Analysis of how to treat investment properties under FRS 102.
Current accounting treatment Under SSAP 19, investment properties are required to be included on the balance sheet at open market value and are not subject to depreciation. The changes in value should not be taken to profit and loss account but to the statement of recognised gains and losses (and credited to a revaluation reserve) unless a deficit is expected to be permanent in which case it does go to the profit and loss account.
Valuation does not need to be by a qualified or independent valuer, but disclosure is required of the names or qualifications of the valuers, the bases used and whether the valuer is an employee or officer of the company.
Investment properties are defined as ‘held not for consumption in the business operations but as investments, the disposal of which would not materially affect any manufacturing or trading operations of the enterprise’.
Accounting treatment under FRS 102 FRS 102 requires valuation at fair value only if the property can be measured reliably without undue cost or effort. If that is not possible, the property should be accounted for as ‘property, plant and equipment’, and not as investment property. If the investment property fair value can be measured reliably, it shall be measured at fair value at each reporting date with changes in fair value recognised in profit or loss.
Disclosure is required of the extent to which the fair value of investment property is based on a valuation by an independent valuer who holds a recognised and relevant professional qualification and has recent experience in the location and class of the investment property being valued. If there has been no such valuation, that fact shall be disclosed.
Investment properties are defined as those ‘held 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’.
Transition On first adopting FRS 102 the entity may elect to measure an investment property at its fair value at transition date, using that value as its deemed cost, or it can elect to use a previous GAAP revaluation as its deemed cost at the revaluation date.
Reporting and commercial impact of the changes The main impact on financial reporting will be any upward revaluation going through the profit and loss account. If material amounts hit the profit or loss (statement of income), there will be an effect on the results of the entity, increasing its retained earnings. Gains on revaluation of investment properties, although included in retained earnings, would not be considered as distributable profits, as they are not realised, and therefore entities should keep track of such gains and consider them separately when making a distribution.
Additionally, where the properties are not revalued and the property is categorised as property, plant and equipment, an additional amount of depreciation will go through profit and loss account and could impact on the operating profit margin and reserves of an entity and therefore may result in the breach of debt covenants, like PBIT-based interest cover, gearing and dividend cover.
Taxation impact of the changes Under FRS 102, investment property whose fair value can be reliably measured without undue cost or effort must be measured at that fair value at each balance sheet date with gains and losses recognised in profit and loss.
These gains or losses will be capital in nature and hence no tax effect until the property is actually sold. HMRC has yet to change their policy to include specific guidance with regard of gains and losses on investment properties. As a general rule, capital expenditure is not allowable as a deduction from business profits unless there is a specific statutory allowance. Instead capital expenditure is added to the cost of the property and will reduce the capital gain on eventual sale of the property.