments to the head lessor (owner) of the underlying asset is neither ignored nor double-counted when valuing and presenting investment property in the statement of financial position.

One common approach is to obtain a valuation of the landlord’s leasehold interest in the underlying asset – that is, the amount that a market participant would pay to:

  • acquire the right to receive rental income over the remaining term of the landlord’s leasehold interest, including rental income under current leases and expected rental income under future new leases that a market participant would expect to enter into subsequently; and
  • assume the obligation to pay rentals to the head lessor (owner) of the underlying asset.

Taking a very simple example, suppose the landlord has obtained a valuation of its leasehold interest of 50 and has calculated that its lease liability measured under IFRS 16 is 25. In this case, the landlord would present in its statement of financial position:

  • a right-of-use asset, presented as investment property and measured at 75 (50 + 25); and
  • a lease liability, presented with other lease liabilities and measured at 25 under IFRS 16.
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Leased investment property

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