Investment properties are initially recognized at cost including all directly attributable expenditure incurred to acquire the property. Subsequently, one of the following two models can be adopted for their accounting, and whichever model is chosen, it must be applied to all the investment properties of an entity.
- Cost model
- Fair value model
Let’s discuss both models for subsequent accounting of investment properties.
Under the cost model, investment properties are carried in the books of account at cost less accumulated depreciation and accumulated impairment losses, if any. As land is not depreciated due to its nature, so it is carried in the books of account at cost less accumulated impairment losses, if any.
Investment property = Cost – accumulated depreciation – accumulated impairment losses
Cost model of investment properties has exactly the same requirement as the cost model of property, plant and equipment.
Fair value model
Under the fair value model, investment properties are revalued at each year end or reporting date and the fair valuation gain or loss is recorded in the income statement. No depreciation is charged under fair value model.
Fair value model of investment properties requires that the fair valuation gains should be recorded in the income statement, contrary to the revaluation model of property, plant equipment, which requires that fair valuation gains should be recorded as other comprehensive income and taken to revaluation surplus reserve.
Now, let’s take a look at the following example to further clarify our concepts regarding both cost model and fair value model.
Company XYZ has purchased a building on 1 January 20×0 for $100,000 with an estimated useful life of 10 years. The company aims to earn rental income from this building. Building remained vacant for the first three months. From 1 April 20×0, the building was rented out to another entity for $5,000 per month. The term of this rent agreement was 2 years. At the end of the year, fair valuation exercise was done and the building’s fair value on 31 December 20×0 was $107,000.
Let’s prepare extracts of balance sheet and income statement under both cost model and fair value model.