IAS 16 / IAS 40 Diploma IFRS Exam Question (Dec 2018)
•You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with (IFRS Standards). The financial statements for the year ended 30 September 2018 are due to be published shortly. A trainee accountant who is assigned to your department is reviewing the financial statements as part of a training exercise. She has prepared a list of queries arising out of this review.
•When I look at the statement of financial position, one of the categories of non-current assets is ‘investment properties’ and another category is ‘property, plant and equipment’ – in which all other properties are included. Surely we invest in all our properties, so why have two categories for them in the statement of financial position? How do we decide what goes where?
•A note to the financial statements states that investment properties are measured at their fair values and not depreciated. Don’t all non-current assets have to be depreciated over their estimated useful lives? Another note states that property included in property, plant and equipment is measured at cost less accumulated depreciation rather than at fair value. Shouldn’t all properties be measured in the financial statements on a consistent basis?
•Finally, I can’t immediately see from the financial statements where the gains or losses relating to the measurement of investment properties are included. The profit statement seems to include two main components – profit or loss and other comprehensive income. Where would the gains or losses go? Presumably the treatment of gains and losses is the same for any non-current assets which are measured at fair value? (10 marks)
Proposed Solution:
IFRS require distinction between property that are covered under Property, Plant and Equipment and Investment Properties and these are accounted for and presented separately.
Property, Plant and Equipment include those assets which are Non-Current, Tangible and are used for business purposes (including production or administrative purposes). Examples would include a factory building, vehicles etc.
Investment Properties include Land or Building which are held for earning rentals, capital appreciation or both.
An entity has a choice to use cost or fair value (revaluation) model for each class of assets under Property, Plant and Equipment. Similarly, Investment properties can be either measured using cost or fair value method. Choice of one method for Properties under Property, Plant and Equipment does not impact the valuation method used for Investment Properties. This would imply that Properties under Property, Plant and Equipment may be measured using Cost model, and Properties under Investment Property may be measured using fair value method. Also, the IFRS require that no depreciation is permitted to be charged on investment properties if these are measured at fair value.
Any gains or losses on changes in fair value of investment properties are recognised through Profit or Loss rather than Other Comprehensive Income. The Other Comprehensive Income option is only applicable for assets accounted for under revaluation method for Property, Plant and Equipment .
Another Proposed Solution:
As per IAS 16, Property, plant and equipment are tangible assets that are
- held for use in the production or supply of goods and services or for administrative purposes; and
- expected to be used for more than one period.
Property plant and equipment can be measured at any of below 2 models:
a) Revaluation model- Fair value less subsequent accumulated depreciation less subsequent impairment loss
b) The cost model- Cost less accumulated depreciation less impairment loss.
Revaluation model is applied for entire class of assets which it belongs.
As per IAS 40, Investment properties are property (land, building, part or both) that are held to earn rental income or for capital appreciation or both.
Entity need to choose anyone from below 2 options to measure Investment properties subsequently:
a) The fair value model
b) The cost model.
This election is applied to all of its investment property.
Gain or losses on subsequent measurement of Investment properties are directly recorded in Profit & Losses in the period in which gain or loss arises.