What is Investment Property as per Ind AS 40? A Comprehensive Guide

When managing financial statements, companies often struggle with categorizing different types of property. One particularly tricky classification is investment property, which gets special treatment under Indian Accounting Standards. Let’s dive deep into what Ind AS 40 says about investment property and how it should be handled in your financial statements.

Definition of Investment Property

According to Ind AS 40, investment property is defined as

Property (land or a building—or part of a building—or both) held 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

In simple terms, if you’re holding property to make money from rent or because you think it’ll increase in value (or both), and not using it for your business operations or planning to sell it soon it’s probably an investment property.

Examples of Investment Property

To make this clearer, Ind AS 40 provides some examples of what counts as investment property:

• Land held for long-term capital appreciation
• Land held for a currently undetermined future use
• A building owned by the entity and leased out under operating leases
• A vacant building held to be leased out under operating leases
• Property being constructed or developed for future use as investment property

What’s NOT Investment Property

Just as important as knowing what qualifies as investment property is understanding what doesn’t. Ind AS 40 specifies that these are not investment properties:

• Property intended for sale in the ordinary course of business (that’s inventory under Ind AS 2)
• Property being constructed for third parties
• Owner-occupied property (covered under Ind AS 16)
• Property leased to another entity under a finance lease

Recognition Criteria

To recognize investment property on your balance sheet, two conditions must be met:

1. It’s probable that future economic benefits associated with the property will flow to the entity
2. The cost of the property can be measured reliably

Initial Measurement

When you first recognize an investment property, you measure it at its cost, including transaction costs. The cost includes:

• Purchase price
• Directly attributable expenditure (legal fees, property transfer taxes, etc.)

If payment is deferred, the cost is the cash price equivalent, with the difference recognized as interest expense over the credit period.

Measurement After Recognition

Here’s where Ind AS 40 differs significantly from its international counterpart (IAS 40). While IAS 40 allows entities to choose between the fair value model and cost model, Ind AS 40 only permits the cost model.

Under the cost model, after initial recognition, investment property is measured using the requirements in Ind AS 16’s cost model. This means the property is carried at cost less accumulated depreciation and impairment losses.

Even though fair value isn’t used for measurement, Ind AS 40 still requires disclosure of fair value for all investment properties. This helps financial statement users understand the actual market value of these assets.

Transfers

A property can be transferred to or from investment property only when there’s a change in use. Ind AS 40 provides examples of evidence of a change in use:

• Commencement of owner-occupation (transfer from investment property to owner-occupied property)
• Commencement of development with a view to sale (transfer from investment property to inventories)
• End of owner-occupation (transfer from owner-occupied property to investment property)
• Inception of an operating lease to another party (transfer from inventories to investment property)

It’s worth noting that just changing your intentions for a property isn’t enough – there must be actual evidence of the change in use.

Disposals

Investment property should be derecognized (removed from the balance sheet) on disposal or when it’s permanently withdrawn from use and no future economic benefits are expected.

Gains or losses from disposal are calculated as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in profit or loss.

Required Disclosures

Ind AS 40 requires several disclosures about investment property, including:

• The accounting policy for measurement
• The criteria used to distinguish investment property from owner-occupied property and property held for sale
• The extent to which fair value is based on a valuation by a qualified independent valuer
• Amounts recognized in profit or loss for rental income and direct operating expenses
• Restrictions on the realisability of investment property
• Contractual obligations to purchase, construct, or develop investment property

Key Differences Between Ind AS 40 and IAS 40

The biggest difference is that IAS 40 permits both the cost model and fair value model, while Ind AS 40 only allows the cost model. This is a significant restriction in the Indian context that affects how investment properties are reported.

Despite this restriction, Ind AS 40 still requires disclosure of fair values even though they can’t be used in the primary financial statements.

Practical Application

Let’s consider a simple example:

Company XYZ purchases a building for ₹1 crore, intending to lease it out to generate rental income. Additional legal fees and transfer taxes amount to ₹10 lakhs.

Initial recognition: The building is recognized as investment property at ₹1.1 crore (purchase price + directly attributable expenditure).

Subsequent measurement: Assuming a useful life of 20 years and no residual value, annual depreciation would be ₹5.5 lakhs using the straight-line method.

After 5 years, the carrying amount would be ₹1.1 crore – (₹5.5 lakhs × 5) = ₹82.5 lakhs.

However, if the fair market value of the building has risen to ₹1.5 crore at that time, this fact would need to be disclosed in the notes to the financial statements, even though the carrying amount remains ₹82.5 lakhs.

Common Challenges

When implementing Ind AS 40, companies often face these challenges:

1. Determining whether a property meets the definition of investment property
2. Obtaining reliable fair value measurements for disclosure purposes
3. Identifying when a change in use has occurred
4. Allocating property that has mixed uses (partly owner-occupied, partly held for rental)

For mixed-use property, Ind AS 40 provides that if the portions could be sold separately, they should be accounted for separately. If they can’t be sold separately, the property is investment property only if an insignificant portion is held for use in production or supply of goods or services or for administrative purposes.

Investment property under Ind AS 40 represents a distinct asset class that requires specific accounting treatment. While the standard shares much with its international equivalent, the restriction to the cost model is a significant difference that affects Indian financial reporting.

For companies with significant real estate holdings not used in operations, properly classifying and accounting for investment property is crucial to presenting an accurate picture of their financial position and performance.

Remember that while fair value isn’t used for measurement in the financial statements, it’s still required for disclosure – meaning companies need to have systems in place to determine the fair value of their investment properties at each reporting date.

By following the guidelines in Ind AS 40, companies can ensure consistent treatment of investment properties and provide users of financial statements with useful information about these important assets.

An investment property is real estate purchased with the primary goal of generating income or profit, either through collecting rent or by reselling it for a higher price. Unlike a primary residence, its main purpose is financial return rather than personal use.