Introduction
Investment property is an essential component of financial reporting, particularly for businesses engaged in real estate investment. Under IFRS (International Financial Reporting Standards), investment properties are accounted for using either the cost model or the fair value model. The fair value model is widely used because it provides a more transparent reflection of an asset’s market value. In this article, I will discuss how investment properties are accounted for using the fair value model, including detailed journal entries and calculations.
What is the Fair Value Model?
The fair value model under IAS 40 (Investment Property) requires that investment properties be measured at their fair value at each reporting date, with changes recognized in the income statement. Unlike the cost model, which accounts for depreciation, the fair value model ensures that properties are always recorded at their current market value.
Initial Recognition of Investment Property
When an investment property is acquired, it is initially recorded at cost, which includes the purchase price and directly attributable expenses such as legal fees, taxes, and professional fees.
Journal Entry for Initial Recognition
Assume I purchase an investment property for $500,000, incurring $20,000 in legal and transaction fees.
\text{Investment Property (Asset)} \quad \text{Dr} \quad 520,000 \text{Cash (Asset)} \quad \text{Cr} \quad 520,000Subsequent Measurement at Fair Value
Under the fair value model, investment property is remeasured at each reporting date. The difference between the new fair value and the carrying amount is recognized as a gain or loss in the income statement.
Example of Fair Value Gain
Suppose that after one year, the market value of the property increases to $550,000. The gain is recorded as follows:
\text{Investment Property (Asset)} \quad \text{Dr} \quad 30,000 \text{Fair Value Gain (Income Statement)} \quad \text{Cr} \quad 30,000Example of Fair Value Loss
If, instead, the market value decreases to $480,000, a fair value loss is recorded:
\text{Fair Value Loss (Income Statement)} \quad \text{Dr} \quad 40,000 \text{Investment Property (Asset)} \quad \text{Cr} \quad 40,000Disposal of Investment Property
When an investment property is sold, any difference between the selling price and its carrying amount is recorded as a gain or loss.
Example of Property Sale
Assume I sell my investment property for $600,000. At the time of sale, the recorded fair value is $550,000.
\text{Cash (Asset)} \quad \text{Dr} \quad 600,000 \text{Investment Property (Asset)} \quad \text{Cr} \quad 550,000 \text{Gain on Sale of Property (Income Statement)} \quad \text{Cr} \quad 50,000Comparing Fair Value Model with Cost Model
| Aspect | Fair Value Model | Cost Model |
|---|---|---|
| Measurement | Market-based valuation | Historical cost minus depreciation |
| Income Statement Impact | Gains/losses recognized immediately | Depreciation expense recorded |
| Transparency | High, reflects real-time market value | Lower, may not reflect current market value |
| Complexity | Requires professional valuation | Easier to implement |
Valuation Methods for Fair Value Measurement
Under IFRS 13 (Fair Value Measurement), fair value is determined using three primary methods:
1. Market Approach
Uses market prices of similar properties as reference points.
2. Income Approach (Discounted Cash Flow – DCF)
This approach calculates fair value based on expected future cash flows discounted to present value:
FV = \sum \frac{CF_t}{(1+r)^t} + \frac{TV}{(1+r)^n}Where:
- CF_t = Cash flow at time tt
- r = Discount rate
- TV = Terminal value
3. Cost Approach
Based on the estimated cost of replacing the asset, adjusted for depreciation.
Challenges of Using the Fair Value Model
- Volatility: Frequent revaluations can create fluctuations in financial statements.
- Subjectivity: Fair value relies on estimates, which may introduce bias.
- Valuation Costs: Requires professional appraisal, adding to expenses.
Conclusion
The fair value model provides a transparent and market-reflective method for accounting for investment properties. However, it comes with complexities such as valuation challenges and income statement volatility. Understanding journal entries, valuation methods, and financial statement impacts helps investors and accountants make informed decisions. By applying IFRS 13 and IAS 40 principles correctly, businesses can ensure accurate financial reporting and compliance with international accounting standards.
