ARTIS REIT – ACCOUNTING FOR INVESTMENT PROPERTIES UNDER IFRS

SITUATION

 Upcoming adoption of IFRS

 IFRS standards related to investment properties allowed for a choice to either record properties at their fair values or
at their historical costs
 Additional decisions would need to be made regarding the implementation of the new accounting standard and related
disclosures

GOALS OF FINANCIAL REPORTING

 Reporting strategy to best reflect the financial position and operations of the trust
 Provide the best information to financial statement users
 Wanted Artis’s accounting treatments to be consistent with the industry’s peer group in order to achieve comparability
across the sector
o Belived there was an overall preference to adopt the fair value model

OBJECTIVES OF THE REIT

 Generate stable, growing, tax-efficient monthly cash distributions

 Grow externally through acquisitions
o Modern “new generation” buildings in good locations
o Buildings that would house high quality, credit worthy tenants for extended lease terms
 Once signing a lease with a tenant, the REIT typically would secure financing for a building for a
period of time that would mirror the length of the lease
 Grow internally through active management and development of its assets

ACCOUNTING FOR INVESTMENT PROPERTIES

 Investment properties: properties held for the purpose to earn rentals or for capital appreciation
 Under GAAP, there was no distinction between investment properties and PP&E  properties were recognized at
historical cost on the BS and amortized over the useful life
 IFRS allowed companies to make a decision regarding their investment properties, they could record it at:
o Fair value
 Differences in fair value from one period to the next would be recognized as net income
 Once a company chose to adopt the fair value mode, it could not switch back to the historical
model
o Historical cost
 Fair value of investment properties still has to be disclosed in the notes to financial statements
 If a company chose to adopt the historical cost model, it would have the option to switch to the fair
value model at a later date
 For companies adopting IFRS for the first time, additional alternative allowed them to record certain assets at fair value
on adoption, regardless of accounting policy choices made regarding following treatment
o Would allow Artis to record investment properties at fair value on adoption of IFRS, and then use either the
fair value model or historical cost model going forward

IMPACT ON FINANCIAL STATEMENTS

 Fair value model
o Significantly increases the volatility of income and assets
o Value will fluctuate from time to time, therefore the amount is considered more volatile
 Historical cost model
o Initial price paid by the company during the purchase of the asset or incurrence of the liability is what is
recorded
o Price on the balance sheet does not change until the security is liquidated, therefore the amount is
considered less volatile
o Eliminates uncertainty from the initial valuation decision, however it creates uncertainty in future periods
about the true value of assets
 Effects on Balance Sheet
o Certain levels of equity are required to be maintained (ex. financial institutions and insurance companies),
are the assets and liabilities vary, the equity also will vary (equity = assets – liabilities)
 Ex. during the financial crisis the value of assets declined, the equity of banks then declined and the
position banks showed on their BS deteriorated, this caused banks to raise more equity to bring
their BS back to position required by government regulations
o Lenders consider the value of assets as collateral, the decline of these assets for cause problems is the
company is not able to service its loans
 Effects on Income Statement
 Effects on Cash Flow Statement
o

ANALYST APPROACH TO REAL ESTATE

 Income under Canadian GAAP not often viewed as a relevant measure due to inclusion of depreciation expense
 As long as the property was properly maintained, the useful life could me indefinite, make depreciation expense
irrelevant
 Analysts commonly valued real estate by assessing operating cash flows generated by properties/appropriate discount
rate
o Discount rate: “cap rate”
o Assumed cash flows generated by the properties were a growing perpetuity
 Analysts could calculate the intrinsic value (perceived value w/o reference to stock value) by projecting cash flows and
applying an estimated cap rate = net asset value per unit after deducting debt
 EPS was not viewed as useful for evaluating operating performance, therefore the real estate sector endorsed the use
of funds from operations’ (FFO)
o Similar to cash flow from operations with some minor adjustments
 Analysts commonly valued firms based on FFO multiples and adjusted funds from operations (AFFO)
o AFFO took into account maintenance capital expenditures

IAS 40

 Requires entities to disclose the extent to which the fair value of investment property was based on a valuation by an
independent valuator who held a recognized and relevant professional qualification and had recent experience in the
location and category of the investment property being valued
 Companies also had to disclose if no such valuation had been performed
 Had to decide whether to hire an external valuator or to have valuations performed in-house
o Wondered if the decision would have an impact on the financial statement users or on trust’s audit fees
o External valuator is costly; some companies used external valuators to appraise a portion of their properties
each year on a rolling basis and then extrapolated the results across similar properties
 had to decide how the valuations would be done
o IAS stated entities were required to disclose the methods and significant assumptions used in determining
fair value, did not prescribe any particular valuation model
o ‘Cap rate’ approach was widely used in the industry, could also use a DCF