Property (land and buildings) can appear in several areas of a business’s balance sheet, and the way it is classified will depend on the company’s intended use of that property. Below we’ve provided some more information on how property is classified in financial statements, and the different accounting treatment adopted. This isn’t intended to be an exhaustive list, and if you have any queries about the accounting treatment (which may affect how gains are taxed when reporting to HMRC), you should contact your business adviser or accountant for clarification.
If you own property that is primarily held to earn rental income or capital appreciation, then it will be classified as investment property. The same applies for any property (or property under construction) not used within the business or in the company’s trade.
Investment property is initially measured at cost and subsequently measured at fair value, which is determined as the amount for which the property could be exchanged or settled between knowledgeable, willing parties in an arm’s length transaction. Any movement in fair value is recognised in your profit and loss account.
There are a number of ways to value a property, and these may include a professional valuation, valuation by reference to rental yield or comparable transactions in the market, or valuation by using a discounted cash flow technique.
Property will be classified as stock if it is held for sale in the ordinary course of business, in other words where there is an intention to sell it.
Stocks are measured at the lower calculation of cost and net realisable value, or in other words, the selling price less costs to sell. Cost includes all such expenditure required to bring the stocks to their current condition and location. Where borrowing costs are incurred, a company has the choice of capitalising these costs or expensing them through profit and loss when incurred.
Where properties are recorded as stocks, and those properties are sold, the revenue generated will be shown as sales in your profit and loss account. Related costs will be shown as cost of sales.
Property, Plant and Equipment (PPE)
Property that is held for use in the production or supply of the company’s goods or services is classified as PPE.
PPE is initially measured at cost, including all associated legal costs, as well as costs sustained to bring the property into its present condition (and location). As with stocks, where borrowing costs are incurred (eg if constructing a property) a company has the choice of capitalising or expensing these costs.
A company also has the option to carry PPE at historic cost less accumulated depreciation and impairment, or at fair value less subsequent depreciation. Where a policy of annual revaluation is selected, such revaluations will go to a revaluation reserve on the balance sheet, as long as they aren’t reversing a previous impairment. A downward movement to below cost will be recognised in profit and loss.
As with other categories of tangible fixed assets, property (excluding land) must be depreciated annually on your balance sheets.
Key points to remember
- Classifying your property correctly is essential in order to properly report your business assets on your balance sheet
- Differing accounting treatments will apply depending on the classification of your property, for example Investment Property, Stock, or Property, Plant and Equipment. It’s important to understand the differences and get it right, so that the balance sheet properly reflects the position of your business
- As noted above, there are instances where you have a choice in accounting policy choices, eg whether to capitalise borrowing costs, or if your business carries PPE at historical cost or valuation. You should always seek professional advice before making such important decisions.
Our specialist team of property advisers can help you with all aspects of accounting, audit, tax and insurance planning which relate to the property sector. From auditing to raising finance and group reorganisations, we have experienced specialists who can look after all your financial needs, and with an in-house insurance team we can access the UK’s leading insurers to find the right cover for almost any property-related risk. We’re here to provide the answers, with our best attention to detail, care and empathy.