Investment Property

[Cliver123]

My company has classified a property interest held under a operating lease as an Investment Property and is using the fair value method to value the Investment property. The Property is leased to the company for a period of 25 years. At the end of 25 years, the value of the Property should be nil. But if we fair value the Property the value is increasing(based on the fair valuations provided by the valuators). What can we do to reduce the value of the Investment Property so that it will be nil at the end of 25 years? Please note that we need to account it as per IFRS'
Please send me your response at the earliest at clevros at yahoo.com

 

[kirby]

OK , I'm lost. Under GAAP or IFRS the lessee does not record an asset for an Operating Lease. So you should not have an asset, fair value or otherwise.
In any case, the lease ends in 25 years and at that point you have no lease at all. So you will have no problem "reducing the value to nil at the end of 25 years>"

 

[Cliver123]

Thansk a lot for your response, Kirby.

I have read the following under IAS17,Quote "A lessee may classify a property interest held under an operating lease as an investment property. If this is done, then the lessee
accounts for the lease as if it were a finance lease, measures investment property using the fair value model and recognizes a lease liability for future lease payments."
My only question is " The fair value of the Investment property is higher than the current cost so should I ask the valuator to consider the lease period of 25 years so that he reduces the price with every year so that the property will be nil at the end of 25 years.

 

[bklynboy]

There seems to be a bit of a contradiction. IAS 17 permits FV under IAS 40 if the lease is classified as a finance lease. This assumes all the risks and rewards are transferred and should transfer the asset at the end of the lease. This is different than what you are stating where you intend to only hold for 25 years and not take possession of the asset. Under that scenario I would argue this is not a finance lease and not permitted to be accounted for as such - making the FV rule inapproprioate for you.

Below is the criteria to be a finance lease from IAS 17:

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]

the lease transfers ownership of the asset to the lessee by the end of the lease term

the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised

the lease term is for the major part of the economic life of the asset, even if title is not transferred

at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset

the lease assets are of a specialised nature such that only the lessee can use them without major modifications being made

Other situations that might also lead to classification as a finance lease are: [IAS 17.11]

if the lessee is entitled to cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee

gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments)

the lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent

That is why you are permitted FV under finance lease since you effectively "own" the asset under the accounting rules.

IFRS is not my area of expertise but is how I read the guidance. What have I missed?

 

[kirby]

Hi Cliver
The key is if you perform the fair value analysis correctly the problem will solve itself. For my example, you get into this 25 year lease to have a property that you in turn will rent to someone else( remember your own folks cannot occupy this property per IFRS 40)

so let's simplify;

So YOU lease the property for 25 years and then you get a tenant for that property who signs a 25 year lease with you. If you estimate your fair value in the investment property as the present value of the tenant's rentals to you then the fair value will, of course, drop each year as time goes on and the years of future rental income coming to you shrink.

Simple in that example.

I don't know your actual conditions but I hope this example helps.

 

[Fidget]

There seems to be a bit of a contradiction. IAS 17 permits FV under IAS 40 if the lease is classified as a finance lease. This assumes all the risks and rewards are transferred and should transfer the asset at the end of the lease. This is different than what you are stating where you intend to only hold for 25 years and not take possession of the asset. Under that scenario I would argue this is not a finance lease and not permitted to be accounted for as such - making the FV rule inapproprioate for you.

Maybe I can clarify a little. Although ownership transferring at the end of the lease is one of the main indicators of a finance lease, it doesn't have to be the case under IFRS. So it's perfectly feasible under IAS 17 to have a finance lease where ownership doesn't transfer at the end of it.

Under IAS 40 the main thing is that propety held meets the criteria for being reclassified as Investment property regardless of whether it is owned or leased. Where it is leased under an operating lease, to be accounted for as investment property, it has to go on the balance sheet and to do that, the treatment of a finance lease under IAS 17 is applied.

 

[Fidget]

Hi Cliver
The key is if you perform the fair value analysis correctly the problem will solve itself. For my example, you get into this 25 year lease to have a property that you in turn will rent to someone else( remember your own folks cannot occupy this property per IFRS 40)

so let's simplify;

So YOU lease the property for 25 years and then you get a tenant for that property who signs a 25 year lease with you. If you estimate your fair value in the investment property as the present value of the tenant's rentals to you then the fair value will, of course, drop each year as time goes on and the years of future rental income coming to you shrink.

Simple in that example.

I don't know your actual conditions but I hope this example helps.

How do you account for your own lease by doing that though?

I'm quite intrigued with the OP's question. The standards seem to fall silent after saying treat operating lease as finance lease if the conditions for reclassifying as investment property are met. I can't find any examples of it happening in practise that give a guideline on how you actually do it. The standards seem to say that it is your own lease that is accounted for as a finance lease rather than based on rental income generated from the property you're leasing.

 

[Fidget]

Actually, scratch that - the penny has dropped.