Financial Accounting Ii Evaluation

Financial Accounting II: Evaluation

INVESTMENT PROPERTY

Student’s name : Doulgkeris Athanasios

Professor’s name : Sónia Maria da Silva Monteiro

ID N° 50354 / ERASMUS

2016

TABLE OF CONTENTS

1. INTRODUCTION……………………………………………………………………………..3

2. FINANCIAL CONTEXT OF PROPERTY…………………………………………………..3

3. DIVISION OF PROPERTY………………………………………………………………….4

4. INVESTMENT PROPERTY: IAS 40…………….….………………………………………7

5. INVESTMENT PROPERTY: the Greek case ……………………………………………10

6. CONCLUSION………………………………………………………………………………11

REFERENCES…………………………………………………………………………………13

1. INTRODUCTION

This working paper is going to study the context of financial accounting and especially, the case of investment property. At the end of the study, the property investment’s Greek case is being emphasized.

2. FINANCIAL CONTEXT OF PROPERTY

As far as the financial perspective of the field of Property is concerned, it bases on two basic categories: in Loans/Mortgages and Property Investments.

In the first one case, the financial institutions have developed different and unique products for different customers’ needs based on new loans forms. It is noted here that these types of loans direct only to companies to use them as customers – not individuals.

On the other hand, the Investment Property case, it is independent of the level of inflation and it is characterized by longer-term benefits.

In order a company to invest in real estate (Property) section, the following should be sure:

The company wants to increase the current or future income of its own: based on this perspective, the owner expects an extra income which will acquire over time.

The company wants to make increased value (unearned increment): in this case, the investor is looking forward to a price increase; so, the purchases of today will create unearned increment for the time, when they will be sold, later, in the future.

Moreover, the investment property gives the owner different types of return; specifically, through (Bond et al., 2000):

Cash flows,

Tax Exemptions,

Equity,

Created unearned increment.

3. DIVISION OF PROPERTY

Every section of industry has its own unique characteristics. This section, property division, is one of the oldest and most important sections in any economy of any country.

According to Zantelis, (2001), "The Economy is a system or set of processes and institutions through which society uses the resources to satisfy human needs and desires. The Real Estate (Property) is an individual economy whose character is determined by the individual and social behavior, in which developed economies using economic individuals ".

Since the main house is the most important asset for each household, it is obvious yet the very important role of property in the most countries’ economies; such as it is in Greece, for example, where there is an old tradition for families with large proportion of housing.

On the other hand, although the property is only a small part of GDP, it still stimulates the whole economy, as well as it affects major macroeconomic variables (e.g. consumption, investment, etc.). So, it is understood that this type of market is linked directly to a country's economy through the financial institutions. The financial institutions provide through suitable procedures the necessary liquidity in order to form a healthy developing-property environment (Zantelis, 2001).

Nowadays, the economy which it is depressed, automatically results an investment-property downturn, by creating and maintaining a continuous negative result. By the depressing influence on the property section, there is a general uncertainty raised; because there is not enough liquidity and ability to raise investment capital (Zantelis, 2001).

Thus, the most important influencing factors according to Bond et al. (2000), which are affecting and will affect this section, are shown below:

Changes in property values; which ​​are affected directly by the “utility”, “rarity”, “desire to meet needs” and “purchasing power”.

The Bureaucracy; meaning the lengthy delay and realization of the necessary procedures in order to be an investment implemented.

The Depression’s results; there is a general insecurity and uncertainty in the section, resulted by the depression of the global economy.

The Taxation of property; it depends on each country’s law.

The Property Financing is largely limited by the Financial Institutions.

The Division of Property, has two main areas:

At first, there is the primary market, which refers to the development and promotion of property (including: Real estate, land with finding, movement processes, property construction, etc.). on the other hand, the secondary market, which refers to the property management and the corresponding provision of services (transfer, lease, management, etc.). (Brown & Matysiak, 2000).

With this distinction, it is easily understood that in any market area of these above, there are different influencing factors.

Additionally, it is noted that in the primary market, four areas can be distinguished (Brown & Matysiak, 2000):

A) Residential

B) Commercial Stores

C) Offices

D) Industrial areas

About factors that affect property prices:

The most important factors that affect property prices, include the following: disposable income, consumption, inflation, interest rates, gross domestic product and economic cycles (Brown & Matysiak, 2000).

Especially, the factor of ‘income’ is estimated as the most important one (via positive relationship), while real interest rates are the second one (via negative relationship). (Baum & Mackmin, 1989).

When GDP is increased, disposable income is increased too; leading to demand’s rise for property and increase of property’s value (unearned increment). (Brown & Matysiak, 2000).

Inflation is a factor that affects the property investment as well; if inflation is unexpected, rents are higher and the value of the property is greater than the expected inflation (Brueggeman & Fisher, 2008). This is due to the fact of the existence of mortgages and that inflation of the property is higher than the overall inflation. If inflation is taller than the cost of capital, it is reduced for owners and this happens because the real after-tax cost of mortgage loans is also reduced. So, the owner creates more income and can invest elsewhere.

It is stated by Benjamin et al. (2001) that the properties offer significant protection from inflation and even more.

On the other hand, economic cycles are characterized by phases of economic recession, followed by phases of development and vice versa. When the economy is on the rising side of the cycle, then the households and the financial operations thereby result increase of consumption, number of credits and demand as well. But when the economy is in he opposite side, households and business malfunction, because of the reduced number of credit and property prices’ fall. (Linneman & Wachter, 1989).

Finally, it is mentioned that, regarding bank rates, they are affected by the prices and demand for real estate property as well.

4. INVESTMENT PROPERTY: IAS 40

Standards in the field of investment property is concerned, they include the following “rules”:

A. Initial Registration

The initial recognition of investment property (as in real estate, plant and equipment) is carried at cost (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007).

As an item’s cost, it is meant (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007):

the purchase price; including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates

any costs directly attributable to bringing the asset to the location and the necessary conditions for the function by management

the costs of dismantling and removing the item and restoring the site on which it is located; undertaking the economic unit undertakes either to repair the item or as a consequence of its use for reasons of element for a specific period, than to produce inventories during that period.

B. Valuation after initial recognition

IAS indicates that the entity can choose either the fair value model or the cost model, while it is needed to apply this principle uniformly to all investment property of its own (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007).

Cost Model

The financial unit, after initial recognition, when has to be chosen for all investment property’s evaluation the use of the cost method, then they should do so in accordance with the requirements of IAS 16 – Property, plant and equipment. In this case, that is, after the initial registration of the investment property should be shown at acquisition cost less accumulated depreciation and any accumulated impairment losses.

Fair Value

The financial unit, after initial recognition, when it is chosen to evaluate all investment properties with the fair value, the gain or loss on change in fair value of investment property recorded in the net profit or loss in the period in which arises. The fair value of investment property shall reflect the market conditions at the balance sheet date. The method of fair value in accordance with IAS 40 is mandatory when the entity owns property with finance lease (leasing) and leased out under operating leases.

C. Transportation

According to IAS, transfers to or from investment property should be made when there is a change in usage (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007).

Briefly, transport allowed by IAS and its types treatment are show below. a. Firstly, the transport types are the following (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007):

Commencement of owner-occupation by the owner in order to transfer from investment property to owner-occupied.

Commencement of development with a view to sale, in order to transfer from investment property to inventories.

Completion of owner-occupation by the owner in order to transfer from owner-occupied to investment property.

Start an operating lease to another party, for transfer from inventories to investment property

Completion of construction or development, in order to transfer properties under construction to investment properties

b. Secondly, as far as the above types of transport property are concerned, the accounting treatment includes the following (Epstein & Jermakowicz, 2009; Alexander et al., 2005; Alfredson et al., 2007):

The deemed cost of property for subsequent accounting under -IAS 16 or IAS 2- shall be its fair value at the date of change in use. (above cases 1-2)

The entity should apply IAS 16 up to the date of change in use. The any difference between book value and fair at that date, is treated as a revaluation filed in equity. (above case 3)

Any difference between the fair value at that date and its previous carrying amount should be recorded in the results. (above cases 4-5)

5. INVESTMENT PROPERTY: the Greek case

Due to the fact of the Greek economic depression in the recent years and the Greek problematic economy, it is resulted that the industry of Property – a section which is closely connected with the Greek economy – has been greatly ‘depressed’, too. By observing the companies that are operating in this section, it is obvious that there is no liquidity. Property investment companies are trying to find buyers for them to sell the unsold properties or tenants to have an annuity, nowadays. Others are trying to survive allocating shares, while others are trying to borrow from their financial institutions. These companies often have not achieved their goal, so they cannot give investors adequate assurance and ensuring, as the indicators are not satisfactory. So it is very important to observe their obligations, and what charges have to be able, in order the degree of self-reliance and independence to be understood.( see Bank of Greece, Real Estate Market Analysis, http://www.bankofgreece.gr/pages/en/Statistics/realestate/default.aspx [retrieved 30.05.2016]).

Investing in residential property brings up very low yields, only higher than term deposits. Roughly the same applies to income properties, which have slightly higher yields (see Bank of Greece, Real Estate Market Analysis, http://www.bankofgreece.gr/pages/en/Statistics/realestate/default.aspx [retrieved 30.05.2016]).

6. COCLUSION

Finally, it is concluded that in the Greek case, investment property it is not profitable nowadays. The reasons why the investment property is not recommended, at least in the current economic environment of Greece, include the following:

The first reason is based on the financial crisis negative results

The rental prices have fallen quite recently, while the unsafe rentals have been increased heavily. Also the supply is much bigger than the demand.

The second reason is related with the market issues, which existed before the crisis

The ‘pathogenesis’ of these issues is based on the overstatement of the value of properties, thereby reducing their ultimate performance.

The third reason is the high levels of taxation

A big amount of the expected profit results is given via taxes, while in the case of unrented property for a long time; all the taxes push the owner in getting substantially damage instead of profit. So, it is observed that there is a high level of risk in such an investment.

REFERENCES

A. Bibliography

Alexander, D.; Britton, A.; Jorissen, A. (2007). International Financial Reporting and Analysis. (3rd Edition). Thomson Learning.

Alfredson, K.; Leo, K.; Picker, R.; Pacter, P.; Radford, J. (2005). Applying International Accounting Standards, Wiley.

Baum, A. & Mackmin, D. (1989). The Income Approach to PropertyValuation. (Third Edition). Routledge, London.

Benjamin J.D., Sirmans G., Zietz E.N. (2001). Returns and Risk on Real Estate and Other Investments: More Evidence. Journal of Real Estate Portfolio Management 01/2001; 7. Washington, DC.

Bond S. Karolyi G., Sanders A., (2000). International Real Estate Returns: A Μultifactor, Multicountry Approach. Real Estate Economics 31, pp. 481-500.

Brown G. & Matysiak G., (2000). Real Estate Investment; A Capital Market Approach. Prentice Hall, London.

Brueggeman W. & Fisher J., (2008). Real Estate Finance and Investments. (14th edition). Jeffrey D. (pub.).

Epstein, J. B. & Jermakowicz, K.  E. (2009), Wiley IFRS 2009: Interpretation and Application of International Accounting and Financial Reporting Standards. Wiley.

Linneman P. D. & Wachter M. S. (1989). The Impacts of Borrowing Constraints on Homeownership. Journal of the American Real Estate and Urban Economics Association, Volume 17, Issue 4, Winter 1989, pages 389-402

Zantellis, P. (2001). Real Estate, Value-Estimates-Development-Investment-Management. Ed. Papasotiriou, Athens.

B. Internet Sources

Bank of Greece, Real Estate Market Analysis, http://www.bankofgreece.gr/pages/en/Statistics/realestate/default.aspx [retrieved 30.05.2016]