INVESTMENT PROPERTIES (PAS 40)

Investment property-property held to earn rentals or for capital appreciation (increase in

value), rather than for: a. use in the production or supply of goods or services or for
administrative purposes; or b. sale in the ordinary course of business. [Note: For the
meantime, the focus is on the property itself. In addition, it will be assumed that the property is
owned by the entity.] In Philippine setting, well-known investment properties are held by real
estate developers, Ayala Land, Inc. and SM Investments. Ex. shopping malls, public
markets, buildings for rent as office spaces, and apartment buildings, provided these
assets are rented out to merchants, vendors, companies and tenants, respectively (collectively,
the lessees). The ff. characteristics made these assets classified as investment properties:
a. Rental income are cash flows which are independently generated from these assets,
without using these assets in conjunction with other assets.
b. Rental income is earned by incurring minimal efforts as the owner will just let the
lessee/s to use the property to become entitled (i.e. passive income).
In contrast with factory building, which is considered as an owner-occupied property because
of the ff. characteristics:
a. It cannot generate cash flows on its own as it is used to house (i.e. conjunction with)
equipment and other machineries to collectively produce goods. These goods, in turn, will be
sold and cash will be generated.
b. The income from selling the goods requires the active involvement of the owner in
creating these goods through a manufacturing process.
Investment Properties Vs. Property, Plant and Equipment

Investment Property Owner-occupied property

Purpose/s Either or both of the ff:One of the ff:
a. to earn rentals; or a. for use in the production or
b. for capital appreciation
supply of goods or services; or
b. for administrative purposes
Assets covered Generally, land and/or Land, building, and other
building only movables (e.g. equipment)
Generation of cash flows Largely independent of Dependent on the collective
the other assets held by use of other assets held by the
the entity. entity.
Nature of income from the Passive Active
property
The ff. are the other examples of investment properties:
a. Land held for long-term capital appreciation rather than for short-term sale in the ordinary
course of business.
b. Land held for a currently undetermined future use. If an entity is not sure what to do with
the land, it is assumed that the land is held for capital appreciation.
c. A building owned by the entity (or a right-of-use asset relating to a building held by the entity)
and leased out under one or more operating leases.
d. A building that is vacant but is held to be leased out under one or more operating leases.
e. Property that is constructed or developed for future use as investment property.
The following are other examples of items that are not investment property:
a. Property intended for sale in the ordinary course of business or in the process of
construction or development for such sale, for example, property acquired exclusively with a
view to subsequent disposal in the near future or for development and resale.
b. Owner-occupied property, including, among other things:
i. Property held for future use as owner-occupied property;
ii. Property held for future development and subsequent use as owner-occupied property;
iii. Property occupied by employees (whether or not the employees pay rent at market rates);
and
iv. Owner-occupied property awaiting disposal.
c. Property that is leased to another entity under a finance lease.
d. Movables (e.g. equipment, vehicle) leased to another entity.
Illustration 1. Villareal Company owns a wide range of assets. As of yearend, it accumulated
the following properties:
Equipment leased out under operating lease P 800,000 OO
Land acquired for undetermined future use 2,000,000 IP
Land acquired as a future site of a factory 1,500,000 OO
 Building rented out to other entities 900,000 IP
Building used as the headquarters 1,050,000 OO
Apartment rented out to employees who pay market rents 700,000 OO
Required: Classify the investment properties and owner-occupied properties

OTHER ISSUES REGARDING PROPERTY CLASSIFICATION

In practice, there are also circumstances wherein a high degree of judgment is needed when
classifying an investment property. These are the following:
a. Ancillary Services b. Dual-use properties c. Lease between and among
parent company and subsidiaries

ANCILLARY SERVICES
It was previously mentioned that rental income is a passive form of income. This does not
mean that the entity should be absolutely hands-off with the property for it to qualify as an
investment property. It will boil down to whether the additional services an entity provides
are significant to the arrangement as a whole.

Ancillary services are:

Significant Insignificant
An entity treats such property as owner- An entity treats such property as investment
occupied property if the services are property if the services are insignificant to
significant to the arrangement as a whole. the arrangement as a whole.

An example of which is an owner-managed An example is when the owner of an office

hotel building provides security and maintenance
services to the lessees who occupy the
building.

However, the readers should not take this to mean that all hotels are not investment properties.
A hotel may be classified as an investment property in the perspective of the owner if the
owner rents it out to a hotel operator. In this case, the owner serves as a passive investor
that will receive periodic rental income from the hotel operator.
DUAL-USE PROPERTIES
It may also be possible that a portion of the property is rented out to lessees and /or held for
capital appreciation, and some portion re held for use in the production or supply of goods or
services or for administrative purposes (i.e. owner-occupied). An example of this scenario is an
office building that is partly occupied by the owner for use as its headquarters and also partly
rented out to lessees. In accounting for this scenario, it is important to first determine whether
the portions can be sold separately or leased out separately under a finance lease (i.e.
separable). A finance lease or capital lease is a financial product, in which a leasing company
gives operating control of an asset to a business for an agreed period, and typically at the end
of the contract, the lessee will become the owner of the asset at the end of the lease, and both
parties share some of the economic risks ...
Separable Not Separable
The portion rented out is classified as a. The whole property is investment
investment property while the remaining property only if an insignificant portion is
portion is classified as owner-occupied owner-occupied; or
property (i.e. account for portions b. The whole property is owner-occupied
separately). property only if an insignificant portion is
rented out or held for capital appreciation.
In practice, the allocation is mainly based on The assessment regarding the significance or
the relative floor space occupied by insignificance of apportion requires judgment.
investment property and owner-occupied
portions.

Illustration 2. BARCELONA Company owned the following properties at the start of 2023, its
first year of operations;
Property Amount
Office building A with a total floor space of 10,000 sq.m.,4,000
of which are occupied by the Company and the remaining is
leased out to other entities. The portions are separable. P3,000,000
Office building B with a total floor space of 15,000 sq. m., 1,000 of
which are leased out to other entities. The portions are not separable.
The Company considers at least 80% of the total floor space as
significant. 2,000,000
Shopping mall with a total floor space of 5,000 sq.m.,4,500 of which
are leased out to other entities. The portions are not separable. 4,000,000

Required: From these properties, determine the amount allocated to investment properties and
owner-occupied properties.
Solution:
1. First, compute for the relative percentages of floor space that is owner-occupied and rented
out to other entities and decide which portion/s is/are investment properties or owner-occupied:
Properties Separable? %Investment %Owner- Final Verdict
Property Occupied
Office Building A Yes 60% 40% 60% Inv. Prop.
(6,000/10,000) (4,000/10,000) 40% Own-Occ
Office Building No 6.67 93.33% 100% Owner-
(1,000/15,000) (14,000/15,000) occupied
Shopping Mall No 90% 10% (500/5,000) 100%
(4,500/5,000) Investment
Property
The significance assessment is based on 80% of the total space.

2. Based on the assessment in Step 1, the following classifications can be made:

Investment property Owner-Occupied
Office Building A
P3,000,000 x 60% P1,800,000
P3,000,000 x 40% P1,200,000
Office Building B 2,000,000
Shopping Mall 4,000,000
Total P 5,800,000 P3,200,000

Note: The significance assessment is not applicable to Office Building A since its portions are
separable.

LEASE BETWEEN AND AMONG PARENT COMPANY AND SUBSIDIARIES

In some cases, an entity owns property that is leased to and occupied by its parent, its
subsidiary or another subsidiary within the same group. The classification of the property
will depend on the relevant financial statements:
Separate Financial Statements Consolidated Financial Statements
The property is classified as Investment The property is classified as owner-
property since, in this perspective, the occupied property since in this perspective,
occupants of the property are third parties. the occupants (i.e., the subsidiaries) together
with the parent company are considered as a
“single economic entity”.

Illustration 3. MADRID Company had the following properties at the end of 2023
Property Carrying Amount
Office Space A rented out to unrelated companies P900,000
Office Space B rented out to a subsidiary 750,000
Equipment A rented out to a subsidiary 250,000
Equipment B rented out to unrelated companies 500,000

Requirement: Classify the properties as individual (separate) and consolidated FS.

These properties are classified in MADRID Company’s individual (separate) and consolidated
financial statements as follows:
Individual FS Consolidated FS_____
Investment Property Owner-Occupied Inv. Property Owner-Occupied
Office Space A P900,000 P900,000
Office Space B 750,000 P750,000
Equipment A P250,000 250,000
Equipment B 500,000 500,000
Totals P1,650,000 P750,000 P900,000 P1,500,000

Note: The equipment regardless to whom it is leased out, will always be classified as owner-
occupied property.
INITIAL RECOGNITION AND MEASUREMENT
An investment property shall be recognized as an asset when, and only when:
a. It is probable that the future economic benefits that are associated with the investment
property will flow to the entity; and
b. the cost of the investment property can be measured reliably.

An owned investment property shall be measured initially at its cost. Transaction costs shall
be included in the initial measurement. Similar with PPE, an investment property can also be
purchased, constructed, exchanged, etc. Accordingly, the initial measurement of PPE and
subsequent costs are still relevant in determining the initial measurement of investment
property.

SUBSEQUENT MEASUREMENT
Generally, an entity shall choose as its accounting policy either the fair value model or the
cost model and shall apply that policy to all of its investment property.

Cost Model Fair Value Model

Accounted under the cost model in PAS 16 Investment properties are measured at
their fair values. Changes in the fair
values shall be recognized in profit or loss
during the period of change. The property is
not subject to depreciation.

Generally, an entity may use either fair value model or cost model but not both. In other
words, generally, an entity cannot voluntarily apply fair value model to one of its investment
properties and at the same time apply the cost model to another investment property or vice
versa. Unlike in PPE, there is no “per class” application of the accounting policy to the
entity’s investment properties.

This is done to prevent manipulation of an entity’s financial position and/or performance by

cherry-picking the application of both models to allow the entity to report the most advantageous
amounts.

An entity may change from one model to another if the change results in the financial
statements providing reliable and more relevant information. However, it is highly unlikely that a
change from the fair value model to the cost model will result in a more relevant presentation.

In determining the carrying amount of investment property under the fair value model, an
entity shall not double-count assets or liabilities that are recognized as separate assets or
liabilities. For example:
a. Equipment such as lifts or air-conditioning is often an integral part of a building and is
generally included in the fair value of the investment property, rather than recognized
separately as PPE.
b. If an office is leased on a furnished basis, the fair value of the office generally includes
the fair value of the furniture because the rental income relates to the furnished office. When
furniture is included in the fair value of an investment property, an entity does not recognize
that furniture as a separate asset.
c. The fair value of investment property excludes prepaid or accrued operating lease
income because the entity recognizes it as a separate liability or asset.

Illustration 4 – Cost Model vs Fair Value Model. On January 1, 2023, SEVILLA Company
acquired a building to be used as an investment property for P4,000,000. The building has a
useful life of five years and residual value of nil. As of December 31, 2023, 2024, and 2025, the
fair values of the building were P4,500,000, P4,200,000, and P4,600,000, respectively.

Journal entries under both cost model and fair value model:
Cost Model Fair Value Model
On January 1, 2023, to record the acquisition On January 1, 2023, to record the acquisition
of the property: of the property:

Investment property - 4,000,000 Investment property – 4,000,000

Cash 4,000,000 Cash 4,000,000

On December 31, 2023, to record the annual On December 31, 2023, to record the
depreciation (P4M/5 yrs.): P500,000 increase in fair value (P4,500,000-
P4,000,000):
Depreciation expense - 800,000 Investment property 500,000
 Accum. Depreciation 800,000 Unrealized gain – P/L 500,000

On December 31, 2024, to record the annual On December 31, 2024, to record the
depreciation (P4M/5 yrs.): P300,000 decrease in fair value (P4,200,000-
P4,500,000):
Depre. Expense 800,000 Unrealized loss – P/L 300,000
Accum. Depreciation 800,000 Investment property 300,000
On December 31, 2025, to record the annual On December 31, 2025, to record the
depreciation (P4M/5 yrs): P400,000 increase in fair value (P4,600,000-
P4,200,000):
Depre. Expense 800,000 Investment property 400,000
Accum. Depreciation 800,000 Unrealized gain-P/L 400,000

By analogy, accounting under fair value model is very similar to the accounting for financial
assets at FVTPL (fair value through profit or loss), wherein the changes in fair values are
recognized in the entity’s profit or loss.

Comparing the Cost and Fair Value Models

The carrying amounts of the property under the two methods are the following:
December 31 2023 2024 2025
Cost Model P3,200,000 P2,400,000 P1,600,000
Fair value model 4,500,000 4,200,000 4,600,000

The reported amounts in profit or loss under the two methods are the following:
Profit or Loss 2023 2024 2025
Cost model – depreciation expense P800,000 P800,000
P800,000
Fair value model – unrealized gains (losses) 500,000 (300,000) 400,000

Based on these comparisons, the following differences can be summarized:

Aspects Cost Model Fair Value Model
Carrying amount of property Decreases steadily because Fluctuates in accordance
of depreciation with changes in fair values
Amounts reported in profit or Depreciation expense and Unrealized gains and losses
loss impairment loss, if any from changes in fair values

SALE OF INVESTMENT PROPERTIES

Same with PPEs, any difference between the carrying amount of investment property at the
time of sale and the proceeds received is reported as gain or loss on sale.

Illustration 5. Going back to SEVILLA Company (Illustration 4), assume that the building was
sold on January 1, 2026 for P4,750,000. In this case, under each model, the carrying amounts
to be used shall be as of December 31, 2025.

Journal entries to record the sale under cost model and fair value model:
Cost Model Fair Value Model
Cash 4,750,000 Cash 4,750,000
Accum. Depn* 2,400,000 Investment property 4,600,000
Investment property 4,000,000 Gain on sale – P/L 150,000
Gain on sale – P/L 3.150,000
*P800,000 x 3 yrs from 2023-2025

Note: There is a much higher amount of gain on sale under cost model since its carrying
amount is much lower.

EXCEPTIONS TO THE GENERAL RULE OF APPLYING ONLY ONE MODEL TO ALL

INVESTMENT PROPERTIES
The following are the exceptions to the general rule of applying either the fair value model or
cost model to all of an entity’s investment properties:
a. If an entity uses fair value model and its unable to measure the fair value of one or some
of its investment properties in a continuing basis.
b. Existence of investment properties backing liabilities that pay a return linked directly to the
fair value of, or returns from, specified assets including that investment property, normally in
mutual funds.

INABILITY TO MEASURE THE FAIR VALUE IN CONTINUING BASIS

There is a rebuttable presumption that an entity can reliably measure the fair value of an
investment property on a continuing basis. This rebuttable presumption is applicable only
at the initial recognition because if an entity has previously measured an investment property
at fair value, then it shall continue to measure the property at fair value.

The fair value of the investment property is not reliably measurable on a continuing basis when,
and only when:
a. The market for comparable properties is inactive; and
b. Alternative reliable measurements of fair value are not available.

If an entity determines that the fair value of an investment property in general is not reliably
measurable on a continuing basis, the entity shall measure that investment property using the
cost model (i.e. to be depreciated) until its disposal. The residual value of the investment
property shall be assumed to be zero.

For investment property under construction, with the expectation that its fair value will be
reliably measurable in the future, the same should be measured at cost (i.e., not to be
depreciated) until the earlier of the following:
a. Its fair value becomes reliably measurable; or
b. Construction is completed.
However, if upon completion, the fair value of the constructed investment property cannot be
reliably measured, an entity shall apply the cost model.

Illustration 6. On January 1, 2023, SEVILLA Company, who uses fair value model in its
investment properties, acquired three depreciable investment properties with following relevant
information:
Total Cost Useful Life Residual Value FV Reliably Measurable?
Building A P2,500,000 7 years P500,000 Yes
Building B 3,000,000 5 years 200,000 No
Building C 3,500,000 4 years 300,000 Yes

(P3,400,000P3,400,000, respectively.

On January 1, 2023, the entry to record the acquisition is as follows:

Investment property – Building A 2,500,000
Investment property - Building B 3,000,000
Investment property - Building C 3,500,000
Cash 9,000,000

Since the fair value of Building B cannot be reliably measured on a continuing basis, the cost
model will be applied for this asset only. Annual depreciation expense of P600,000
(P3,000,000/5 yrs.) will be recorded. In accordance with PAS 40, residual value is
considered to be zero, even if there is a given P200,000 amount.

Although the Company may use the cost model for one investment property, the entity shall
continue to account for each of the remaining properties with reliably measurable fair values
using the fair value model.

On December 31, 2023 depreciation of Building B shall be recorded as follows:

Depreciation expense – Building B 600,000
Accum. Depreciation- Building B 600,000

To record the P250,000 (P2,750,000-P2,500,000) increase in fair value of Building A, and

P100,000 (P3,400,000 – P3,500,000) decrease in fair value of Building C, respectively:
Investment property – Building A 250,000
Unrealized gain – P/L 250,000

Unrealized loss – P/L 100,000

Investment property – Building C 100,000

The total carrying amount of investment properties as of December 31, 2023 is as follows:
Building A (at FV) P2,750,000
Building C (at FV) 3,400,000
Building B (at cost) 3,000,000
Accum. Depreciation- Building B (600,000)
Total carrying amount P8,550,000

INVESTMENT PROPERTIES IN MUTUAL FUNDS

If an entity maintains a separate mutual fund and that fund contains investment properties, an
entity shall split its investment properties into two pools:
a. Investment properties in mutual funds (Pool 1); and
b. All other investment properties (Pool 2).

An entity may apply either fair value model or cost model in all of investment properties in one
pool and may also apply either model in another pool, regardless of the choice made in the
other pool.

For example, if fair value model is applied to Pool 1, an entity still has a choice between fair
value model and cost model to Pool 2 (i.e. not required to apply fair value model in Pool 2).
This is yet another exception to the general rule that only one model shall be applied to all of an
entity’s investment properties.

SUBSEQUENT MEASUREMENT COMPARISON WITH PPEs

It should be recalled that PPEs (i.e., owner-occupied properties) are subsequently accounted for
using either the cost model and the revaluation model.

If an entity uses revaluation model for its PPEs and fair value model for its investment
properties, issues may arise if an asset is misclassified between these two asset categories. If
an asset that should be classified as PPE is misclassified as investment property, changes in its
fair value will be incorrectly reported in profit or loss, instead in OCI in the form revaluation
increase or decrease.

On the other hand, issues may also arise if an entity uses cost model for its PPEs and fair
value model for investment properties. If an asset, that should be classified as PPE, is
misclassified as investment property, changes in its fair value will be recognized in profit and
loss, instead of not recognizing it at all (i.e. cost model does not recognize changes in FV).

These are the main reasons why considerable concept discussions were earlier made in
classifying assets as investment property or as an owner-occupied property.