Karlstads universitet 651 88 Karlstad

Tfn 054-700 10 00 Fax 054-700 14 60 Information@kau.se www.kau.se

Karlstads Business School, department of Economy

Nicole Dang

IAS 40

Investment Property

The amendment of IAS 40

International Financial Accounting D-level thesis

Date/Term: 09-10-26

Supervisor: Bernt Andersson

Examiner: Bernt Andersson

Abstract

Since IAS 40 Investment Property applies for all listed companies in EU year 2003 and the

fair value valuation became available there have been discussions after the implementation.

Now in year 2009, the latest discussion and amendment in the standard has gone through. The

amendment in IAS 40 was concerning investment property under construction. IASB

approved that IAS 40 Investment Property also will applies to investment property under

construction, if their aim is to become investment properties in the future. At first, properties

under initial development were excluded from IAS 40 and were treated as fixed assets carried

at cost. Entities could therefore not calculate gains of building projects until they were

completed (Marshall 2004). Wessels (2008) states “the new standard takes out calculated

guesses on the value of the development and reflects what is happening in the actual market”.

New Zeeland had a discussion about the supplementary costs for New Zeeland entities which

comes with the new amendment, were an independent part is required for review when

valuation is made (Chartered Accountants Journal 2008). Valuation of constructions is

according to me a more difficult process than to valuate a completed property since there are

higher risks and more uncertainties within the construction. Because of this I think it is

necessary to be more concrete and specific about the valuation process of investment property

under construction. In general I think the upcoming problems within the amendment are all

about lack of guidance in IAS 40. Overall I think the forthcoming problems within the

amendment are all about lack of guidance in IAS 40. However I do think this is an

improvement, but an unfinished improvement which requires more development and needs to

be more worked on.

Table of contents

1. METHOD .................................................................................................................................................. 1

2. THEORETICAL FRAMEWORK ..................................................................................................................... 2

2.1 INTRODUCTION .................................................................................................................................................. 2

2.2 INTERNATIONAL ACCOUNTING STANDARDS BOARD .................................................................................................. 2

2.3 IAS 40 INVESTMENT PROPERTY ............................................................................................................................ 3

2.5 OPINIONS ABOUT THE AMENDMENT OF IAS 40 ....................................................................................................... 5

3. DISCUSSIONS AND CONCLUSIONS ............................................................................................................ 7

4. BIBLIOGRAPHY ......................................................................................................................................... 9

Page 1

1. Method

In order to understand more about the new change within IAS 40 Investment Property, I have

chosen to first describe the authority which issues the standard, International Accounting

Standards Board (IASB). It is important to understand the structure of IASB and how they

proceeding when develop and improving their framework, since this would clarify the

question why they approved the amendment in IAS 40. Further on a definition of IAS 40 and

the valuation methods in IAS 40 are also explained, which I think is needed in order to

understand the amendment of IAS 40 and the following dilemmas which are discussed in the

paper. To obtain a more complete picture of the standard I have also chosen to describe how

the amendment of IAS 40 was proposed to IASB and was first dismissed. I think it is

necessary in turn to get a critical view and to understand why it is still disagreements about

this improvement in IAS 40. There have been difficulties in finding scientific articles and

research material on this area since IASB recently approved this amendment. For that reason I

wanted to include opinions about the amendment from a diversity of users. Their opinions are

important since they practice this standard at a daily basis and thus could encounter and

identify problems. As mentioned, this amendment of IAS 40 is still fresh and there is not

much written about the outcome, because of this I obtained the most information from

trustworthy homepages, published articles from auditing firms, exposure drafts from

authorities which deal with investment property, lesson notes from Bo Nordlund´s lecture

about real estate and some scientific articles.

With this as basis, I am presenting a discussion containing my areas of interest and focus

points for this paper, from my own perspective. Conclusions and suggestions for

improvements will be presented in the final part of my writings.

Page 2

2. Theoretical framework

2.1 Introduction The original version of IAS 40 Investment Property was first available in year 2000. EU later

implemented the standard and it then applied for all listed companies within member

countries. Fair value accounting was then offered as measurement basis for investment

properties. The first major change in IAS 40 came when IASB approved leaseholds to be

accounted as investment properties. Now in year 2009, the latest discussion and amendment

in the standard has gone through. The amendment in IAS 40 was concerning investment

property under construction. Investment property under construction which before was in the

scope of IAS 16, will now be accounted as for investment property and fall within IAS 40.The

EU has yet so far not implemented the amendment of IAS 40. Since this is a recent change in

the standard, there are so far no studies about how this amendment would effect valuation of

property under constructions.

2.2 International Accounting Standards Board International Accounting Standards Board (IASB) are the issuer of the International Financial

Reporting Standards (IFRS), which is applicable to general financial statements of all

commercial, industrial or business reporting entities whether it is private or public.1 EU

implemented IFRS in 2002 and all listed companies in member countries must therefore use

the IFRS in their annual consolidated financial statement (Tew 2003).

The IASB is an independent standard setting body and is overseen by the Trustees of the

International Accounting Standard Committee (IASC) (IASB 1 2009). IASB describes their

objective as “…to develop a single set of high quality, understandable and enforceable

accounting standards to help participants in the world’s capital markets and other users

make economic decisions” (IASB 3 2009). The purpose of IASB is also to provide users and

investors with relevant information that could be useful in their decision making when facing

financial issues2.

The Trustees are experts and have longtime experiences within different economic areas and

are selected for a three-year period in order to act for the best of public interest (IASB 2

2009). The Trustees reviews and support IASB in their work and also oversees the use of

IFRS. The Trustees are involved in the consultation process, the developing process of IFRS,

where they improve amendments after discussions with organizations around the world and

interested individuals. The consultation process is divided in several stages and the Trustees

are responsible for steering the process to the final stage, meaning publish the amendment

after approval3. While the Trustees working with improvements within the IFRS framework,

the International Financial Reporting Interpretations Committee (IFRIC) acts as reviewer of

the IFRS. They are chosen by the Trustees for reviewing arising issues within the IFRSs and

also for develop interpretations of the standard (IASB 4 2009).

1 Dominic Ranches. Lecture; Introduction to IFRS 090915.

2 Bo Nordlund. Lecture; Valuation and Accounting property 091009.

3 Gunnar Rimmel. Lecture; Current International developments 090929.

Page 3

2.3 IAS 40 Investment property

Definition IAS 40 paragraph 5 defines an investment property as “… (land or a building—or part of a

building—or both) held (by the owner or by the lessee under a finance lease) to earn rentals

or for capital appreciation or both, rather than for; use in the production or supply of goods

or services or for administrative purposes; or sale in the ordinary course of business.”

In other words, an investment property is not aimed for business purposes or sale. The

purpose of an investment property is to generate rental income or capital appreciation or

a combination of these. Further on in IAS 40 paragraph 10, states that if a part of the

investment property is used for business purposes, that part shall be accounted separately, but

this is only due to if it can be sold separately. If the portions cannot be sold separately, the

property can only be classified as investment property, if the portions which are aimed for

business purposes are insignificant (Sundgren et al. 2007).

Valuation methods, Fair value and Cost-model At the Swedish implementation of IAS 40, IASB permits users to retain value accounting

under cost-method or adopt fair value (IAS 40:30 2009). If fair value method is chosen, it is

not possible to revert to the cost-model method (IAS 40:31 2009). However, the same method

is required for all investment properties, but with the exemption in IAS 40:53 which implies

that "reliable market valuation can be made" (Sundgren et al.2007).

The cost-model uses the historical cost with a reduction of accumulated depreciation, when

calculating values of investment properties. If relevant, the impairment losses of the property will

also be considered in the calculation (Nordlund 2 2008). Fair value is described in IAS 40

paragraph 5 as “…the amount for which an asset could be exchanged between knowledgeable,

willing parties in an arm’s length transaction”4. Fair value method obliges entities to carry

the fair value of their investment properties and present it within the Balance sheet.

Adjustments of the fair value shall be reported in the income statement and there will be no depreciation on the properties (Nordlund 2 2008). The change in fair value of investment

properties will be included in the entities’ operating profit thus affecting the income statement

more than valuation at cost, but in return it will provide a greater relevance in the balance

sheet (Sundgren et al. 2007). A recent study made by Stella So and Malcolm Smith

demonstrates that fair value method is highly preferred, though the free choice between the

two methods (So & Smith 2009). Pursuant to Laux & Leuz (2009), cost accounting may not

be the most appropriate measurement in situations where the value only can be decided by an

operating market. In such circumstances the operating market would be volatile and thus cost

accounting would not reflect the current fundamental value of the object (Laux & Leuz 2009).

Further on Muller et al. (2008) also implies that entities which chose to not provide fair value

accounting are facing higher information asymmetry. Trussel & Rose (2009) have a another

perspective and indicates that those who support cost accounting thinks fair value accounting

as less reliable, since it could lead to short term fluctuations and extreme volatility in the

balance sheet.

4 Dominic Ranches. Lecture; Introduction to IFRS 090915.

Page 4

2.4 Amendment of IAS 40

The proposal of adjustment of IAS 40 was discussed in 2007 and by May 2008 the IASB

approved the new change in IAS 40 (IVSC 2 2009). The issue from the beginning was if

investment property under construction should be included in IAS 40 Investment Property

instead of under the rules of IAS 16 Property, Plant and Equipment (IASB 2006).

At first, properties under initial development were excluded from IAS 40 and were treated as

fixed assets carried at cost. Entities could therefore not calculate gains of building projects

until they were completed (Marshall 2004). IFRIC proposed to IASB in 2006 and reflected

about the inconsistency within the IAS 40, where investment property redevelopment is

included but investment property under construction is excluded and instead fall in the scope

of IAS 16. They appointed the major similarities between the two categories, and also thought

the two should be valued within the same standard (IASB 2006). IFRIC also though fair value

accounting has become more pervasive and the valuation techniques more “robust”, therefore

should investment property under construction belong within the scope of IAS 40 (IASB

2006). IFRIC also reflected that there was an increasing experience regarding the use of fair

value as measurement basis among entities. Because of this, it would let entities to be more

able of measure the fair value of investment property under construction with reliability

(IASB 2006). This proposal was first dismissed by IASB, since they thought there may be no

existing market for investment property under construction thus making fair value valuation

complicated. Secondly the IASB also feared about the uncertainty costs which occur to

complete investment property under construction and also about the future income it will

generate (IASB 2006). However, IASB did agree upon the fact that fair value accounting is

the most reliable measurement when it comes to property valuation (IASB 2006).

IFRIC appointed about the retain cost-model method in existing IAS 40, which is available

for countries with less develop property markets. After discussions with organizations and

other authorities which mainly are in agreement with IFRIC, IASB approved that investment

property under construction will in the future also be in the scope of IAS 40 Investment

Property (Deloitte 2009).

The amendment of IAS 40 applies to all investment properties under construction on the 1st of

January 2009 or after, meaning all investment properties under construction of this date or

after will be measured at fair value (IVSC 2 2009). This is only due to if the purpose of the

property under construction is to become an investment property in the future (Nordlund

2008). There is though an exemption within the standard that allows entities to apply the

amendment of IAS 40 to investment property under construction before the 1st January 2009,

but this is only if there are a possibility of determining the fair value of the property

construction before the issue date of the amendment (Ernst & Young 1 2009). The

amendment of IAS 40 allows entities to choose between the fair value methods or the cost-

model method, this selection applies to all investment properties within the entity. Meaning it

is not admissible to use fair value method for investment property, but exercise cost-model for

investment property under construction (PricewaterhouseCoopers 2009). If the cost-model is

chosen as a measurement for investment property under construction instead of fair value

method, an estimation of fair value is still required to be presented in a note within the

balance sheet (IVSC 2 2009).

Page 5

There are situations where an entity has chosen to practice the fair value method as a

measurement basis, but afterwards not be able to determine the fair value of its properties

under construction. In such cases, IAS 40 allows those properties under construction to be

calculating at cost until the fair value could be reliable determined or when the construction is

completed (IAS 40:53 2009). This exemption is only accepted when there is lack of

comparable market transactions and reliable alternatives for estimation of the fair value are

not available (IAS 40:53 2009). It is assumed by IASB that the fair value becomes reliable

determined when the property construction is completed and therefore are entities obliged to

change back to the fair value method when this occurs (IAS 40:53A 2009).

2.5 Opinions about the amendment of IAS 40 According to Wessels (2008) was the old way of calculating investment property under

construction not the best or accurate method to present truth value. She states “the new

standard takes out calculated guesses on the value of the development and reflects what is

happening in the actual market”. This means that entities not only have to calculate

construction cost but also have to estimate the asset value depending on what it would be sold

in the market (Wessels 2008). In 2008 New Zeeland had a discussion about the amendment in

IAS 40. The concerning was about supplementary costs for New Zeeland entities which

comes with the new amendment, were an independent part is required for review when

valuation is made (Chartered Accountants Journal 2008).Valuate an investment property in

accordance to the fair value method is already tricky enough and it would be a more

problematic situation if this applies to a property under construction (Chartered Accountants

Journal 2008). According to the standard, an independent part is not required when

determining the fair value of properties, but they are encouraged to do so (IAS 40:32 2009).

Wessels (2008) also mentioned that this change could affect entities either in a positive or

negative way, depending on the property market. It would be positive for entities if there is a

rising property market and thus reflecting higher values of the asset in the books than the

construction costs. On the other hand it would be negative for entities if there is high inflation

or a declining property market. Since it would lead to low property market values and

therefore could construction costs exceeds fair values of properties being built.

According to Ernst & Young (1 2009) there will be some difficulties in finding comparable

properties under construction thus estimation models will be required for valuation. So far

there is no specific valuation guidance in IAS 40 about investment property under

construction and thus making the valuation process more complicated for users (Ernst &

Young 1 2009). In another perspective Ernst & Young (2 2009) thinks this new amendment of

IAS 40 is an overall improvement since measure investment property under construction at

fair value will also give investors further information about the profit potential.

PricewaterhouseCoopers (2009) reflects that the old version of IAS 40 included major

investment property reconstruction thus excluding investment property under construction,

which results an inconsistency within the standard. This dilemma was also agreed by Ernst &

Young, which appointed that this new amendment would improve the consistency of IAS 40

(Ernst & Young 2 2009). Ernst & Young (1 2009) suggests entities to present value of the

investment property under construction as a part of total investment property in the Balance

sheet. If entities have both investment properties under construction and completed

investment properties, it is best to present these two categories separately (Ernst & Young 1

Page 6

2009). To be more precise and provide external parties a more accurate view, notes and also

further assumptions and accounting estimations for both categories could be added within the

Balance sheet (Ernst & Young 1 2009).

Page 7

3. Discussions and conclusions

In the past few years there have been discussions about the valuation issues within IAS 40,

whether if fair value accounting is more appropriate as measurement basis for investment

property than cost accounting. There are still disagreements among users and authorities upon

this matter. However, the use of fair value seems to be more accepted than before and

according to IFRIC there are increasing experiences among entities regarding the use of fair

value. This was one of the reasons of why IAS 40 now also applies to property under

constructions. I do think this was positive change within the standard and also an

improvement. First of all I do not understand why property constructions were first excluded

from the standard while property rebuilding was not. I do not see any differences between a

property construction and a property rebuilding. A major rebuilding of the property could

mean tearing the entire property down to bare ground and starts to build up again, even

though there is no property left to be “rebuilt”. In such situations I think it is more likely to

define the property as under construction rather than as a property rebuilding. However the

definition line between those two terms was very subtle and thus I agree with PWC and Ernst

& Young that this amendment would reduce the previous inconsistency within the standard.

According to Wessels (2008), is fair value accounting able to show the “real” value of the

property construction, since it would reflect the value of the construction project due to the

existing market. As I know the property market is in many ways similar to the stock market, it

all depends on the willingness of what others would pay for the stock or the asset within the

existing market. Because of this I think practice fair value accounting on investment property

under constructions would lead to a more truthful picture of the property and it would also be

beneficial to investors as they can later easier estimate or determine the fair value of the

completed property.

Although this change is welcomed by me and most users, I still find some weakness within

the amendment. First of all, I think the market for property under construction is in general

very poor. As Ernst & Young mentioned about difficulties in finding comparable properties

under construction thus estimation models will be required in order to find fair value of the

construction. I agreed with Ernst & Young, that it should be a specific guidance in this area or

otherwise it could cause confusions among users. I think the lack of specific guidance in the

standard could result a huge range of diversity when it comes to valuation of investment

property under construction among entities. The management of entities would use different

calculation methods to estimate the value of their construction projects. I therefore think the

use of different estimation models would lead to a biased fair value accounting since it no

longer is about the fair value, but about the value which is found depending on what kind of

estimation model has been used.

In general I think the valuation process of a property construction is a more complicate and

difficult process than the valuation process of a completed property, since there are higher

risks and more uncertainties within the construction itself. There could be unpredicted

changes in the economic environment which could lead to unexpected costs. For example,

unexpected rectification costs because of damages on the construction, or price changes of

construction materials. There is also a chance of a construction risk, meaning additional work

Page 8

is required in order to complete the property. Because of this I think it is necessary to be more

concrete and specific about the valuation process of investment property under construction. I

also think those typical problems mentioned above should be described in the standard and

guidelines of resolving those problems should also be included.

I think the implementation of this standard will be succeed if there were more restricted

guidelines which in some way forcing users to use the standard in a similar way and not give

them too much options. I believe too much options could sometimes lead to own

interpretations and also to misunderstandings. This were I think an independent part should be

drawn in. Even though there are no requirements within the standard for an independent part

to be involved in the valuation process, I believe it is needed as long as the standard offers a

wide range of options.

Overall I think the forthcoming problems within the amendment are all about lack of guidance

in IAS 40. However I do think this is an improvement, but an unfinished improvement which

requires more development and needs to be more worked on.

Page 9

4. Bibliography

Deloitte (2009). Förbättringar till International Financial Reporting Standards. Annual

improvements project. [Online]. Available:

http://news.deloitte.se/ifrs_news/IFRSnov2008.pdf [2009-10-6]

Ernst & Young 1 (2009). Accounting for investment property under construction: a practical

guide. [Online]. Available:

http://www.ey.com/Publication/vwLUAssets/Accounting_for_investment_property_under_co

nstruction_-_June_09/$FILE/IPUC%20guidance%20secured.pdF [2009-10-10]

Ernst & Young 2 (2009). Caution: fair value in progress. Accounting for investment property

under construction. [Online]. Available:

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S_Fair_values_under_construction.pdf [2009-10-10]

FRSB (2008). FRSB developments. Chartered Accountants Journal, 87 (4), pp. 47-48.

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by IASB and effective by 1st January 2009.

IASB 1 (2009). About IASB. [Online]. Available:

http://www.iasb.org/About+Us/About+the+IASB/About+the+IASB.htm [2009-10-01]

IASB 2 (2009). About the Trustees of the IASC Foundation. [Online]. Available:

http://www.iasb.org/About+Us/About+the+Trustees/About+the+Trustees.htm [2009-10-01]

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Page 10

IVSC 2 (2009). Published paper: The Valuation of Investment Property under construction

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[2009-10-12]

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