DipIFR Syllabus B. Elements of financial statements - IAS 40 Investment property Part 1 - Past Papers ^{13 / 15}

You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS® Standards). The financial statements for the year ended 30 September 2018 are due to be published shortly. A trainee accountant who is assigned to your department is reviewing the financial statements as part of a training exercise. She has prepared a list of queries arising out of this review.

Query One
When I look at the statement of financial position, one of the categories of non-current assets is ‘investment properties’ and another category is ‘property, plant and equipment’ – in which all other properties are included. Surely we invest in all our properties, so why have two categories for them in the statement of financial position? How do we decide what goes where?

A note to the financial statements states that investment properties are measured at their fair values and not depreciated. Don’t all non-current assets have to be depreciated over their estimated useful lives? Another note states that property included in property, plant and equipment is measured at cost less accumulated depreciation rather than at fair value. Shouldn’t all properties be measured in the financial statements on a consistent basis?

Finally, I can’t immediately see from the financial statements where the gains or losses relating to the measurement of investment properties are included. The profit statement seems to include two main components – profit or loss and other comprehensive income. Where would the gains or losses go? Presumably the treatment of gains and losses is the same for any non-current assets which are measured at fair value? (10 marks)

Required:
Provide answers to the queries raised by the trainee. You should justify your answers with reference to relevant IFRS Standards.

Note: The mark allocation is shown against each of the three queries above.

(b) Epsilon prepares financial statements to 31 March each year. The following events have occurred which are relevant to the year ended 31 March 2017:

(i) On 1 April 2016, Epsilon purchased a new head office property for $60 million. On 1 April 2016, Epsilon leased out the top three floors of the property to a third party on a long-term operating lease. The annual rental receivable by Epsilon was $2 million, starting on 31 March 2017. The top three floors of the property were capable of being sold in a separate transaction. On 1 April 2016, the directors of Epsilon estimated that the initial cost of the property should be allocated as follows for accounting purposes:

On 31 March 2017, the property had an estimated total fair value of $64 million. The directors consider that 25% of this fair value was attributable to the top three floors of the property. The directors of Epsilon wish to use the cost model for measuring property, plant and equipment and the fair value model for measuring investment property. Epsilon depreciates the buildings component of properties over an estimated useful life of 50 years, with no estimated residual value. The rental payable to Epsilon on 31 March 2017 was paid in accordance with the terms of the lease. (8 marks)

(ii) On 1 April 2016, Epsilon purchased a brand from a competitor for an agreed price of $80 million. The directors of Epsilon believe that the useful life of the brand is indefinite. On 31 March 2017, no reliable estimate of its selling price was available but the directors of Epsilon estimated that the value in use of the brand was $85 million. The directors of Epsilon wish to use the fair value model for measuring intangible assets whenever permitted by International Financial Reporting Standards. (5 marks)

Required:
Explain and state how the two events should be reported in the financial statements of Epsilon for the year ended 31 March 2017.

Note: The mark allocation is shown against each of the two events above.

You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS). You have recently produced the final draft of the financial statements for the year ended 30 September 2016 and these are due to be published shortly. The managing director, who is not an accountant, reviewed these financial statements and prepared a list of queries arising out of the review.

Query Two
The notes to the financial statements say that plant and equipment is held under the ‘cost model’. However, property which is owner occupied is revalued annually to fair value. Changes in fair value are sometimes reported in profit or loss but usually in ‘other comprehensive income’. Also, the amount of depreciation charged on plant and equipment as a percentage of its carrying amount is much higher than for owner occupied property. Another note says that property we own but rent out to others is not depreciated at all but is revalued annually to fair value. Changes in value of these properties are always reported in profit or loss. I thought we had to be consistent in our treatment of items in the accounts. Please explain how all these treatments comply with relevant reporting standards. (7 marks)

Required:
Provide answers to the queries raised by the managing director.

Note: The mark allocation is shown against each of the four queries above.

Epsilon prepares financial statements to 31 March each year. The rate of income tax applicable to Epsilon is 20%. The following information relates to transactions, assets and liabilities of Epsilon during the year ended 31 March 2016:

(i) Epsilon has an investment property which it carries under the fair value model. The property originally cost $30 million. The property had an estimated fair value of $35 million on 31 March 2015 and $38 million on 31 March 2016. In the tax jurisdiction in which Epsilon operates, gains on the fair value of investment properties are not subject to income tax until the properties are disposed of.

(ii) Epsilon has a 40% shareholding in Lambda. Epsilon purchased this shareholding for $45 million. The shareholding gives Epsilon significant influence over Lambda but not control and therefore Epsilon accounts for its interest in Lambda using the equity method. The equity method carrying value of Epsilon’s investment in Lambda was $70 million on 31 March 2015 and $75 million on 31 March 2016. In the tax jurisdiction in which Epsilon operates, profits recognised under the equity method are taxed if and when they are distributed as a dividend or the relevant investment is disposed of.

(iii) Epsilon measures its head office property using the revaluation model. The property is revalued every year on 31 March. On 31 March 2015, the carrying value of the property (after revaluation) was $40 million and its tax base was $22 million. During the year ended 31 March 2016, Epsilon charged depreciation in its statement of profit or loss of $2 million and claimed a tax deduction for tax depreciation of $1·25 million. On 31 March 2016, the property was revalued to $45 million. In the tax jurisdiction in which Epsilon operates, revaluation of property, plant and equipment does not affect taxable income at the time of revaluation.

Required:
Assuming that there are no other temporary differences other than those indicated above, compute:

You should include brief explanations to support your computations. (12 marks)

Delta is an entity which is engaged in the construction industry and prepares financial statements to 30 September each year. The financial statements for the year ended 30 September 2015 are shortly to be authorised for issue. The following events are relevant to these financial statements:

(a) On 1 October 2000, Delta purchased a large property for $20 million and immediately began to lease the property to Epsilon on an operating lease. Annual rentals were $2 million. On 30 September 2014, the fair value of the property was $26 million. Under the terms of the lease, Epsilon was able to cancel the lease by giving six months’ notice in writing to Delta. Epsilon gave this notice on 30 September 2014 and vacated the property on 31 March 2015. On 31 March 2015, the fair value of the property was $29 million. On 1 April 2015, Delta immediately began to convert the property into ten separate flats of equal size which Delta intended to sell in the ordinary course of its business. Delta spent a total of $6 million on this conversion project between 31 March 2015 and 30 September 2015. The project was incomplete at 30 September 2015 and the directors of Delta estimate that they need to spend a further $4 million to complete the project, after which each flat could be sold for $5 million. Delta uses the fair value model to measure property whenever permitted by International Financial Reporting Standards. (9 marks)

Required:
Explain and show how the three events would be reported in the financial statements of Delta for the year ended 30 September 2015.

Note: The mark allocation is shown against each of the three events above.