Hello,
Please I need inputs on an accounting matter.
In a situation where, there is an contract between a land owner and a developer, the contract requires the developer to build pre-defined property(s) on a land in exchange for right to rent on the property(s) built for a particular period(e.g 20 years), after which full ownership of the land and properties transfers to the land owner.
Is there an IFRS that covers this illustration and how can the transaction be recorded in the books of the land owner and developer?
Accounting for agreements on land use.
Re: Accounting for agreements on land use.
On the surface it sounds a lot like "A contract that conveys the right to use an asset [the land] for a period of time in exchange for consideration [the eventual transfer of the buildings]." which is the definition of a lease. And hence IFRS 16 applies.
But I would want to really understand the contract. Specifically does the developer have:
(a) the right to obtain substantially all of the economic benefits from use of the identified asset; and
(b)the right to direct the use of the identified asset
A lot will come down to what rights are transferred to whom. Does the developer have control of who rents and at what price? Or is a form of sale of the constructed buildings where it is actually the original owner who "rents" the property (effectively purchasing the buildings).
But I would want to really understand the contract. Specifically does the developer have:
(a) the right to obtain substantially all of the economic benefits from use of the identified asset; and
(b)the right to direct the use of the identified asset
A lot will come down to what rights are transferred to whom. Does the developer have control of who rents and at what price? Or is a form of sale of the constructed buildings where it is actually the original owner who "rents" the property (effectively purchasing the buildings).
Re: Accounting for agreements on land use.
Thank you ex ifrs for your reply.
The right to obtain substantially all the economic benefits is transferred to the developer. The developer determines who rents and at what price.
Are you confirming that Ifrs 16 applies to this scenario?
Also, seeing that the consideration may not be accurately determined at inception, how do we determine the lease liability?
The right to obtain substantially all the economic benefits is transferred to the developer. The developer determines who rents and at what price.
Are you confirming that Ifrs 16 applies to this scenario?
Also, seeing that the consideration may not be accurately determined at inception, how do we determine the lease liability?
Re: Accounting for agreements on land use.
Here's how I see it:
The landowner leases out the land, with the building acting as a form of non-monetary payment for this lease. Given that the transfer of the building's ownership is predetermined, I'd view it as an asset belonging to the landowner from day 1, which is then also leased out to the developer. By the way, can one not own a building situated on land they own? In Poland, for instance, the landowner automatically becomes the owner of any building on their land.
Regarding the developer, they account for revenue from the building's construction, and their consideration is the right to use both the land and building.
Makes sense? It's a mess!
The landowner leases out the land, with the building acting as a form of non-monetary payment for this lease. Given that the transfer of the building's ownership is predetermined, I'd view it as an asset belonging to the landowner from day 1, which is then also leased out to the developer. By the way, can one not own a building situated on land they own? In Poland, for instance, the landowner automatically becomes the owner of any building on their land.
Regarding the developer, they account for revenue from the building's construction, and their consideration is the right to use both the land and building.
Makes sense? It's a mess!
Re: Accounting for agreements on land use.
Thank you Marek,
2 questions.
1. How do we measure the lease liability at inception?
2. Can you please elucidate on the 2nd paragraph, accounting for revenue for the developer, I don't seem to understand.
3. Do you know if there is a paragraph in IFRS 16 that speaks to this scenario?
2 questions.
1. How do we measure the lease liability at inception?
2. Can you please elucidate on the 2nd paragraph, accounting for revenue for the developer, I don't seem to understand.
3. Do you know if there is a paragraph in IFRS 16 that speaks to this scenario?
Re: Accounting for agreements on land use.
I agree it is a mess. Marek, I can see how you could get to IFRS 15 for the "sale of the buildings". I flirted with this too. But it seems to my that IFRS 16 trumps IFRS 15. That is the scope of IFRS 15 explicitly excludes things captured by IFRS 16 (so if we agree IFRS 16 applies, IFRS 15 falls to the side). Also I am not even sure we are in IFRS 15 setting this aside, is the landowner really a "customer"? And anyway, does this really seem to have the substance of an ordinary sale?
Certainly in the UK the land and building can be separated, much property is leasehold (you lease the land but own the house). There is no question of the leaseholder "owning the house" just because they own the property.
So for the lessee it is presumably a finance lease with all the joy of estimating the fair value of the consideration and the fair value of the right to use the land. But for the land owner it is probably an operating lease? So the accounting is somewhat easier.
Certainly in the UK the land and building can be separated, much property is leasehold (you lease the land but own the house). There is no question of the leaseholder "owning the house" just because they own the property.
So for the lessee it is presumably a finance lease with all the joy of estimating the fair value of the consideration and the fair value of the right to use the land. But for the land owner it is probably an operating lease? So the accounting is somewhat easier.
Re: Accounting for agreements on land use.
Considering this is about a property developer, it's reasonable IMO to view the land owner as "as a customer willing to obtain goods or services resulting from the entity’s ordinary activities". When it comes to the construction of the building, it doesn't appear to fit within IFRS 16's scope, since the lease can begin only after the construction is finished. Thus I still think that the construction falls under IFRS 15 and only then IFRS 16 comes into play 
Re: Accounting for agreements on land use.
I think this is one of those times we are going to have to agree to disagree. I don't think constructing a building, using it, and 20 years later handing it over is ordinary business for a developer. As for the lease, I am leasing out the land, not the building. The developer gets control of the land from day 1, the building is not being leased, it is what the developer chooses to do with the land. The building stays purely on their books (until year 20). The compensation for leasing the land is settled by delivering a 20 year old building in 20 years (or I bet the contract has some monetary amount in lieu).
Note also that if you did treat it under IFRS 15, you could not even recognise revenue until year 20, at no other point is control of the building handed over to the land owner.
Note also that if you did treat it under IFRS 15, you could not even recognise revenue until year 20, at no other point is control of the building handed over to the land owner.
Re: Accounting for agreements on land use.
I'm persuaded!