FRS 102 Explained

Steve Collings explains accounting for investment property under FRS 102

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 administrative purposes, or

(b) sale in the ordinary course of business.”

The distinction between investment property and owner-occupied property is crucial because the accounting treatments in Section 16 and Section 17 Property, Plant and Equipment are significantly different. Essentially, where a property earns rentals for a business then it will meet the definition of investment property and hence be accounted for under Section 16.

Initial recognition

When a property meets the definition of investment property it is initially recognised at cost plus all directly attributable costs (e.g. legal fees).

If payment is deferred beyond normal credit terms, the initial cost of the investment property is the present value of all future payments. If the investment property is being self-constructed, the provisions in FRS 102, paras 17.10 to 17.14 will apply.

FRS 102, para 16.6 states that the initial cost of a property interest held under a lease and classified as an investment property is accounted for as a finance lease even if the lease would otherwise be classed as an operating lease if it was within the scope of Section 20 Leases. Therefore, the asset is recognised at the lower of the fair value of the property and the present value of the minimum lease payments with a corresponding finance lease creditor. Any premium paid is treated as part of the minimum lease payments and hence is included in the cost of the asset, but excluded from the liability.

Subsequent measurement

As noted above, at each reporting date the investment property must be remeasured to fair value with changes in fair value passing through profit or loss. Do not take any revaluation gains or losses directly to a revaluation reserve because this is not the correct accounting treatment.

Changes are recognised in profit and loss because the entity is applying the fair value accounting rules in the Companies Act 2006. In addition, deferred tax must also be brought into account.

Example: Revalued investment property

On 1 March 2019, Pickup Co Ltd acquired an investment property for £150,000 including all associated legal fees and stamp duty. The company has an accounting reference date of 31 December.

On 31 December 2019, the value of the investment property had increased to £30,000. The change in fair value is accounted for as follows:

Dr Investment property              £30,000

Cr Fair value adjustments

(profit and loss)                          £30,000

Being increase in fair value of investment property as at 31 December 2019

This gain must not be taken to a ‘Revaluation reserve’ as was the case under old UK GAAP because it must pass through the profit and loss account. While FRS 102 does not use ‘operating profit’ most entities are continuing to use the operating profit line item on the face of the profit and loss account and such gains must be included within the calculation of operating profit (i.e. within cost of sales or administrative expenses as appropriate).

FRS 102, para 29.16 also requires deferred tax to be brought into account for such investment properties using the tax rates and allowances which will apply to the sale of the asset. If we assume that Pickup Co Ltd has no plans to sell the asset for the foreseeable future, then deferred tax is calculated using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Hence we can use 17% as this will be the corporation tax rate that will apply for the corporation tax year starting 1 April 2020. Therefore, deferred tax is accounted for as follows:

Dr Tax expense (profit and loss)    £5,100

Cr Deferred tax provision             £5,100

Being deferred tax on the investment property fair value gain at 17%

It should be emphasised that because the change in fair value has been recognised in profit and loss, it is not presented within a revaluation reserve. The net gain of £24,900 (£30,000 less £5,100) is not distributable to the shareholders because it is not a realised gain. Therefore, Pickup Co Ltd could choose to transfer a portion of its profit and loss reserves (retained earnings) equal to the net cumulative fair value gain for presentation purposes to a separate reserve called a ‘Non-distributable reserve’. They do not have to do this because there is nothing in company law that requires a separate component of equity for such non-distributable gains, but it is advisable so the directors can keep a track of reserves that cannot be distributed.

• Steve Collings is a Partner at LWA Chartered Certified Accountants and Statutory Auditors

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