www.pwc.co.uk Applying IFRS for the real estate industry November 2017 Applying IFRS for the real estate industry Contents Introduction to applying IFRS for the real estate industry 1 1. Real estate value chain 2 1.1. Overview of the investment property industry 2 1.2. Real estate life cycle 2 1.3. Relevant accounting standards 3 2. Acquisition and construction of real estate 5 2.1. Overview 5 2.2. Definition and classification 5 2.3. Acquisition of investment properties: asset acquisition or business combination 9 2.4. Asset acquisitions: Measurement at initial recognition 15 2.5. Accounting for forward contracts and options to acquire real estate 18 2.6. Special considerations: investment properties under construction 20 2.7. Accounting for rental guarantees 21 2.8. Development properties: accounting for the costs of construction 23 3. Subsequent measurement of investment property 27 3.1. Costs incurred after initial recognition 27 3.2. Replacement of parts of investment property and subsequent expenditure 28 3.3. Subsequent measurement: Cost model 29 3.4. Impairment 32 3.5. Subsequent measurement: Fair value model 36 3.6. Fair value measurement of investment property: IFRS 13 38 3.7. Change in use of assets: transfers into and out of investment property 45 4. Rental income: accounting by lessors 49 4.1. Overview of guidance 49 4.2. Definition of a lease 49 4.3. Rental income: Lessor accounting 50 4.4. Premiums for properties in a prime location 56 4.5. Surrender premiums 56 4.6. Assumption of potential tenant’s existing lease 57 4.7. Key money 58 4.8. Letting fees 58 4.9. Tenant deposits received 59 4.10. Revenue from managing real estate property 60 4.11. Lease modifications 64 4.12. Revenue recognition: Surrender premium/break costs 65 4.13. Tenant obligations to restore a property’s condition 65 5. Real estate structures and tax considerations 66 PwC Contents Applying IFRS for the real estate industry 5.1. Consolidation 66 5.2. Joint arrangements 72 5.3. Taxation 76 6. Disposal of investment property 83 6.1. Classification as held for sale under IFRS 5 83 6.2. Sale of investment property 83 7. Other reporting issues 86 7.1. Functional and presentation currency 86 7.2. Cash flow statement 88 8. Disclosures 91 8.1. Segment disclosures 91 8.2. IFRS 13 disclosures 96 8.3. Disclosure of fair value for properties accounted for using the cost model 97 PwC Contents Applying IFRS for the real estate industry Introduction to applying IFRS for the real estate industry What is the focus of this publication? This publication considers the main accounting issues encountered by real estate entities and the practices adopted in the industry under International Financial Reporting Standards (IFRS). Who should use this publication? This publication is intended for real estate entities that construct and manage real estate property. Activities such as the construction of properties on behalf of third parties, and holding or developing properties principally for sale or otherwise own use, are not considered in this publication. This publication is intended for: audit committees, executives and financial managers in the real estate industry; investors and other users of real estate industry financial statements, so they can identify some of the accounting practices adopted to reflect features unique to the industry; and accounting bodies, standard-setting agencies and governments throughout the world that are interested in accounting and reporting practices and responsible for establishing financial reporting requirements. What is included? This publication covers issues that we believe are of financial reporting interest due to their particular relevance to real estate entities and/or historical varying international practice. This publication has a number of sections designed to cover the main issues raised. This publication is based on the experience gained from the worldwide leadership position of PwC in the provision of services to the real estate industry. This leadership enables PwC’s Real Estate Industry Group to make recommendations and lead discussions on international standards and practice. We hope you find this publication helpful. PwC 1 Applying IFRS for the real estate industry 1. Real estate value chain 1.1. Overview of the investment property industry The investment property or real estate industry comprises entities that hold real estate (land and buildings) to earn rentals and/or for capital appreciation. Real estate properties are usually held through a variety of structures that include listed and privately held corporations, investment funds, partnerships and trusts. 1.2. Real estate life cycle The life cycle of real estate that is accounted for as investment property typically includes the following stages: Acquisition and Leasing or Sale or Management construction of subleasing of demolition of of real estate 4 1 real estate 2 real estate 3 real estate Step 1: Acquisition and construction of real estate Control of real estate can be obtained through: direct acquisition of real estate; construction of real estate; or leasing of real estate, under either operating or finance leases. Entities normally perform strategic planning before the acquisition, construction or leasing, to assess the feasibility of the project. Entities might incur costs attributable to the acquisition, construction or leasing of real estate, during this first step of the cycle. Entities might also enter into financing arrangements to secure the liquidity required for the acquisition and construction of real estate. Step 2: Leasing or subleasing of real estate Most real estate entities primarily hold real estate for own use or for the purpose of earning rentals. For entities holding real estate for the purpose of earning rentals, lease agreements might contain a variety of terms. The most common terms that will feature in all leases include matters such as the agreed lease term (and any options to extend that term), as well as the agreed rental payments due. Additional items that might feature include payments for maintenance services, insurance, property taxes and terms of lease incentives provided to the tenant. Step 3: Management of real estate Real estate entities often provide management services to tenants who occupy the real estate that they hold, to ensure that the property is in good condition and to preserve the value of the real estate. These services might be performed by the real estate owners themselves, or they might be outsourced to other entities that are designed to provide these services. Services might include maintenance of common areas, cleaning and security. Step 4: Sale or demolition of real estate Real estate entities might sell the real estate that they hold at the end of the life cycle to benefit from capital appreciation. Alternatively, entities might proceed with demolition of the property, potentially with a view to construction of a new property. PwC 2 Applying IFRS for the real estate industry 1.3. Relevant accounting standards Acquisition and construction of real estate that is accounted for as investment property is governed by the requirements of IAS 40, ‘Investment property’, IAS 16, ‘Property, plant and equipment’, and IAS 23, ‘Borrowing costs’. The requirements of IAS 17, ‘Leases’, apply when an entity leases out the real estate property or an entity does not elect to classify its property interest under an operating lease as investment property. The requirements of IAS 18, ‘Revenue’, apply for revenue generated by a real estate entity other than lease income. This publication is based on accounting standards that are effective for periods beginning on or after 1 January 2017. There are a number of new standards, interpretations or amendments to existing standards issued as of the date of this publication that are not yet effective. Their impact is presented in separate sections under each relevant area or otherwise referred to specifically in the guide. The standards, interpretations or amendments are as follows: IFRS 9, ‘Financial Instruments’, which replaces guidance of IAS 39 on classification and measurement of financial instruments (‘IFRS 9’); IFRS 15, ‘Revenue from contracts with customers’, which replaces the guidance in IAS 18, IAS 11, IFRIC 13, IFRIC 15, IFRIC 18 and SIC 31 (‘IFRS 15’); IFRS 16, ‘Leases’, which replaces IAS 17, IFRIC 4, SIC 15 and SIC 27 (‘IFRS 16’); ‘Transfers of investment property’ amendments to IAS 40, ‘Investment Property’; IFRIC 22, ‘Foreign currency transactions and advance consideration’ (‘IFRIC 22’); and IFRIC 23, ‘Uncertainty over income tax treatments’ (‘IFRIC 23’). The following standards, effective as at the date of this publication, are referred to in the guide: IFRS 3, ‘Business combinations’ (‘IFRS 3’); IFRS 5, ‘Non-current assets held for sale and discontinued operations’ (‘IFRS 5’); IFRS 7, ‘Financial instruments: disclosures’ (‘IFRS 7’); IFRS 8, ‘Operating segments’ (‘IFRS 8’); IFRS 10, ‘Consolidated financial statements’ (‘IFRS 10’); IFRS 11, ‘Joint arrangements’ (‘IFRS 11’); IFRS 13, ‘Fair value measurement’ (‘IFRS 13’); IAS 1, ‘Presentation of financial statements’ (‘IAS 1’); IAS 2, ‘Inventories’ (‘IAS 2’); IAS 7, ‘Statement of cash flows’ (‘IAS 7’); IAS 8, ‘Accounting policies, changes in accounting estimates and errors’ (‘IAS 8’); IAS 11, ‘Construction contracts’ (‘IAS 11’); IAS 12, ‘Income taxes’ (‘IAS 12’); IAS 16, ‘Property, plant and equipment’ (‘IAS 16’); IAS 17, ‘Leases’ (‘IAS 17’); IAS 18, ‘Revenue’ (‘IAS 18’);