Getting to grips with the latest changes to the UK FRS and investment property
Following on from our recent webinar with FRS expert Steve Collings, where he discussed the recent changes arising from the Triennial Review, in this article below, Steve focuses on a specific area that attracts many questions when he lectures.
One of the key changes under the review included the treatment of intra-group investment properties. Whilst discussing this, it has become apparent that there has been some confusion about how to treat any fair value gains and losses on Investment Properties under FRS 102.
In his blog, Steve writes about how to help accountants gain a clearer understanding of the issues and how to tackle them. You can also watch his recorded webinar.
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with investment property in Section 16 Investment Property. Investment property is defined as:
‘Property (land or a building, or part of a building, or both) held by the owner or by the lessee under a finance lease 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 administration purposes, or
(b) Sale in the ordinary course of business.’
Essentially, if a property is used to earn rentals or is being held until its value reaches an optimum price at which point the entity will sell the property to realise its fair value, the property is investment property. In addition, land can also be investment property, as can a property in the course of construction.
Fair value gains and losses
FRS 102 uses the fair value accounting rules in the Companies Act 2006 to account for investment property. This means that all fair value gains and losses must go through the profit and loss account.
Example – Fair value gain
Halliwell Co Ltd has an investment property on its balance sheet. On 31 October 2018, the property’s value increased by £20,000. The entries are as follows:
Dr Investment property revaluations (IRIS code 563/5) £20,000
Cr Fair value movements (IRIS code 373/4) £20,000
Being increase in fair value of investment property at 31 October 2018
The gain must not be taken directly to equity via a revaluation reserve because the alternative accounting rules in the Companies Act 2006 are not being applied. The important point to emphasise is that fair value gains and losses must pass through profit and loss.
FRS 102 requires deferred tax to be brought into account for non-monetary assets subject to revaluation. In addition, FRS 102, paragraph 29.16 also requires deferred tax to be brought into account for investment properties. When calculating deferred tax, it is important to use the tax rate which will apply when the timing differences reverse and not the rate of tax in force at the balance sheet date. FRS 102, paragraph 29.16 requires deferred tax to be brought into account for investment property movements using a rate of tax which will apply to the sale of the asset. In most cases, the date of sale and hence the rate of tax which will apply when the investment property will be sold is unlikely to be known and hence we will use the rate of tax enacted or substantively enacted by the balance sheet date.
Example – Deferred tax
Continuing with the example above (showing the fair value gain of £20,000). The rate of tax will be 17% as this will apply for the corporation tax year starting 1 April 2020 (it is assumed that this is the rate which will apply when the asset is sold). A fair value gain gives rise to a deferred tax liability, or an increase to an existing deferred tax liability in respect of that investment property or a reduction to a deferred tax asset in respect of that investment property.
The entries to record the deferred tax liability associated with the fair value gain are:
Dr Deferred tax (profit and loss) (IRIS code 450) £3,400
Cr Deferred tax provision (IRIS code 931/3) £3,400
Being deferred tax at 17% of £20,000
Impact on distributable profit
The fair value gain on the investment property is not a realised gain for distribution purposes, hence is non-distributable. Most practitioners are ring-fencing such non-distributable profits in a non-distributable reserve. Professional bodies such as ICAEW and ACCA are advising member firms to call such reserves a ‘Non-distributable reserve’ rather than a ‘Fair value reserve’ because a fair value reserve can include profits which are distributable. There is nothing in company law which requires a separate reserve to be maintained, but it is an effective way of keeping non-distributable profits separate from those which are distributable.
The important points to note where investment property is concerned is that all such properties must be remeasured to fair value at each balance sheet date and directors can carry out their own valuations (although this will be a risk for the auditor if the company is audited as internal valuations are not independent). Fair value gains and losses must pass through the profit and loss account – they are not taken directly to equity and reported as other comprehensive income. In addition, do not forget to bring deferred tax into account.
FRS 102 (March 2018) contains an accounting policy choice for intra-group investment property only meaning such properties can be measured using the cost model (i.e. cost less depreciation less impairment) or at fair value through profit and loss. If a group wishes to take advantage of this accounting policy choice then it can do, but if it wishes to early adopt this accounting policy choice then it must apply FRS 102 (March 2018) from the same date.
Steve Collings, FMAAT FCCA
Steve Collings, FMAAT FCCA, is the audit and technical partner at Leavitt Walmsley Associates Ltd and the author of several books on the areas of financial reporting and audit. Steve specialises in financial reporting (UK GAAP and IFRS), auditing and solicitors’ accounts rules. Steve is also a regular contributor of articles to AccountingWEB.co.uk and works closely with various professional bodies assisting them with issues relating to financial reporting and audit. He was the winner of the Accounting Technician of the Year award at the British Accountancy Awards in 2011 and was awarded ‘Outstanding Contribution to the Accountancy Profession’ in 2013.