Definition of an investment property: a group of assets leased out under a single operating lease
A Lessor enters into the following two single contract leases in order to earn rentals. All the individual assets subject to the leases meet the test of being classified as an operating lease. The lessor applies the fair value measurement model for subsequent measurement of investment property.
Lease 1: Vineyard and winery
A vineyard including a winery is leased out under an operating lease. The vineyard comprises the following assets:
- Land;
- Vineyard infrastructure (e.g. trellises) ;
- Winery building structures;
- Winery plant and machinery (crushing equipment, distilling equipment);
- Vines (grapes are excluded, as they belong to the lessee).
Lease 2: Port
A port is leased out under an operating lease. The port comprises the following assets:
- Land;
- Warehouses;
- Transport infrastructure to and from the port (roads, rail tracks, bridges);
- Wharves;
- Light towers (that enable the 24 hour operation of the port);
- Specialised container cranes.
To what extent can the ‘other assets’ included in the leases (but which are not considered to constitute a piece of land or a building) be included in the investment property definition under IAS 40?
The consequence of including plant and equipment in the definition of investment property is that if the investment property is accounted for at fair value, changes in the fair value of that plant and equipment will be recognised in profit or loss.
From a literal reading of the definition of an investment property it could be argued that an investment property can consist only of a building (or part of a building), a piece of land, or both and cannot include ‘other assets’. However, such a reading of paragraph 5 of IAS 40 is inconsistent with paragraph 50 of IAS 40, which implies that a broader interpretation is more appropriate. Paragraphs 50(a) and (b) of IAS 40 read as follows:
‘In determining the fair value of investment property, an entity does not double-count assets or liabilities that are recognised 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 recognised separately as property, plant and equipment.
(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 investment property, an entity does not recognise that furniture as a separate asset.’
Although paragraph 50 addresses the fair valuation of investment property, it nevertheless implies that other assets that are integral to the land and buildings should also be regarded as being part of the investment property.
Consequently, in our view, an item other than a piece of land or a building should be regarded by a lessor as being part of an investment property if this item is an integral part of it, that is, it is necessary for the land and buildings to be used by a lessee in the intended way and is leased to the lessee on the same basis (e.g. over the same lease term) as the land and buildings. The determination as to whether or not an item constitutes an integral part of an investment property requires judgement and will depend on the particular facts and circumstances. However, it is our view that in order for all the assets to be classified as investment property, the following conditions should be present:
- the land and buildings should be the ‘dominant assets’ that form the investment property;
- the ‘other assets’ are leased to the lessee together with the land and building as a whole; and
- the entire group of assets is generating the income stream from the lease contract.
This means that, in the case of Lease 1, the investment property comprises the land, the vineyard infrastructure, the winery building structures and the winery plant and machinery. Vines, which meet the definition of biological assets, are subject to the requirements of IAS 41. This is because ‘biological assets related to agricultural activity’ are outside the scope of IAS 40. [IAS 40.4(a)].
In the case of Lease 2, the investment property comprises all of the assets – i.e. the land, the warehouses, the transport infrastructure, the wharves, the light towers, and the specialised container cranes.