ias 40 practical examples

Today we will talk about investment properties and carry out a series of practical examples where we will refer to IAS 40, IAS 16, and IFRS 16.

An investment property is a 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 capital appreciation or both and not for:

Its use is in the production or supply of goods or services, administrative purposes, or sale in the ordinary course of operations.

Practical example 1 IAS 40: Investment properties to obtain income:

In January of year 1, an entity gives the right to use a building to independent third parties under in 15-year operating lease with annual payments of $2,000:

The example mentioned above meets the definition of investment property because the entity uses the asset to obtain income, not for its use or the production of goods or services.

Otherwise, we would be talking about property, plants, and equipment.

It is essential to clarify that if the type of lease were not operating but financial, it would not be an investment property; it would be an account receivable.

Let us remember that IFRS 16 practically does not present changes from the point of view of the lessor.

Practical example 2 IAS 40: Investment properties to obtain capital gains.

In January of year 1, an entity acquires land worth 30,000.

The entity expects that in the next 6 years, the market for the purchase and sale of this type of asset will be on the rise.

For this reason, the company expects the asset to appreciate in the long term and thus obtain a profit.

An investment property is also an asset held for capital gains.

At this point, two elements in the analysis must be kept in mind.

However, if an entity holds properties for sale in the short term in the ordinary course of business and thus obtains a profit, we would not be talking about an investment property but the sale of inventory.

Practical example 3 IAS 40: Investment properties with undetermined future use.

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An entity in January of year 1 acquires land.

The entity is uncertain whether it will use the asset to build a luxury housing project or whether it will use the asset to generate capital gains.

The decision will be made at the end of year 2, considering the demand for housing of this type.

Paragraph 7 of IAS 40 establishes that if an entity has land with undetermined future use, it must recognize it as an investment property.

Determining whether land does have an undetermined future use is a task that the entity’s management must carry out according to its judgment.

In this way, if the entity subsequently decides that the asset is connected to housing construction, it must reclassify this asset to an inventory account.

Practical example 4 IAS 40: Investment properties between a parent and its subsidiary.

An entity (parent) owns a building that it leases to its subsidiary under an operating lease in exchange for annual payments of 2,000.

The subsidiary uses the building to sell inventory.

Paragraph 15 of IAS 40 establishes, 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 owner-occupied from the group’s perspective.

However, from the perspective of the entity that owns it, the property is investment property if it meets the definition in paragraph 5 of ias 40

Therefore, the lessor treats the property as investment property in its individual financial statements.

Thus, the building is not classified as an investment property item in the parent company’s consolidated financial statements.

Such financial statements present the controlling entity and its subsidiary as a single entity.

Then, the consolidated entity uses the building for the supply of goods.

Therefore, the consolidated group accounts for the building as an item of property, plant, and equipment.

On the other hand, in the parent’s separate financial statements, the building is classified as an investment property.

In other words, it is a property held for rental purposes.

Practical example 5 IAS 40: Investment properties according to IFRS 16.

In January of the year, entity A acquires a building for 30,000.

This entity gives the right to use this asset to entity B for 20 years.

Entity B sub-leases this asset to Entity C for eight years.

In this example, entity B must recognize a right-of-use asset as a consequence for the building leased from entity A.

The entity cannot recognize an investment property because this entity does not control the asset, but rather the right to use it.

However, this right-of-use asset behaves like an investment property because its use is focused on generating income.

This is why the definition of investment property of paragraph 5 of IAS 40, the standard refers to a right-of-use asset.

Practical example 6 IAS 40: Investment properties according to IAS 16

In January of year 1, an entity acquires a building to earn rentals under operating leases.

However, the entity uses the cost model for the subsequent measurement of this asset and uses IAS 16 instead of IAS 40.

Remember that IAS 40 establishes that an entity can choose between two models for the subsequent measurement of an investment property.

The cost model and the fair value model.

IAS 40 states that an entity must always choose to measure investment property at fair value.

Suppose an entity considers that the fair value is unavailable, or it is impossible to make a reliable measurement of this value.

In that case, it must use the cost model of IAS 16.

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