Real Estate

New guidance for existing leases of land and buildings

a big issue for the real estate industry
Application date: Annual periods beginning on or after 1 January 2010. Early application permitted.

What is the issue?
The International Accounting Standards Board
(IASB)/Hong Kong Institute of Certified Public
Accountants (HKICPA) published its second annual
improvement project in April 2009/May 2009. The
improvement process is a timely and efficient way to
make amendments to IFRS/HKFRS and address
inconsistencies within or between standards and areas
where the standards are unclear.
There are 15 amendments, affecting 12 standards
some more than others. While the improvements are not
intended to change the meaning of the standards, some
result in changes to the way that particular transactions
or balances are accounted for by entities in the real
estate industry.
A good example of that is the improvement to IAS/HKAS
17 Leases which requires entities with leasehold
property (that is, combined land and property) to
reassess the classification of the land element as a
finance or operating lease.
What is the impact on the real estate
industry?
The current default classification for the land element of
a leasehold property is an operating lease. This is based
on the notion that the life of land is infinite and therefore
the lessee could not possibly enjoy the majority of risks
and rewards during a finite lease term.
However, under the amendment this default classification
no longer applies. Instead, it will be possible for the land
element in leasehold property to be classified as a
finance lease. All entities in the real estate industry will
need to reassess their existing land leases to ensure
they have the appropriate classification.
In particular, property holding entities will have to apply
this amendment retrospectively based on the information
that existed at the inception of the lease. Where this is
impractical, entities will need to assess the land element
of their property leases using information available at the
time of applying the amendment (for many entities that
will be in annual December 2010 accounts).
What issues might arise in practice in
applying this new guidance?
Land leases with very long-term leases, even where
the title is not expected to pass to the lessee by the
end of the lease term, may now be regarded as
finance leases.
In some markets, such as Hong Kong, transaction
values have not varied significantly for properties with
different remaining lease terms (unless a renewal of
the lease is not expected).
For example, the market price of a property with a 30-
year land lease is equivalent to that with a 50-year
land lease. This appears to indicate that either the
market considers the reversionary interest to be small
or that the lease term specified in the land lease will
be capable of extension for a nominal amount; hence,
the actual lease term will always revert to a longer
period. In such cases, the land interest is
substantially the same as a freehold interest, such
that the lessee (through the pricing structure) is
actually exposed to substantially all the risks and
rewards of ownership of land. In these
circumstances, the classification of the interest as
being held under a finance lease is consistent with
the substance of the interest and the economic
position of the lessee.
If the land interest is classified as a finance lease and
the related property interest is held for the entitys
own use, the current guidance in IAS/HKAS 16
Property, plant and equipment would apply to the
measurement of the property. Under this standard,
the accounting for land interest could be performed
using either the cost model or the revaluation model,
depending on the lessees accounting policy. The
depreciable amount of the land interest would be
allocated to each accounting period over the period
of expected use on a systematic basis that is
consistent with the depreciation policy adopted for
the building that is owned.


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may not be current or accurate. These materials are not a substitute for reading any relevant accounting standard, professional pronouncement or guidance or any other
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In contrast, if the land interest is classified as a
finance lease and the related property interest is held
for earning rentals and/or for capital appreciation,
IAS/HKAS 40 Investment property would apply.
Under that standard the entity would need to account
for both the land and property interest using either
the cost model or the fair value model, depending on
the lessees accounting policy for investment
property. Most entities currently account for
investment property at fair value. Therefore, these
entities will need to periodically remeasure the
property (including the land) to fair value and record
changes in fair value in the income statement.
If the land interest is classified as a finance lease and
the related property interest is held for sale in the
ordinary course of business or is in the process of
being developed for such a sale, IAS/HKAS 2
Inventories would apply to the accounting for the
land. That is, the land interest would be measured at
the lower of cost and net realisable value and it would
no longer be subject to amortisation.
Considerations when applying the
amendment in practice
The new guidance indicates that entities should use
their judgement to decide whether the lease transfers
the significant risks and rewards of ownership of the
land. The new guidance indicates that the
IASB/HKICPA considers land leases with a term as
short as "several decades" might now be regarded as
finance leases if the lessee is economically in the
same position as a purchaser.
As a result of the amendment, we expect more land
leases to be classified as finance leases. This is
particularly the case where the market considers the
reversionary interest to be small or that the lease
term specified in the land lease will be capable of
extension for a nominal amount. Many entities may
need to engage property valuation experts to
determine the fair value of the land lease and
whether risks and rewards have been transferred.
Note. This amendment is consistent with the
IASB/HKICPAs plans to replace IAS/HKAS 17 Leases
and ensure that all leases are put "on-balance sheet".

Take a broad look at changes to accounting for leases new proposals coming soon
The IASB/HKICPA has issued an exposure draft to the leasing standard in August 2010, which will overhaul the current
requirements in HKAS 17 Leases and reduce the differences between accounting for leases under IFRS/HKFRS and
US GAAP. The proposals have significantly changed current practice; the IASB/HKICPA appear ready to require all
leases, not just finance leases, to appear on the balance sheet.
We will share PwC insights with entities in the real estate industry soon. In the meantime, please talk to your usual
PwC representative or our Real Estate contacts for latest updates.