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of the property which, as set out in 2 above, is mainly based on the entity’s intention
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when the property is first acquired. Subsequent to initial recognition, assets might be
reclassified into and from investment property (see 9 below).
The likelihood of obtaining such permissions, however, is relevant in recognition and
measurement of any additional costs to the property. Developers typically incur
significant costs prior to such permissions being granted and such permissions are rarely
guaranteed. Therefore, in assessing whether such pre-permission expenditure can be
capitalised – assuming it otherwise meets the criteria – a judgement must be made, at
the date the expenditure is incurred, of whether there is sufficient probability that the
relevant permissions will be granted. Conversely, if during the application and approval
process of such permits it is no longer expected that necessary permits will be granted,
capitalisation of pre-permission expenditure should cease and any related amounts that
were previously capitalised should be written off (either under the fair value model in
IAS 40 (see 6 below) or in accordance with IAS 36 – Impairment of Assets, if the cost
model is applied (see 7.3 below)). Further, if the cost model is used, the carrying amount
of any related property subject to development or redevelopment (or, if appropriate,
the cash generating unit where such an asset belongs) should be tested for impairment,
where applicable, in accordance with IAS 36 (see 7.3 below).
3.2
Other aspects of cost recognition
3.2.1
Repairs and maintenance
Day-to-day servicing, by which is meant the repairs and maintenance of the property
which largely comprises labour costs, consumables and minor parts, should be
recognised in profit or loss as incurred. [IAS 40.18]. However, the treatment is different if
large parts of the properties have been replaced – the standard cites the example of
interior walls that are replacements of the original walls. In this case, the cost of
replacing the part will be recognised at the time that cost is incurred if the recognition
criteria are met, while the carrying amount of the original part is derecognised (see 10.3
below). [IAS 40.19].
The inference is that by restoring the asset to its originally assessed standard of
performance, the new part will meet the recognition criteria and future economic benefits
will flow to the entity once the old part is replaced. The inference is also that replacement
is needed for the total asset to be operative. This being the case, the new walls will
therefore meet the recognition criteria and the cost will therefore be capitalised.
Other than interior walls, large parts that might have to be replaced include elements
such as lifts, escalators and air conditioning equipment.
3.2.2
Allocation into parts
IAS 40 does not explicitly require an analysis of investment properties into components
or parts. However, this analysis is needed for the purposes of recognition and
derecognition of all expenditure after the asset has initially been recognised and (if the
parts are significant) for depreciation of those parts (see Chapter 18 at 5.1). Some of this is
not relevant to assets held under the fair value model that are not depreciated because
the standard expects the necessary adjustments to the carrying value of the asset as a
whole to be made via the fair value mechanism (see 6 below). However, entities that adopt
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the cost model are obliged to account for assets after initial recognition in accordance
with the requirements of IAS 16. The cost model is discussed further at 7 below.
3.3
Acquisition of investment property or a business combination?
IFRS 3 – Business Combinations – defines a business as ‘[a]n integrated set of activities
and assets that is capable of being conducted and managed for the purpose of providing
a return in the form of dividends, lower costs or other economic benefits...’.
[IFRS 3 Appendix A]. However, the standard goes on to say that a business need not include
all of the inputs or processes that the seller used in operating that business if market
participants are ‘capable of’ acquiring the business and continuing to produce outputs,
for example, by integrating the business with their own. [IFRS 3.B8, B11].
The phrase ‘capable of’ is sufficiently broad that judgement will be required in assessing
if an acquired set of activities and assets, such as investment property, constitutes a
business. In isolation this requirement could be interpreted to mean that the acquisition
of most investment properties should be dealt with as a business combination under
IFRS 3 (and therefore be recognised in accordance with IFRS 3 rather than IAS 40). If
dealt with under IFRS 3, then the initial accounting for investment property is
considerably more complex. For example, amongst other requirements:
• initial direct costs are expensed (IAS 40 allows these to be capitalised – see 4.1 below);
• the initial recognition exception for deferred taxation does not apply (IAS 12 –
Income Taxes – does not allow deferred taxation to be provided on existing
temporary differences for acquisitions that are not business combinations); and
• goodwill is recognised (often itself ‘created’ by the provision of deferred taxation).
Judging whether an acquisition is a business combination or not is therefore of
considerable importance. [IAS 40.14A].
IAS 40 notes, in relation to the need to distinguish investment property from owner-
occupied property, that where certain ancillary processes exist in connection with an
investment property they are often insignificant to the overall arrangement (see 2.8
above). Consequently, it may be appropriate to conclude that, where such acquired
processes are considered by IAS 40 to be insignificant, an investment property
acquisition is within the scope of IAS 40 rather than IFRS 3. However, it should be
noted that IAS 40 and IFRS 3 are not mutually exclusive and this determination is not
the specific purpose of the standard’s observation about ancillary services.
In July 2011, the Interpretations Committee received a request seeking clarification on
precisely this point – whether the acquisition of a single investment property, with lease
agreements with multiple tenants over varying periods and associated processes, such
as cleaning, maintenance and administrative services such as rent collection, constitutes
a business as defined in IFRS 3.5
Consequently, the IASB issued the Annual Improvements to IFRSs 2011-2013 Cycle on
12 December 2013 which amended IAS 40 to state explicitly that the judgement
required to determine whether the acquisition of investment property is the acquisition
of an asset or a group of assets – or a business combination within the scope of IFRS 3
– should only be made with reference to IFRS 3.
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This clarified that the discussion about ‘ancillary services’ in paragraphs 7-14 of IAS 40
(see 2.8 above) relates to whether or not property is owner-occupied property or
investment property and not to det
ermining whether or not a property is a business as
defined in IFRS 3. Determining whether a specific transaction meets the definition of a
business combination as defined in IFRS 3 and includes an investment property as
defined in IAS 40 requires the separate application of both standards. [IAS 40.14A].
It will be a matter of judgement for preparers, but it may still be appropriate to conclude
that, when applying the guidance in IFRS 3, if acquired processes are considered to be
insignificant (whether by reference to guidance in IAS 40 or otherwise) an investment
property acquisition is within the scope of IAS 40 rather than IFRS 3. This judgement
will rest upon the facts and circumstances of each acquisition. If significant, disclosure
of this judgement would be required by IAS 1 – Presentation of Financial Statements.
[IAS 1.122].
The definition of a business is applied regardless of whether the entity purchases a
property directly or, in the case of consolidated financial statements, via the shares in
another entity.
We discuss at 3.3.1 below a recent Exposure Draft relating to the definition of a business.
See also Chapter 9 at 3 for additional discussion in identifying a business combination.
3.3.1
Possible future developments – exposure draft on definition of a
business
The IASB recognises the difficulties in determining whether an acquisition meets the
definition of a business – which are not just limited to investment property – and
explored this issue in its post-implementation review of IFRS 3 which was completed
in June 2015. As a result, in June 2016 the IASB issued an Exposure Draft ED/2016/1 –
Definition of a Business and Accounting for Previously Held Interests (Proposed
amendments to IFRS 3 and IFRS 11) (‘the Exposure Draft’). The proposed amendments
include clarification of the application of the definition of a business. The IASB aims to
provide additional guidance to help distinguish between the acquisition of a business
and the acquisition of a group of assets.
The Exposure Draft proposes a screening test designed to simplify the evaluation of
whether an integrated set of activities and assets constitutes a business. Under the
proposed amendments, an integrated set of activities and assets is not a business if
a concentration of fair value exists. A concentration would exist if substantially all
of the fair value of the gross assets acquired is concentrated in a single identifiable
asset or group of similar identifiable assets. This proposed ‘screening test’ is based
on the fair value of the gross assets acquired (i.e. any acquired input, contract,
process, workforce and any other intangible asset that is not identifiable), rather
than the fair value of the total consideration paid or the net assets. Thus, the
significance of a single asset or a group of similar assets acquired is assessed without
considering how they are financed.
For this screening test, a single identifiable asset is any asset or group of assets that
would be recognised and measured as a single identifiable asset in a business
combination. In addition, for this screening test, tangible assets that are attached to, and
cannot be physically removed and used separately from, other tangible assets without
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incurring significant cost, or significant diminution in utility or fair value to either asset,
should be considered a single identifiable asset.
If this screening test indicates that an integrated set of activities and assets is not a
business, then an entity would not have to evaluate the other guidance included in the
definition of a business. This is discussed further in Chapter 9 at 3.
The Exposure Draft also proposed a number of examples to IFRS 3 to assist with the
interpretation of what is considered a business. These include examples relating to the
acquisition of investment properties.
One of the proposed examples describes an entity that purchases a multi-tenant
corporate office park with six 10-storey office buildings that are fully leased. The
acquired set of activities and assets includes the land, buildings, leases and contracts for
outsourced cleaning and security. No employees, other assets, or other activities are
transferred. The contracts for outsourced cleaning and security are ancillary and have a
fair value of nil.
After considering the guidance proposed in the Exposure Draft as described above, the
entity concludes that:
(a) the buildings and the land are considered as a single asset for the purpose of
assessing the concentration of fair value because, although they are different
classes of tangible assets, the buildings are attached to the land and cannot be
removed without incurring significant cost;
(b) the building and the leases are considered as a single asset, because they would be
recognised and measured as a single identifiable asset in a business combination in
line with paragraph B42 of IFRS 3;
(c) the group of six 10-storey office buildings is a group of similar assets (all office
buildings); and
(d) the fair value associated with the acquired contracts for cleaning and security is nil.
Consequently, the fair value of the gross assets acquired is concentrated in a group of
similar assets and so the set of activities and assets purchased is not a business.6
A second example assumes the same facts as in the example above except that the
purchased set of activities and assets includes the employees responsible for
leasing, tenant management, and managing and supervising all operational
processes and the purchase price is significantly higher because of the employees
and processes acquired.
In these circumstances, the entity concludes that there is significant fair value associated
with the acquired workforce, i.e. the fair value of the gross assets purchased is not
concentrated in a group of similar identifiable assets. The set of activities and assets has
outputs as it generates revenues through the in-place leases. Consequently, the entity
will need to apply the criteria in the other proposed guidance included in the definition
of a business to determine whether the set includes both an input and a substantive
process. See Chapter 9 at 3 for detailed discussion.
In this specific example in the Exposure Draft, the entity concludes that the set of
activities and assets acquired is a business because the set includes an organised
workforce that performs processes (i.e. leasing, tenant management and supervision of
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the operational processes) critical to the ability to continue producing outputs when
applied to the acquired inputs (i.e. the land, buildings, and in-place leases).7
In its April 2017 meeting the IASB discussed the comments received on the Exposure
Draft particularly relating to the screening test (as described above) and tentatively
decided to:
• make the screening test optional on a transaction-by-transaction basis. Thus an
entity could on a transaction-by-transaction basis elect to bypass the screening test
and assess directly whether a substantive process has been acquired;
• confirm that the screening test
is determinative. This means that if an entity has
carried out the screening test and concluded that a concentration exists, the entity
should treat the transaction as an asset purchase. There is no further assessment
that might change that conclusion. If no concentration exists, the entity then
should assess whether it has acquired a substantive process;
• specify that the gross assets considered in the screening test exclude: i) goodwill
resulting from the effects of deferred tax liabilities, and ii) deferred tax assets;
• clarify that guidance on ‘a single asset’ for the screening test also applies when one
of the acquired assets is a right-of-use asset, as described in IFRS 16 (for example
leasehold land and the building on it are a single asset for the screening test);
• clarify that when assessing whether assets are ‘similar’ for the screening test, an
entity should consider the nature of each single asset and the risks associated with
managing and creating outputs from the assets; and
• clarify that the new guidance on what assets may be considered a single asset or a
group of similar assets is not intended to modify the existing guidance on similar
assets in paragraph 36 of IAS 38 – Intangible Assets – and the term ‘class’ in IAS 16,
IAS 38 and IFRS 7 – Financial Instruments: Disclosures.8
The IASB subsequently continued discussing the comments received on various
aspects of the Exposure Draft and, in its June 2017 and October 2017 meetings,
tentatively decided to reaffirm a number of items already included in the Exposure
Draft and clarify certain principles used. In its October 2017 meeting, the IASB also
specifies that the gross assets considered in the screening test (as describe above)
exclude cash and cash equivalents acquired.9 See Chapter 9 at 3.2.6 for detailed
discussion of these updates.
4 INITIAL
MEASUREMENT
4.1 Attributable
costs
IAS 40 requires an owned investment property to be measured initially at cost, which
includes transaction costs. [IAS 40.20]. If a property is purchased, cost means purchase
price and any directly attributable expenditure such as professional fees, property
transfer taxes and other transaction costs. [IAS 40.21].