Accounting standard study group CIMA Sri Lanka division Study of SLAS 40: Investment property Objective Prescribe the accounting treatment for investment property and related disclosure requirements. Scope Recognition of investment property Measurement of investment property Disclosure of investment property Key definitions Investment property: Land or building that is held (by the owner or by the lessee under a finance lease) with the intention of earning a rent or a generating capital gain. Therefore, a distinguishing feature is that it generates cash flows that are largely independent of other assets. Examples of property that do not qualify as investment property: Owner occupied property. Property held for sale in the ordinary course of business or in the process of construction or development for such sale. Property being constructed or developed on behalf of a third party. Property that is being constructed or developed for future use as investment property. Owner occupied property: Property that is held for use in the production or supply of goods or services, or for administrative purposes. Finance lease: A lease that transfers almost all the risks and rewards related to ownership of the asset to lessee, where the ownership of the asset may or may not be transferred at the end of the lease period.

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property

Fair value: The amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. Cost: The amount of cash or cash equivalent paid or the fair value of other considerations given to acquire an asset at the time of its acquisition or construction. Carrying amount: Amount at which an asset is recognised in the balance sheet. Recognising an asset as investment property Investment property should be recognised as an asset only when the following criteria are met; It is probable that the future economic benefits that are associated with the investment property will flow to the enterprise, and The cost of the investment property can be measured reliably. Measuring the value of investment property Initial measurement Investment property is first measured at cost. The cost of a purchased investment property includes the purchase price, and any directly attributable expenditure such as legal fees, property transfer tax etc. The cost of a selfconstructed investment property is its cost at the date when the construction or development is completed. Subsequent expenditure Subsequent expenditure relating to an investment property that has already been recognised should be added to the carrying amount of the investment property when it is probable that future economic benefits, in excess of the originally assessed standard of performance of the existing investment property, will flow to the enterprise. Any other subsequent expenditure should be recognised as an expense in the profit and loss account in the period in which it is incurred. The cost of an investment property does not increase due to start-up costs unless it is essential for the property to be brought in to working condition. Losses incurred as a result of the property been unoccupied, abnormal amounts of wasted material, labour or other resources will not increase/decrease the value of investment property. When a company acquires a building which requires renovation for the asset to start generating financial returns, the renovation costs are included in the carrying value in the financial statements. For example if a company spends additional costs after the initial recognition - to air condition an apartment complex, and it is likely that the company could increase the monthly rental of each apartment where the actual rental income would be higher as opposed to the previously predicted rental income, then the company can recognise the cost of air conditioning as part of subsequent expenditure on investment property. Measurement subsequent to initial recognition After initial recognition, an enterprise should choose either the ‘fair value model’ or the ‘cost model’ as its accounting policy and should apply that policy to all of its investment property.

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property

Cost model This method requires measurement of all of its investment property using the benchmark treatment in SLAS 18, Property, Plant and Equipment.

Carrying amount = Cost – (Accumulated depreciation + Accumulated impairment losses)

Fair value model Gains or losses arising from a change in fair value of investment property should be recognised in the profit and loss statements of the relevant period. Fair Value of investment property would usually be the market value of the property. It should reflect the actual market conditions and the circumstances as at the balance sheet date and should not reflect anything of the past nor the future. Disclosures to be made in financial statements Cost and fair value model SLAS 40 amendments to the standard in 2003 requires all organisations to determine the fair value of investment property, annual fair value can be carried out by the Board of Director’s of the organisation while the standard requires qualified, experienced and independent valuer to carry out a valuation on the property once in every three years. The criteria developed by the enterprise to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business; The methods and significant assumptions applied in determining the fair value of investment property, including a statement whether the determination of fair value was supported by market evidence or was more heavily based on other factors. The extent to which the fair value of investment property is based on a valuation by an independent valuer, and if there has been no such valuation, that fact should be disclosed. The amounts included in the income statement for rental income from investment property; direct operating expenses arising from investment property that generated rental income during the period and investment property that did not generate rental income during the period. The existence and amounts of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal. Material contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements.

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property

Fair value model In addition to the disclosure required by either cost of fair value model, an enterprise that applies the fair value model should also disclose a reconciliation of the carrying amount of investment property at the beginning and end of the period showing the following: Additions, disclosing separately those additions resulting from acquisitions and those resulting from capitalised subsequent expenditure. Additions resulting from acquisitions through business combinations. Disposals. Net gains or losses from fair value adjustments. The net exchange differences arising on the translation of the financial statements of a foreign entity Transfers to and from inventories and owner-occupied property. Other movements.

Cost model In addition to the disclosure required by either cost or fair value model, an enterprise that applies the cost model should also disclose the following; The depreciation methods used. The useful lives or the depreciation rates used. The gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period. A reconciliation of the carrying amount of investment property at the beginning and end of the period showing the following; Additions, disclosing separately those additions resulting from acquisitions and those resulting from capitalised subsequent expenditure. Additions resulting from acquisitions through business combinations. Disposals. Depreciation. The amount of impairment losses recognised, and the amount of impairment losses reversed, during the period. The net exchange differences arising on the translation of the financial statements of a foreign entity. Transfers to and from inventories and owner occupied property. Other movements. Example of application Athena PLC incurred Rs. 50 million in purchasing a prime land in the city. A further Rs. 100 million was incurred to construct an apartment complex consisting of 40 luxury apartments each identified to have cost equally.

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property

Followings costs were incurred thereafter: Elevator system to the apartment:

Rs.1 million

Legal fees on leased agreements with the occupants:

Rs.100,000

Property transfer taxes:

Rs.100,000

Interest on delayed payment of Rs.10 million to a supplier:

Rs. 30,000

Loss incurred on the purchase of faulty aluminium railings:

Rs. 50,000

Two out of 40 apartments in the complex are reserved to be allocated as the marketing and finance divisions of Athena PLC. Out of the remainder, five apartments are yet unoccupied which results in a loss of Rs. 100,000 per month, per apartment. Should this property be classified as investment property? If ‘yes’, calculate the value of the investment property that should be discloses in the financial statements of Athena PLC. Narration of cost

Values to include

Values to exclude

Reason for exclusion

Land

47,500,000

2,500,000

Occupied by Athena PLC

Construction

95,000,000

5,000,000

Occupied by Athena PLC

Elevator

1,000,000 100,000*33

Subsequent operational costs

Legal fees on lease agreement Property transfer tax

100,000

Start-up cost incurred to bring the building to working condition

Interest on delayed payment

30,000

Abnormal loss

Loss on purchase of faulty

50,000

Abnormal loss

100,000*5

Losses incurred due to non-

aluminium railings Loss on unoccupied apartments

occupancy/abnormal loss

Key points to note Exemptions SLAS 40 does not apply to the following; Natural resources that’s regenerative (e.g. forests) Non-regenerative resources (E.g. mineral rights, the exploration for and extraction of minerals, oil, natural gas). Property or rights held by a company to carry out extractions wouldn’t allow a company to recognise such property as investment property in their financial statements though it fulfils the investment property definition criteria. From a business perspective the criteria listed under SLAS 40 can be used to determine the value when carrying out discounted cash flow projections during acquisition of investment property.

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property

The fair value only reflects the knowledge and estimates of participants in the market and the factors that are relevant to the market participants in general. The value of investment property would differ among different participants in the market, and market factors like industry performance, competition, etc. would increase or decrease the valuation of investment property to different entities. However, ‘fair value’ does not reflect any of the portfolio combinations, synergies or values that are attributable to a specific organisation. When determining the fair value of investment property, organisations need to avoid double counting of assets. For example cost of elevators, air conditioners that are required for the smooth functioning of the investment property should not be double counted and disclosed as ‘Property, Plant and Equipment’ under SLAS 18. Loop holes Investigations of managerial discretion over fair value reporting reveal that managers select permissible accounting methods to report higher earnings. Disclaimer This document is compiled with the objective of presenting a basic overview of the respective Sri Lanka Accounting Standard, and does not construe professional advise in application of the Standard. For specific application and understanding of all facets of the Standard, the relevant Sri Lanka Accounting Standard issued by The Institute of Chartered Accountants of Sri Lanka should be referred. Useful web-links pertaining to Accounting Standards

http://www.icasrilanka.com/Technical/Accounting%20Standards.html http://www.iasb.org/Home.htm Compiled by the members of the Accounting Standard Study Group

Manil Jayasinghe (Chairman) Achintha Gamage Chamil Hathurusinghe Jayani Amarasinghe Kanagasabapathy Arulmoly Methmal Seneviratne Nilushika Gunasekera

Compiled on 31 July 2010

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Accounting standard study group, CIMA Sri Lanka Division Study of SLAS 40: Investment Property