IAS 40 – Investment Property
What is investment property and how is it distinguished from owner-occupied property?
Investment property is real estate held to earn rental income and/or for capital appreciation. What distinguishes investment property from other property held by the reporting entity (owner-occupied property) is that investment property generates cash flows that are, to a large extent, independent of the other assets held by the reporting entity. The accounting treatment of investment property is one of the rare cases in which certain industry characteristics justified a different accounting approach for similar types of assets for all reporting entities. In other words, the principles established in IAS 40 regarding investment property apply not only to companies whose primary business is the leasing of income-producing properties, but to all reporting entities that hold real estate to earn rental income and/or for capital appreciation.
What is the measurement concept underlying IAS 40?
IAS 40 sets out the accounting treatment of investment property and the related disclosure requirements. The Standard’s concept is that, given the nature of investment property, the fair value model is the most relevant measurement basis. Under the fair value model, investment property is measured at fair value, with changes in fair value recognised in profit or loss. Based on this approach, measuring investment property using the cost model over long periods provides information that is less relevant to users of financial statements. However, mainly for pragmatic reasons, the Standard allows the use of the cost model due to companies’ familiarity with it. Under the Standard, all entities must determine the fair value of investment property, whether for measurement purposes (if the fair value model is chosen) or for disclosure purposes (if the cost model is chosen).
Why does IAS 40 justify fair value measurement for investment property?
The rationale for measuring investment property at fair value is based on the fact that such property is passive in nature, generating cash flows that are largely independent of other assets held by the reporting entity. In this context, the cash flows generated by a building for rental to others with long-term lease agreements can be compared to the cash flows from bonds. This rationale differs from the accounting treatment of property, plant and equipment measured at fair value under the revaluation model. Property, plant and equipment are not passive assets since they generate cash flows typically dependent on other assets held by the reporting entity, e.g., raw material inventory and a registered trademark. For example, assume a family owns two identical apartments. One is used for living, and the other is held as a long-term investment. If the fair value of both apartments rises significantly, the family perceives a “gain” with respect to the apartment held for investment, since that is its intended purpose. By contrast, no “gain” is felt with respect to the capital appreciation of home, as the family needs this apartment to live in.
Which measurement model is most commonly applied in practice?
In practice, most companies choose to apply the fair value model, partly because the common analysis and comparison method in the industry is based on net asset value (NAV). For example, in a survey conducted by EY and published in December 2024, it was found that more than 90% of the companies in the survey (over 50 real estate companies across the globe) measured their investment property portfolios using the fair value model.
How does IAS 40 differ conceptually from IAS 16?
The Standard represents a significant conceptual shift as the first accounting standard to permit the use of the fair value model for the accounting treatment of non-financial assets. Under this option, the asset is not depreciated on a systematic basis, and all changes in fair value during the period are recognised in profit or loss. As a result, adopting the fair value model leads to a situation where the statement of comprehensive income includes a mix of realised gains and losses (e.g., rental income and maintenance expenses) and unrealised gains and losses (changes in fair value). This contrasts with the revaluation model under IAS 16 Property, Plant and Equipment, where revaluation increases and reversals are recognised in other comprehensive income and accumulated in a separate component of equity (revaluation surplus). Furthermore, given the different nature of investment property compared to the entity’s property, plant and equipment, IAS 40 requires that investment property be presented separately on the statement of financial position — even when the cost model is applied.
How does IAS 40 treat investment property under construction or development?
The provisions of the Standard also apply to investment property under construction or development for future use as investment property. Accordingly, if the reporting entity measures investment property using the fair value model, it must measure investment property under construction or development at fair value, provided fair value can be reliably measured. Measuring investment property under construction at fair value raises many practical challenges. One key issue is how to determine the fair value of assets under construction when the percentage of completion is relatively low and only a few lease contracts have been signed. In such cases, uncertainty is relatively high, raising the question of whether the fair value of investment property can be reliably measured
Which standard governs the measurement of fair value for investment property?
For measuring the fair value of investment property, entities must apply IFRS 13 Fair Value Measurement, which defines “fair value” and provides principles, valuation techniques, and a hierarchy for determining fair value whenever another IFRS requires or permits measurement of an asset or liability at fair value.
What additional industry disclosures are commonly provided alongside IAS 40?
Many companies in Europe present extensive information in their financial statements based on the recommendations of the European Public Real Estate Association (EPRA). This information includes a general framework for financial reporting and disclosures, various principles for valuation, table analysing and comparing company performance over different periods, and different methods for calculating NAV and reported results based on assumptions that may be more relevant to investors than their presentation in the financial statements.