initial measurement of a lessee’s right-of-use asset. [IFRS 16.24]. Lease incentives that are
payable to the lessee at lease commencement reduce a lessee’s lease liability. [IFRS 16.27].
Further, under IFRS 16, the requirement on initial direct costs is consistent with the
concept of incremental costs of obtaining a contract in IFRS 15 (see Chapter 28
at 10.3.1). IFRS 16 defines initial direct costs as ‘incremental costs of obtaining a lease
that would not have been incurred if the lease had not been obtained ...’.
[IFRS 16 Appendix A]. Examples of such costs are commissions and contingent fees that
would not have incurred if the lease had not been obtained. Under IAS 17, initial direct
costs are ‘incremental costs that are directly attributable to negotiating and arranging a
lease ...’. [IAS 17.4]. The revised definition of initial direct costs under IFRS 16 could result
in some changes in practice for lessors. In addition to excluding allocated costs (e.g.
salaries), which also were excluded under IAS 17, initial direct costs will now exclude
costs incurred regardless of whether the lease is successfully finalised (e.g. fees for
certain legal advice, estate agent fees not contingent upon success). Example 13 of the
Illustrative Examples to IFRS 16 also indicates that certain payments made to an existing
lessee to incentivise that lessee to terminate its lease could also be regarded as initial
direct costs. Lessees and lessors apply the same definition of initial direct costs.
IFRS 16 requires lessors to include initial direct costs in the carrying amount of the
underlying asset in an operating lease. These initial direct costs are recognised as an
expense over the lease term on the same basis as lease income. [IFRS 16.83]. IFRS 16
requires lessees to include their initial direct costs in their initial measurement of the
right-of-use asset. [IFRS 16.24].
For further discussion, see Chapter 24 at 4.5.2, 4.7, 5.2.1, 5.2.2 and 6.3.
Prior to adoption of IFRS 16, SIC-15 required that such incentives granted to a lessee are
recognised as a reduction in lease income over the term of the lease. Consequently, they
did not form part of the cost of the investment property (see also 6.6.1 below for the
requirement to adjust the fair value of an investment property to avoid ‘double counting’
in circumstances where a lease incentive exists and is recognised separately). It was
therefore relevant to distinguish between lease incentives and other capital expenditure.
Lease incentives were described in SIC-15 as follows:
‘In negotiating a new or renewed operating lease, the lessor may provide incentives for
the lessee to enter into the agreement. Examples of such incentives are an up-front cash
payment to the lessee or the reimbursement or assumption by the lessor of costs of the
lessee (such as relocation costs, leasehold improvements and costs associated with a
pre-existing lease commitment of the lessee). Alternatively, initial periods of the lease
term may be agreed to be rent-free or at a reduced rent.’ [SIC-15.1].
There was no additional guidance in SIC-15 to assist in the identification of incentives,
but a similar requirement existed in previous United Kingdom GAAP (in UITF
abstract 28 – Operating lease incentives) and provides helpful additional detail:
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property
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‘A payment (or other transfer of value) from a lessor to (or for the benefit of) a lessee
should be regarded as a lease incentive when that fairly reflects its substance. A payment
to reimburse a lessee for fitting-out costs should be regarded as a lease incentive where
the fittings are suitable only for the lessee and accordingly do not add to the value of
the property to the lessor. On the other hand, insofar as a reimbursement of expenditure
enhances a property generally and causes commensurate benefit to flow to the lessor,
it should be treated as reimbursement of expenditure on the property. For example,
where the lifts in a building are to be renewed and a lease has only five years to run, a
payment made by the lessor may not be an inducement to enter into a lease but payment
for an improvement to the lessor’s property.’13
The distinction between costs that enhance the value of the property, and those that
are of value to the tenant, can be seen in Extract 19.2 below.
While IAS 40 does not contain specific guidance on the accounting treatment of initial
direct costs of arranging leases over a property, such as legal and agency fees, such costs
should be recognised as an expense over the term of the resultant lease. This practice
can also be seen in Extract 19.2 below. In practice, this means, if the cost model is used,
such costs are presented as part of the cost of the investment property, even if they do
not strictly form part of it and are then amortised separately over the lease term.
An entity using the fair value model should also initially include these costs as part of
the carrying value of the investment property. However, in our view, at the next
reporting date such initial costs would be recognised in profit and loss in the reported
fair value gain or loss, as they would otherwise exceed the fair value of the related
investment property. This is consistent with the treatment of transaction costs incurred
on acquisition of a property discussed in 6.4 below.
Adding initial direct costs to the carrying amount of the leased property is consistent
with the guidance provided in IFRS 16, as described above. It is also consistent with the
guidance provided in IAS 17 applicable to an entity that holds the leased property in a
lease arrangement, i.e. a lessee in a finance lease and a lessor in an operating lease
(see Chapter 23 at 4 and 5.2). [IAS 17.20, 24, 52].
Extract 19.2: The British Land Company PLC (2015)
NOTES TO THE ACCOUNTS [extract]
1
Basis of preparation, significant accounting policies and accounting judgements [extract]
Net rental income [extract]
Initial direct costs incurred in negotiating and arranging a new lease are amortised on a straight-line basis over the period from the date of lease commencement to the earliest termination date.
Where a lease incentive payment, including surrender premia paid, does not enhance the value of a property, it is
amortised on a straight-line basis over the period from the date of lease commencement to the earliest termination date.
4.10 Contingent
costs
The terms of purchase of investment property may sometimes include a variable or
contingent amount that cannot be determined at the date of acquisition. For example,
the vendor may have the right to additional consideration from the purchaser in the
1376 Chapter 19
event that a certain level of income is generated from the property; or its value reaches
a certain level; or if certain legislative hurdles, such as the receipt of zoning or planning
permission, are achieved.
A common issue is whether these liabilities should be accounted for as a financial
liability or as a provision. This is important because remeasurement of a financial
liability is taken to profit or loss, whilst changes in a provision could, by analogy to
IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities –
be recorded as an adjustment to the cost of the asset.
The Interpretations Committee took this question onto its agenda in January 2011,14 but
in May 2011 chose to defer further work on it until the IASB concluded on its discussions
on the accounting for the liability for variable payments as part of the leases project.15
At its July 2013 meeting, the IASB considered this issue again and noted that the initial
accounting for variable payments affects their subsequent accounting. Some IASB
members expressed the view that the initial and subsequent accounting for variable
payments for the purchase of assets are linked and should be addressed
comprehensively. The IASB noted that accounting for variable payments is a topic that
was discussed as part of the Leases and Conceptual Framework projects and decided
that it would reconsider this issue after the proposals in the Exposure Draft – Leases
(published in May 2013) had been redeliberated.16
The Interpretations Committee revisited this issue at its meetings in September 2015,
November 2015 and March 2016. It determined that this issue is too broad for it to
address within the confines of existing IFRSs. Consequently, the Interpretations
Committee decided not to add this issue to its agenda and concluded that the IASB
should address the accounting for variable payments comprehensively.17
As a result, in May 2016 the IASB tentatively decided to include ‘Variable and
Contingent Consideration’ in its pipeline of future research projects and noted that it
expected to begin work on projects in its research pipeline between 2017 and 2021.18
Until such time as the IASB implements any changes, in our view, the treatment as either
a provision or as a financial liability is a matter of accounting policy choice. Of course,
for investment property held at fair value, this policy choice primarily affects
classification within the income statement.
It is important to note that this policy choice is not available for the contingent costs of
acquiring investment property as part of a business combination. The treatment of
contingent costs in these circumstances is described in Chapter 9 at 7.1.
For more related discussions see Chapter 17 at 4.5 and Chapter 18 at 4.1.9.
4.11 Income from tenanted property during development
An issue that can arise is whether rental and similar income generated by existing
tenants in a property development may be capitalised and offset against the cost of
developing that property.
IAS 16 requires that the income and related expenses of incidental operations are
recognised in profit or loss and included in their respective classifications of income and
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property
1377
expense (see Chapter 18 at 4.2). [IAS 16.21]. We consider that rental and similar income
from existing tenants are incidental operations to the development.
In our view there should not be a measurement difference between the cost of a
property development dealt with under IAS 40 and the cost of development dealt with
under IAS 16. Therefore, rental and similar income generated by existing tenants in a
property dealt with under IAS 40 and now intended for redevelopment should not be
capitalised against the costs of the development. Rather rental and similar income
should be recognised in profit or loss in accordance with the requirements of IFRS 16
(see Chapter 24) or, if not yet adopted, IAS 17 (see Chapter 23), together with related
expenses. For these purposes it is irrelevant whether the investment property is held at
cost or fair value.
4.12 Payments by the vendor to the purchaser
On occasion, a transaction for the purchase of an investment property may include an
additional element where the vendor repays an amount to the purchaser – perhaps
described as representing a rental equivalent for a period of time.
The question then arises whether, in the accounts of the purchaser, this payment should
be recorded as income (albeit perhaps recognised over a period of time) or as a
deduction from the acquisition cost of the investment property on initial recognition.
In our view such amounts are an integral part of the acquisition transaction and should
invariably be treated as a deduction from the acquisition cost of the investment property
because the payment is an element of a transaction between a vendor and purchaser of
the property, rather than a landlord and tenant. In the event that the repayments by the
vendor are spread over time, the present value of those payments should be deducted
from the cost of the investment property and an equivalent receivable recognised
against which those payments are amortised.
5
MEASUREMENT AFTER INITIAL RECOGNITION
Once recognised, IAS 40 allows an entity to choose one of the two methods of accounting
for investment property as its accounting policy (except as noted in 5.1 below):
• fair value model (see 6 below); or
• cost model (see 7 below).
An entity has to choose one model or the other, and apply it to all its investment
property (unless the entity is an insurer or similar entity, in which case there are
exemptions that are described briefly at 5.2 below). [IAS 40.30].
The standard does not identify a preferred alternative; although the fair value model
currently seems to be the more widely adopted model among entities in the real estate
sector (see 7.2 below).
The standard discourages changes from the fair value model to the cost model, stating
that it is highly unlikely that this will result in a more relevant presentation, which is a
requirement of IAS 8 – Accounting Policies, Changes in Accounting Estimates and
Errors – for any voluntary change in accounting policy. [IAS 40.31].
1378 Chapter 19
All entities, regardless of which measurement option is chosen, are required to
determine the fair value of their investment property, because even those entities that
use the cost model are required to disclose the fair value of their investment property
(see 12.3 below). [IAS 40.32, 79(e)].
5.1
Property held under an operating lease
Prior to adoption of IFRS 16, there was an exception to the choice of measurement: a
property interest that was held by a lessee under an operating lease may be classified as an
investment property – provided that the fair value model was applied for the asset
recognised. This classification choice was available on a property-by-property basis
(see 2.1 above) but, once an entity had classified one such property as investment property,
it then had to apply the fair value model to all of its recognised investment properties.
When IFRS 16 became effective in 2019 (see 1.1 above), the classification alternative for
property interests under operating lease is no longer available (see 2.1 above). Under
IFRS 16, if a lessee applies the fair value model in IAS 40 to its investment property, the
lessee will also apply that fair value model to the right-of-use assets that meet the
definition of investment property in IAS 40 (see Chapter 24 at 5.3.1.B). [IFRS 16.34].
Note also that when a lessee uses the fair value model to measure an investment
property that is held as a right-of-use asset, it wil
l measure the right-of-use asset, and
not the underlying property, at fair value. [IAS 40.40A].
5.2
Measurement by insurers and similar entities
There is an exception to the requirement that an entity must apply its chosen
measurement policy to all of its investment properties. This is applicable to insurance
companies and other entities that hold specified assets, including investment properties,
whose fair value or return is directly linked to the return paid on specific liabilities (i.e.
liabilities that are secured by such investment properties).
These entities are permitted to choose either the fair value or the cost model for all such
properties without it affecting the choice available for all other investment properties
that they may hold. [IAS 40.32A]. However, for an insurer or other entity that operates an
internal property fund that issues notional units, with some units held by investors in
linked contracts and others held by the entity, all properties within such a fund must be
held on the same basis because the standard does not permit the entity to measure the
property held by such a fund partly at cost and partly at fair value. [IAS 40.32B].
If an entity elected a model for those properties described above that is different from the
model used for the rest of its investment properties, sales of investment properties between
these pools of assets are to be recognised at fair value with any applicable cumulative change
in fair value recognised in profit or loss. Consequently, if an investment property is sold from
a pool in which the fair value model is used into a pool in which the cost model is used, the
fair value of the property sold at the date of the sale becomes its deemed cost. [IAS 40.32C].
When IFRS 17 is adopted (see 13.1 below), paragraph 32B of IAS 40 (as discussed
above) will be amended. The previous reference to ‘insurers and other entities
[operating] an internal property fund that issues notional units’ will be replaced by
‘[s]ome entities operate, either internally or externally, an investment fund that
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provides investors with benefits determined by units in the fund.’ The revised
paragraph will also refer to entities that issue insurance contracts with direct
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 271