Sunnie Ltd has investment property on its balance sheet which is valued in accordance with FRS 102, Section 16. By the end of December 31, 2021, the value of the property had increased by £35,000 compared to the previous year. The company has generated annual profits of around £500,000 a year for the past five years, and the company`s forecasts suggest that this level of profits will continue for the foreseeable future. If a property meets the definition of investment property, it must be accounted for under Article 16 of Article 102 of the FRS. Micro-entities opting for SRF 105 would apply SRF 105, Section 12 Tangible Capital Assets and Investment Property. Another important change is that deferred taxes on increases in the book value of investment properties will be fully provided. Previously, they were only recognized when the asset was to be sold. Summary of significant changes to the accounting for tangible capital assets and investment property. One of the most common issues concerns the classification of investment properties and when real estate should or should not be classified as such. The FRS 102 glossary contains the definition of investment properties, namely: These are some of the confusing areas of FRS 102 with regard to investment properties that seem to have caused problems for creators. In all cases, it is advisable to have a thorough understanding of the detailed aspects of FRS 102 so that accounting policies can be applied correctly and a true and fair view can be presented in the financial statements. Goods such as visual arts owned by a commercial organization for purposes other than contributing to knowledge and culture (e.g. adding value as an investment) are not treated as cultural heritage.
Real estate appraisals can be confusing for some preparers, especially since the treatment of fair value and revaluation gains and losses varies considerably depending on the classification of the property. If there is uncertainty as to whether an investment property should be treated, it is always advisable to consult the definition in the FRS 102 glossary and compare the use of the property with the definition. It would also be desirable to seek the advice of third parties to ensure that the correct treatment (and subsequent accounting treatment) is appropriate in the circumstances. FRS 102 requires deferred taxes on fair value gains and losses on investment properties and revaluation gains and losses on property, plant and equipment. Deferred taxes are determined on the basis of tax rates and laws that have been materially issued or enacted up to the balance sheet date. Another representative questioned the presentation of a „revaluation reserve” for a set of FRS 105 financial statements received from an outgoing accountant. It appears that, when the investment property was moved to FRS 105, the value of the investment property had been `frozen` at the time of the changeover to FRS 105 and that a revaluation reserve had been set up. FRS 105 does not permit the use of a previous GAAP measure as „assumed costs” (because the revalued amounts are inconsistent with the legislation), so the presentation of a revaluation reserve in an FRS 105 balance sheet is inappropriate.
Instead, FRS 105, paragraph 28.01(c) provides an optional exemption that allows, among other things, the first adopter to easily convert all revaluation gains and losses previously recognised in equity reserves against the value of the property at the time of transition. That is a fairly broad definition. Investment properties may consist of only one piece of land, or a single property, or both. In practice, if a property generates a rental income stream for the business, the property would be classified as an investment property. If land is considered for long-term capital gain, it will also be classified as an investment object. Correct classification is crucial, as it can affect subsequent accounting. At initial accounting, the property is valued at cost. Costs may include several components, including the purchase price and directly attributable costs. FRS 102, paragraph 17.10 contains a list of cost elements, which include legal fees, bad purchase taxes and site preparation costs.
One delegate questioned the scenario in which a client owns a building and leases part of that building to a third party and the resulting accounting treatment. In this example, the property would be classified as a mixed-use property. This issue is addressed in paragraph 16.4 of SRF 102. This paragraph stipulates that mixed-use real estate must be separated between investment property and tangible capital assets if the resulting shares can be sold separately or leased separately under a finance lease. Financial reporting on investment property has been substantially revised. Investment properties are now defined as assets held to generate rental income or capital appreciation. In addition, all contractual obligations entered into by the entity to acquire, develop, maintain or improve investment property, as well as the duration and amount of leases in respect of investment property, shall be disclosed. Gains on changes in the fair value of investment properties are not distributable to shareholders. This is because profits must be „realized” to be considered distributable, which essentially means that they have been converted into cash or can easily be converted into known cash. There is no guarantee that investment property can be sold immediately, so any net gain recognized in profit or loss will be classified as non-distributable.
Therefore, in the example above of Sunnie Ltd, the net profit of £26,250 (£35,000 – £8,750) is not distributable. Gains and losses on investment properties at fair value must be settled through profit or loss. Once this is done, they can be converted into a separate component of equity (for example, a „non-distributable reserve”). Although nothing in company law dictates it, it is an effective way to separate distributable and non-distributable reserves. Revaluation gains and losses are accumulated in the revaluation reserve (i.e. they are not recognised in the income statement like fair value gains and losses on investment property). Revaluation gains are recognised in profit or loss only if they offset a revaluation loss previously recognised in relation to that asset recognised in profit or loss. Any additional profit shall then be recognised in the revaluation reserve. If a property meets the definition of investment property, it is initially carried at cost: purchase price plus all directly attributable costs (including legal fees, stamp duty and brokerage fees).