Accounting for Real Estate – IFRS Basics

For real estate owners, accountants, and auditors alike, keeping track of all the nuances to the reporting requirements of the various financial reporting frameworks can be challenging. As auditors, we’re seeing entities report on the basis of U.S. GAAP, IFRS, income tax, cash, special purpose frameworks, e.g. to report on Form NYC TC-201 if you’re New York City-based, or based on the specifics of a contract like an operating or partnership agreement. We’re also seeing entities with requirements to contemporaneously report on multiple different financial reporting frameworks. More and more, due to foreign investment, we see requirements for real estate entities to report financial information in accordance with International Financial Reporting Standards (“IFRS”). We’ll cover some of the basics and things to keep in mind when reporting on IFRS for real estate entities.

When reporting under IFRS, the very first question to resolve is, does the entity own investment property, inventory property, or owner-occupied property?

International Accounting Standards “IAS” 40 Investment Property:

Investment property is defined as property (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 for capital appreciation or both, rather than for (a) use in the production or supply of goods or services or for administrative purposes; or (b) sale in the ordinary course of business.

Owner-occupied property is property held (by the owner or by the lessee as a right-of use asset) for use in the production or supply of goods or services or for administrative purposes.

The standard provides several examples of investment property, but in short, this may include a building whose space is leased under operating leases, or land held for long-term capital appreciation.

Property that does not meet the definition of investment property and is outside the scope of IAS 40 includes:

1. property intended for sale in the ordinary course of business or in the process of construction or development for such sale (see IAS 2 Inventories), for example, property acquired exclusively with a view to subsequent disposal in the near future or for development and resale.
2. owner-occupied property (see IAS 16 (Property, Plant and Equipment) and IFRS 16 (Leases)), including (among other things) property held for future use as owner-occupied property, property held for future development and subsequent use as owner-occupied property, property occupied by employees (whether or not the employees pay rent at market rates) and owner-occupied property awaiting disposal.
3. property that is leased to another entity under a finance lease.

Investment property is initially measured at cost, which includes all directly attributable costs to consummate the purchase. Thereafter, the reporting entity shall elect an accounting policy to utilize either the fair value model or cost model to measure its investment property. Under the fair value model, gains and losses arising from fair value adjustments are recognized in profit or loss at each reporting period. An entity that chooses the cost model shall measure investment property:

1. in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations if it meets the criteria to be classified as held for sale (or is included in a disposal group that is classified as held for sale);
2. in accordance with IFRS 16 if it is held by a lessee as a right-of-use asset and is not held for sale in accordance with IFRS 5; and
3. in accordance with the requirements in IAS 16 for the cost model in all other cases.

Unlike U.S. GAAP, IFRS does not require the favorable or unfavorable elements of acquired operating leases to be recognized separately as IAS 40 requires that the investment property take into account the rental income derived from current leases in order to measure the fair value of investment property.

An important item to note: Entities that elect the cost model are still required to disclose the fair value of investment property in the financial statements. Therefore, entities that elect the cost model will likely not benefit from any cost saving of any third-party valuations.

When a change in use occurs, the entity shall transfer property to or from investment property when the property meets or ceases to meet the definition of investment property and there is evidence of a change in use. Consult the standard for further details.

There are numerous disclosure requirements enumerated in IAS 40 relative to both the fair value and cost models and preparers of financial statements should refer to the standard.

IAS 2 Inventories:

Real estate entities acquiring or constructing property for resale in the ordinary course of business (inventory property) shall account for such property in accordance with IAS 2. In accordance with this standard, the cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. While IAS 2 does not provide for specific direct or indirect conversion costs with respect to the production of inventory property, this would include the cost of land, construction, professional fees, insurance, real estate taxes, etc., and interest as provided for in IAS 23 Borrowing Costs.

Inventory property is measured at the lower of cost or net realizable value (“NRV”). NRV is defined as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. NRV is assessed at each reporting period and write-downs of inventory property to NRV are charged to expense during such period.

When inventory property is sold, its carrying amount is recognized as an expense in the period in which the related revenue is recognized. When evidence of an increase in NRV exists as a result of changes in economic circumstances, the extent of previous write-downs may be reversed and is recognized as a reduction of the amount of inventory expensed in the period.

IAS 2 requires the following disclosures in the financial statements, which are applicable to inventory property:

1. the accounting policies adopted in measuring inventories, including the cost formula used;
2. the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
3. the amount of inventories recognized as an expense during the period;
4. the amount of any write-down of inventories recognized as an expense in the period in accordance with paragraph 34;
5. the amount of any reversal of any write-down that is recognized as a reduction in the amount of inventories recognized as expense in the period in accordance with paragraph 34;
6. the circumstances or events that led to the reversal of a write-down of inventories in accordance with paragraph 34; and
7. the carrying amount of inventories pledged as security for liabilities.

This summary serves to answer some questions relative to real estate entities reporting in accordance with IFRS and to better guide preparers of financial statements. There are many nuances and provisions to the standards referenced herein and financial statement preparers should refer back to them for further information and detail.