Difference Between IAS 40 Under Going Concern and IAS 40 Under Liquidation

Introduction

IAS 40, “Investment Property,” outlines the accounting treatment for investment property and provides guidance on the measurement and disclosure of such properties. This report explores the key differences in applying IAS 40 under a going concern assumption and during liquidation.

IAS 40 Under Going Concern

Core Principle

Under IAS 40, investment property is property (land or a building—or part of a building—or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for use in the production or supply of goods or services or for administrative purposes, or sale in the ordinary course of business.

Recognition

Investment property is recognized as an asset when it is probable that the future economic benefits associated with the property will flow to the entity and the cost of the property can be measured reliably.

Example: A company purchases a commercial building for R10,000,000 to earn rental income and recognizes it as an investment property.

Measurement

Investment property can be measured using either the cost model or the fair value model after initial recognition:

• Cost Model: Investment property is carried at cost less accumulated depreciation and any accumulated impairment losses.

• Fair Value Model: Investment property is carried at fair value, with changes in fair value recognized in profit or loss.

Example: A company uses the fair value model and revalues its investment property annually. If the fair value increases from R10,000,000 to R11,000,000, the company recognizes a gain of R1,000,000 in profit or loss.

Rental Income and Expenses

Rental income from investment property is recognized on a straight-line basis over the lease term. Operating expenses, including maintenance and repairs, are recognized as an expense when incurred.

Example: A company earns R500,000 in rental income from its investment property and incurs R100,000 in operating expenses. The net rental income of R400,000 is recognized in profit or loss.

Disclosure

Entities must disclose the methods and significant assumptions applied in determining the fair value of investment property, the extent to which the fair value of investment property is based on a valuation by an independent valuer, and the amounts recognized in profit or loss.

Example: A company discloses that the fair value of its investment property is determined by an independent valuer using market comparables.

IAS 40 Under Liquidation

Core Principle

During liquidation, the primary objective is to sell investment property quickly to maximize cash flows. The measurement focus shifts to the expected liquidation proceeds rather than ongoing rental income and long-term capital appreciation.

Recognition

The recognition criteria for investment property remain the same, but the urgency to realize cash flows may impact decisions related to holding and disposing of properties.

Example: A company in liquidation continues to recognize its investment property but focuses on preparing it for sale.

Measurement

Under liquidation, investment property is measured at the lower of carrying amount and fair value less costs to sell. This conservative approach ensures that the assets are not overstated and reflects the urgency of liquidation sales.

Example: A company in liquidation has an investment property with a carrying amount of R10,000,000. The estimated fair value less costs to sell is R9,000,000. The carrying amount is adjusted to R9,000,000 to reflect the lower fair value less costs to sell.

Rental Income and Expenses

During liquidation, the focus shifts from earning rental income to selling the property. Rental agreements may be terminated or renegotiated to facilitate the sale. Any rental income and related expenses are recognized up to the point of sale.

Example: A company in liquidation earns rental income of R300,000 and incurs R50,000 in expenses up to the sale of its investment property. These amounts are recognized in profit or loss.

Impairment

Frequent reassessment of investment property values is necessary to reflect the lower expected disposal values. Impairment losses are more likely to be recognized as properties are written down to their recoverable amounts.

Example: A company in liquidation reassesses its investment property and recognizes an impairment loss of R1,000,000 if the fair value less costs to sell is lower than the carrying amount.

Liquidation Proceeds

During liquidation, investment properties are measured at the lower of carrying amount and the liquidation proceeds. This value is often lower due to forced sale conditions and the urgency to liquidate assets quickly.

Example: A company sells its investment property with a carrying amount of R8,000,000 for R7,000,000 in a liquidation auction. The carrying amount is adjusted to reflect the lower sale proceeds.

Disclosure

Disclosure requirements remain critical under liquidation, but the focus shifts to providing information about the sale of investment properties, changes in fair value assessments, and the impact on financial statements.

Example: A company discloses the sale of its investment property, the proceeds from the sale, and any adjustments made to the carrying amount due to the liquidation process.

Conclusion

The application of IAS 40 under a going concern assumption and during liquidation involves the same fundamental principles but different practical considerations. Under going concern, the focus is on sustainable rental income and capital appreciation, with measurement at fair value or cost. In contrast, during liquidation, the emphasis shifts to immediate realization of investment properties at expected liquidation proceeds, reflecting the urgency to generate cash flows. Entities must carefully reassess their investment property values and write-downs to ensure accurate and transparent financial reporting during liquidation. This adjustment ensures that stakeholders receive a true and fair view of the entity’s financial position and performance during the liquidation process.

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