FRS 102: Intra-group investment property changes explained
In March 2018, the FRC issued revised editions of UK GAAP which reflects the changes made as part of the triennial review. The triennial review amendments come into mandatory effect for accounting periods commencing on or after 1 January 2019, hence December 2019 year ends will be the first affected by the amendments if they have not been early adopted.
In terms of early adoption, reporting entities can early adopt the triennial review amendments provided they are all applied at the same time with the exception of the amendments in respect of directors’ loans and gift aid payments.
One of the changes made to FRS 102 is in respect of investment property that is rented out to another group member (intra-group investment property).
In FRS 102 (March 2018), there is an accounting policy choice available to groups to measure intra-group investment property using either the cost model (ie cost less depreciation less impairment) or at fair value through profit or loss.
It is likely that many groups will choose to measure intra-group investment property under the cost model. The issue that arises is where a group has such investment property and has accounted for the investment property at fair value through profit or loss under section 16 Investment Property and now wishes to measure the property under the cost model.
Transition from section 16 to section 17 Property, Plant and Equipment
It is expected that many groups will wish to use the accounting policy option in FRS 102, paragraph 16.4A which states:
‘An entity that rents investment property to another group entity shall account for those properties either:(a) at fair value with changes in fair value recognised in profit or loss in accordance with this section (the appendix to section two provides guidance on determining fair value); or
(b) by transferring them to property, plant and equipment and applying the cost model in accordance with section 17.
An entity choosing to apply (b) above shall provide all the disclosures required by Section 17, other than those related to fair value measurement.’
Where a group decides that (b) is their preferred choice, the entity will be permitted to use the fair value of its intra-group investment property as its deemed cost at the date of transition to the Triennial Review 2017 Amendments. FRS 102 defines the ‘date of transition’ as:
|‘The beginning of the earliest period for which an entity presents full comparative information in a given standard in its first financial statements that comply with that standard.’
Hence, where a group has a 31 December 2019 reporting date and has not early adopted the triennial review amendments, the date of transition will be 1 January 2018; being the start date of the comparative period reported in the financial statements.
There is a transitional provision in FRS 102, para 1.19(a) which provides a choice of accounting treatment on transition as follows:
‘When an entity first applies the Triennial review 2017 amendments, as an exception to retrospective application, it:(a) may elect to measure an investment property rented to another group entity, that is measured on an ongoing basis at cost less accumulated depreciation and accumulated impairment losses, at its fair value and use that fair value as its deemed cost at the date of transition for the Triennial review 2017 amendments; and
The other choice would be to use the historical cost of the intra-group investment property and then depreciate/impair the asset as if it had always been carried under the cost model.
For the purpose of this article, it is assumed that the entity will use the fair value as deemed cost at the date of transition.
On transition to the new accounting policy of measuring the intra-group investment property under the cost model, an entity will freeze the fair value of the property at its date of transition. Any fair value uplift at the date of transition is then transferred from either retained earnings or a separate reserve (eg a fair value/non-distributable reserve if a separate component of equity is maintained for such fair value adjustments) to a revaluation reserve.
This is because once the property is transferred to section 17 Property, Plant and Equipment using its fair value as deemed cost, it is being transferred at a revalued amount. Section 17 uses the Alternative Accounting Rules in company law where revalued amounts are concerned hence accumulated gains must be presented within a revaluation reserve.
Topco Ltd is preparing its financial statements to 31 December 2019. It has an investment property that it rents out to its subsidiary which has been held at fair value in accordance with FRS 102, section 16 and wishes to apply the accounting policy choice in FRS 102, paragraph 16.4A(b) and uses the cost model in section 17 to measure the property.
Extracts from the working papers of Topco Ltd for the investment property are as follows (note for the purposes of this example it has been assumed that the company has maintained a separate component of equity in which to segregate the fair value gains on the property):
Step 1 – Transitional adjustments
The date of transition to the triennial review amendments in this example is 1 January 2018 (being the start date of the comparative period reported in the financial statements). The fair value of the property at this date is £430,000. The entries in Topco’s books to record the change in accounting policy are as follows:
(Note this assumes the company presents investment property separately on the face of the balance sheet).
If Topco had not maintained a separate component of equity, the debit would be to retained earnings (profit and loss reserves).
Step 2 – Restate the comparative year
The 31 December 2018 financial statements showed a further fair value increase of £40,000 and an increase in the deferred tax provision of £6,800. These were recorded in the financial statements as follows:
The financial statements need to be restated by reversing these adjustments because the property has been transferred to section 17 from the date of transition. We then need to bring in the depreciation charge on the property (because it is now being measured at cost less depreciation less impairment).
Assuming the directors have assessed a useful economic life of 40 years for the building and the value of the land, which is non-depreciable, is £50,000, the depreciation charge for 31 December 2018 will be £9,500 ([£430,000 – £50,000] / 40) and also in the current year 31 December 2019.
Step 3 – Consider transferring the excess depreciation from the revaluation reserve
The annual depreciation charge if the property was stated at cost would be £8,750 ([£400,000 – £50,000) / 40). However, it is being measured using a revalued amount of £380,000 (£430,000 – £50,000) resulting in a depreciation charge of £9,500.
The accounting regulations state that an amount may be transferred from the revaluation reserve to retained earnings if the amount was previously charged to that account or represents realised profit. Therefore, Topco may choose to transfer the excess depreciation of £750 from the revaluation reserve to retained earnings to avoid distributable profit from being understated.
While there would be no corporate tax implications, it should be noted that the above change in accounting policy would reduce pre-tax profit in the comparative year in Topco’s individual financial statements by £49,500, being the reversal of the £40,000 fair value gain plus the depreciation charge of £9,500.
Also, it is worth noting to provide the disclosures required by either section 10 Accounting Policies, Estimates and Errors (see paragraph 10.14) or Section 1A Small Entities in respect of a change in accounting policy
As stated earlier in the article, it is likely that many groups will opt for the accounting policy choice in FRS 102, para 16.4A(b) to measure intra-group investment property under the cost model. It is probably easier to use the property’s fair value as deemed cost at the date of transition (although others may prefer to use historic cost as adjusted for depreciation/impairment).
The important point to emphasise is that the policy change is applied as far back as the start date of the comparative year with closing comparatives restated to comply with FRS 102.