UK Company Accounts The New Reporting Regime. Factsheet 06 Accounting for Investment Property. Peter Edwards

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1 UK Company Accounts The New Reporting Regime Factsheet 06 Accounting for Investment Property Peter Edwards

2 Contents Introduction... 2 New UK GAAP v. Old UK GAAP... 3 Small companies... 9 Micro-entities... 9 What do you need to do now?...10 Page 1

3 Introduction Under Old UK GAAP there is a well established and widely accepted policy of accounting for investment property at open market value. Fair value accounting is a key aspect of New UK GAAP as set out in FRS 102. At first sight, therefore, it may seem reasonable to conclude that there will be few, if any, differences between the two regimes in accounting for investment property. The reality is, of course, quite different. The following section sets out the main features of accounting for investment property under New UK GAAP in FRS 102, the key differences compared with Old UK GAAP and the impact of the differences on company accounts. Page 2

4 New UK GAAP v. Old UK GAAP Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Definitions Investment property is property owned OR property held under a finance lease to earn rental income or for capital appreciation or both. Includes property let to and occupied by another group company. Property held under an operating lease can be capitalised and treated as an investment property provided the fair value of the interest (different from the value of the property itself) can be measured reliably. The operating lease must be accounted for as a finance lease. Property let to another group company is excluded from the definition of investment property. No specific guidance on this aspect. For some groups there will be more work in the preparation of consolidated accounts. Where a group company lets its property to another group company it must be treated as investment property in the accounts of the property holder. However from a group perspective the property is not let to an outside entity. Therefore in the group s consolidated accounts it must be classified as owner occupied property under Property, Plant and Equipment. A consolidation adjustment will be necessary each year to derecognise fair value gains or losses and replace with an appropriate depreciation provision. In practice it is arguable that the 'undue cost and effort' exemption from classification as investment property should apply in these circumstances. Page 3

5 Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Definitions (continued) The following are NOT investment property: Used for purposes of own business Held for sale in the ordinary course of business Mixed use property where the fair value of the investment property element cannot be reliably determined Held primarily for the provision of social benefits. No special treatment for property held primarily for the provision of social benefits. Inserted with charities in mind; so should not be interpreted too broadly. Page 4

6 Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Measurement Initial measurement (upon acquisition) is at cost and subsequently at fair value( 1 ) as at each accounts date. Fair value is only required if this can be measured reliably without undue cost or effort on an ongoing basis. If this is not possible the property is accounted for as if it was normal Property, Plant and Equipment and carried at cost less depreciation. There is no cost model option. Investment property should be included at open market value. Presumably it was assumed that a company would either have an internal valuer or could readily appoint an external valuer. Arguably none as there is a well established history of carrying investment property at valuation. However, some may now try to argue that a valuation involves undue cost and/or effort particularly if the nature of the property is unusual or in a difficult location. Page 5

7 Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Measurement (continued) Changes in fair value are recognised in profit or loss (FVTPL). Changes in open market value( 2 ) are recognised in the Statement of Total Recognised Gains and Losses (STRGL) and taken direct to Revaluation Reserve UNLESS a reduction in value (or its reversal) is expected to be permanent, in which case the reduction or reversal is recognised in profit or loss. Potential volatility in reported profit or loss arising from changes in fair value which may need to be explained to lenders, investors and other users of the accounts. There may be implications for agreements based on profit such as employee remuneration, earn-outs and loan agreements. In a rising market this may potentially increase bonuses, earn-outs and share option rewards above expectation. Changes in fair value (gains and losses) and related deferred tax have no impact on distributable reserves as these are unrealised under the Companies Act Depreciation is not provided. Investment property held under a finance lease must be depreciated once the remaining lease term is below 20 years. The fact that depreciation is not provided is no longer a breach of the Companies Act Consequently there is no breach that requires disclosure in the accounts. Page 6

8 Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Measurement (continued) Deferred tax must be provided on the revaluation gain and charged to profit or loss. No requirement to provide deferred tax unless a binding sale agreement is in place at the accounts date. Provision for deferred tax will reduce the upward impact of a revaluation gain on net assets and on reported profit or loss. A significant reduction in net assets due to deferred tax provisions could affect banking covenants. Separate Revaluation Reserve is not required but is an option. Separate Revaluation Reserve is required. Separate disclosure of distributable and nondistributable reserves is recommended to minimise confusion as to the amount of reserves that are distributable. Reclassification Investment property is reclassified as Property, Plant and Equipment (PPE) if there is no longer a reliable measure or if the use of the property changes so that it no longer meets the definition of an investment property. Property is transferred into or out of the investment property category only when there is a change in use. Page 7

9 Accounting for Investment Property: outline approach New UK GAAP (FRS 102) Key differences in Old UK GAAP Impact of FRS 102 Rental income Lease incentives used to attract tenants must be spread over the full term of the lease. Lease incentives are spread over the period to the first break clause. Profit and associated tax liability will be higher during the early part of the lease. Tax may be payable before any cash is received from the tenant. (1) Fair value is the amount for which an asset could be exchanged between knowledgeable and willing parties in an arm s length transaction. This differs from the definition of open market value (see note 2 below) required under old UK GAAP. In practice, however, it seems likely that an old UK GAAP valuation could continue to be used as a fair value under new UK GAAP. (2) Open market value is the best price at which a sale would be completed for cash assuming a willing seller, a reasonable period for marketing and negotiation, no special interest purchaser and both parties acting knowledgeably, prudently and without compulsion. Page 8

10 Small companies For a small company that is adopting FRS 102 Provisions applicable to small entities (Section 1A Small Entities of FRS 102) the recognition and measurement requirements for investment property are as set out in the table above under New UK GAAP. In short this is measurement at fair value with changes through profit or loss (FVTPL). However there are no specific disclosure requirements for a small entity in respect of investment properties. Judgements will, therefore, need to be made as to what, if any, discretionary disclosures are made to ensure the accounts give a true and fair view. Micro-entities Micro-entities applying FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime need not make a distinction as to the basis on which they carry investment property in their balance sheet. Under FRS 105 investment property is lumped together with Property, Plant and Equipment which must be measured at cost less depreciation and impairment. Fair value accounting is not permitted under FRS 105. This significantly different and restrictive approach to accounting for investment property may help micro-entities decide whether or not to step-up to FRS 102. If they wish to carry investment property at fair value and report changes in value in their published accounts adoption of FRS 102 is necessary. Page 9

11 What do you need to do now? A company that must, or opts to, adopt FRS 102 has a number of key points to consider including, where relevant: Renegotiation of agreements based on reported profit and/or net assets. Use of the undue cost and/or effort exemption from fair valuation, particularly in respect of property of an unusual nature or in a difficult location. Capitalisation of investment property held under an operating lease. For a charity in particular, exclusion from fair valuation of property held primarily for the provision of social benefits. A group company that owns property which is let to and occupied by another group company should arrange a fair valuation of the property as at three dates one at the transition date, one at the comparative balance sheet date and one at the current balance sheet date, or consider the 'cost and effort' exemption. In addition to the above a small company that is adopting FRS 102 Section 1A Small Entities must consider what discretionary disclosures should be made in their accounts to ensure a true and fair view. A micro-entity must decide whether to keep the simple approach required by FRS 105 or to adopt the possible benefits and costs of fair value accounting under FRS 102. Those of the above points which require interpretation of the conditions for exemption or discretionary disclosures to show a true and fair view should be discussed in good time with the company s auditor, where relevant. To discuss any of these points or to find out more about the new financial reporting regime under UK GAAP please contact Peter Edwards, Head of Audit and Assurance Services. e: peter.edwards@alliotts.com t: Note: The information set out in this Factsheet is based on our understanding of the financial reporting provisions as at 6 June 2016 Page 10

12 Contact Us By Phone London: +44(0) Guildford: +44 (0) By Post London: Guildford: Imperial House, Kingsway, London, WC2B 6UN Friary Court, High Street, Guildford, Surrey, GU1 3DL Online www Twitter Alliotts are registered to carry on audit work in the UK and regulated for a range of investment business activities; and licensed to carry out the reserved legal activity of non-contentious probate in England and Wales by the Institute of Chartered Accountants in England and Wales.

THE TAX IMPLICATIONS FOR CHARITY TRADING

THE TAX IMPLICATIONS FOR CHARITY TRADING NIGEL ARMSTRONG Date last reviewed: 14th Feb 2017 As a specialist advisor on taxation to the charity and not for profit sector, Nigel Armstrong, our Head of Taxation