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Real estate IFRS accounting update

Howard Freedman
Head of Property and Construction

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With the recent transition to International Financial Reporting Standards as adopted by the European Union (IFRS) for AIM groups and the continued publication of new and revised accounting standards, there is a lot of information for finance teams to keep track of.

In this briefing, we have focused our attention on selected accounting issues under IFRS for the real estate sector.

  • Disclosure of significant accounting judgements and estimation uncertainties

    IAS 1 Presentation of Financial Statements requires disclosure of significant accounting policy judgements and key sources of estimation uncertainty.

    For the real estate sector, areas of significant accounting policy judgements and key sources of estimation uncertainty could include areas such as:
    • Adoption of cost or fair value measurement for investment properties
    • Treatment of borrowing costs - currently, the costs can either be expensed or capitalised where they relate to a qualifying asset (this ill change in 2009)
    • Classification of properties as property, plant and equipment, investment property or inventory
    • Determination of the fair value of an investment property where no active market exists
    • Determination of the net realisable value for properties held as inventory
    • Provisions for onerous leases and dilapidations can require significant estimation
    • Classification of leases as finance leases and measurement of finance lease creditors

  • Is it a business combination or an asset acquisition?

    In the real estate sector property transactions can be undertaken through Special Purpose Vehicles (SPVs).

    These transactions may or may not fall within the scope of IFRS 3 Business Combinations as the SPVs may fail to meet the definition of a ‘business’ in the standard.
    • Acquisitions of SPVs that do not meet the definition of a business combination are usually accounted for on consolidation as asset purchases with the price paid being recorded as the cost of the properties and other assets acquired.
    • Acquisitions of SPVs that meet the definition of a business combination are accounted under the purchase method in accordance with IFRS 3. This may result in the recognition of positive or negative goodwill, fair value adjustments and accounting policy adjustments.

  • A change of use of properties – the accounting impact

    On 29 November 2007, the Financial Reporting Review Panel (“FRRP”) completed their review of the 2006 accounts for Grainger Trust plc. The Panel was concerned about the reclassification of trading properties to investment properties.

    IAS 40 Investment Property limits the circumstances in which transfers to, or from, investment property can be made to those circumstances, specified in the standard, that provide evidence of a change in use. As a result of discussion with the Panel, the directors agreed that the transfer did not comply with the requirements of IAS 40 as it did not provide evidence of the required change in use.

    On initial recognition, a property may be recognised as property, plant and equipment, investment property or inventory. As the categorisation of the asset determines the measurement of the asset, the change in use can result in a change in the measurement of the property’s value and potentially the recognition of a gain or loss.

    IAS 40 Investment Property provides specific guidance on the transfer of properties in and out of investment properties and what evidence of the change in use is required. The recognition of the change in value is different depending on the categorisation of the asset before and after the change in use.

  • Capitalisation of Borrowing Costs in 2009

    The amendment to IAS 23 Borrowing Costs (issued in March 2007) removes the benchmark treatment of expensing all borrowing costs. Entities are now required to capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. All other borrowing costs must be expensed. The amendment also specifically scopes out borrowing costs directly attributable to a qualifying asset measured at fair value and inventories that are manufactured or produced in large quantities on a repetitive basis.

    Under the transitional provisions of the amendment, where the application of the amendment results in a change in accounting policy (i.e. for an entity which had previously expensed all borrowings) the amendment should only be applied to borrowing costs relating to qualifying assets for which the commencement date of capitalisation is on or after 1 January 2009. However, an entity can choose to designate a date prior to 1 January 2009 and apply the revised standard to borrowing costs relating to all qualifying assets for which the commencement date of capitalisation is on or after the designated date.

    The amendment has not yet been endorsed for application in the EU.