The new accounting standard for investment in real estate

by  — 7 November 2012

The Financial Accounting Standard 26 (FAS 26) on Investment in Real Estate, issued by the Accounting Organisation for Islamic Financial Institutions (AAOIFI) in June 2012 proposes a new and clarified approach of accounting for investment in real estate,writes Yusuf Sayed.


The new standard provides separate and detailed guidance on accounting for investments in real estate given the nature and complexity of such investments. The standard does not significantly change the way investments in real estate are accounted for, but does provide further clarifications and added guidance. The key difference from the existing standard is the treatment of fair value changes. On the date of application, this would lead to recognising the fair value gains by re-measuring investments in real estate in equity rather than the current practice of recognising the fair value changes in the income statement.

The aim is to reduce complexity, and increase transparency and consistency in accounting of real estate investments. The implications of the standard have to be quickly assessed by the entities having significant real estate exposures and the standard requires retrospective amendment, which means entities also have to consider the prior year’s fair value movements to assess the implication on their financial statements.

AAOIFI issued the standard on Investment in Real Estate in June 2012. The new standard provides more detailed and expanded guidance on definitions, recognition, measurement and disclosures of investment in real estate as compared to the limited guidance within the previous Financial Accounting Standard (FAS) 17 Investments. The key difference from the existing standard is the treatment of fair value changes. The other changes suggested by the new standard represent changes in the nature of clarifications to the current requirements of the standard and entities reporting under AAOIFI are not likely to be substantially affected by the adoption of this new standard. It is probably also important to note the standard covers only direct investment (in real estate in other words land or building or property under construction) and excludes exposure through shares and financial instruments.

Initial recognition of fair value

The investment in real estate is initially recognised at its cost including any directly attributable expenditure. The standard aims to provide a clarified definition on costs and guidance for differentiation between owner occupied, inventory and investment in real estate. It also makes provision for guidance of classifying assets under construction.

An entity will classify whether the investment in real estate is being held-for-use or held-for-sale. For held-for-use investments, an entity selects either the fair value model or cost model as its accounting policy, which should then be applied consistently.
The standard however does not permit under construction assets to be measured at fair value until the construction is completed. Any impairment of investment in real estate should be evaluated on an assets-by-asset basis and not on a portfolio basis each reporting period starting from 1 January 2013.

The Scope

The new standard applies to each level of the financial statements separately, which means both consolidated and individual financial statements. For example if a subsidiary holds investment in real estate, the guidance of this standard will apply to investments in the real estate in preparation of the consolidated financial statements.
For operating Ijara assets this standard applies for measurement of investment in real estate held with the intent of earning periodical consideration, which is defined in Financial Accounting Standard FAS 8 as operating Ijarah under one of two methods, the cost or fair value can be adopted. However, for all other matters FAS 8 will apply.
Ijarah Muntahia Bittamleek assets are not covered under the scope of this standard, which effectively means the choice to fair value such assets is not available and FAS 8 continues to apply. The standard also does not apply to investment in specialised assets in real estate related to agricultural activities, and rights and resources related to mining and exploration activities such as oil, natural gas etcetera.

Definition of the new standard

The previous definition has largely been retained, but significantly expanded on. Investment in real estate is property held to earn periodical income or for capital appreciation or both, rather than for use in the production or supply of goods or services or for administrative purposes (owner occupied real estate).
The guidance to the standard provides detailed discussions and examples of application in the hope of bringing consistency in its application. The standard provides for cost recognition outlines and expanded guidance for classifying those costs.

The cost of a constructed or under construction property includes any expenditure that is directly attributable to bringing an asset to the location and the condition necessary for it to operate in the manner intended by the management.
Unlike the previous interpretation under FAS 17, the new standard does not provide different measurement models for investments based on the source of funding. However, the new standard continues with the requirement to apportion gains, losses, income and expenses taking into consideration the split between the owners’ equity and equity of the investment account holders.

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