by John Hughes

Here’s another of the issues arising from extracts of enforcement decisions issued in the past by the European Securities and Markets Authority (ESMA) (for more background see here); this is from their 15^th edition:

• “The issuer operates in the commercial and agricultural industry and owns a large plot of land, which had been used in its normal operations and is classified as property, plant and equipment. Furthermore, the issuer has acquired additional land for agricultural use on a continuing basis.
• In July 2011, as the production on the land had stopped and no further production was planned, the issuer transferred the land from owner-occupied property to investment property, as it intended to sell or lease it. The change in the use of the land was caused by difficulties in transporting the harvest from this location to the markets. While transferring an investment property, the issuer chose to account for the land under the fair value model in IAS 40.
• At the time of the transfer, the issuer claimed that it was not possible to determine the fair value of the land reliably, due to the unclear legal structure related to the ownership of the land. According to paragraph 53 of IAS 40, the issuer treated the land as ‘property under construction’ and measured it at cost.
• In the second half of 2011, the issuer incurred costs regarding clearing the land and making it more attractive to potential buyers or lessees as well as legal costs. These costs were expensed in the income statement.
• On December 31 2011 the issuer clarified the legal status of the land, considering that its fair value could be reliably measured. The issuer reported a fair value gain, determined as the difference between the fair value at that time and its previous carrying amount which was recognized in the income statement according to paragraph 65 of IAS 40.”

The enforcer (as ESMA likes to term it) disagreed with this treatment, taking the view that land with unclear legal status can’t be treated as an investment property under construction, and requiring it to be measured at fair value from the time of the transfer to investment property (accounting for any difference between the book value and the fair value at the time of the transfer in accordance with IAS 16, as a gain or loss). The largest part of this thinking is simply a common sense view of “construction” as “a process that would result in physical changes to the property,” and a conclusion that clearing and preparing land doesn’t fall within that concept, because land is fundamentally constant and unchanging (even if the things that might be built on it aren’t).

In an age of escalating environmental uncertainty, and in which every other Hollywood blockbuster seems to imagine a threat to the basic fabric of the planet, there’s surely something comforting about the old-fashioned solidity with which accounting standards treat ownership of land. With some exceptions, says IAS 16.58, “such as quarries and sites used for landfill,” land has an unlimited useful life and therefore is not depreciated; it immediately contrasts this with buildings, which are always regarded as having a limited useful life, no matter how imposing and eternal they might seem to us at the present moment. Like the stubborn rancher in an old Western, a landowner knows he can always count on what’s beneath his feet – until of course the bad guys shoot him dead and steal it. But such melodrama aside, only man’s reckless pillaging can undermine this most enduring right, a message succinctly summed up in the IASB’s grim evocation of previously eternal landscapes blighted by quarries and landfills.

Maybe the issuer thought in good conscience that since IAS 40 includes a concept of investment property under construction, it must be possible for land to somehow fit within the concept, and in its attempt to figure out how that might be, ended up over-thinking itself into a trap. After all, the issuer might have thought to itself, so much of accounting is built on abstractions of one kind or another; to regard clearing and preparing as being a sort of construction isn’t such an egregious stretch. But it should have realized it was digging itself a hole on a sacred playing field, trying to undermine one of the last remaining accounting insights that can be expressed simply as a truism: land is land is land.

In any case, as ESMA also observes, even if the land could have been regarded as being under construction, it still wouldn’t have naturally followed that it be measured at cost – IAS 40 includes investment property under construction within the general statement that it’s only “in exceptional cases” that the fair value of investment property isn’t reliably measurable on an ongoing basis. In this case: “The enforcer assumed that the issuer had a good understanding of how to determine the fair value of the land as it was able to determine the fair value of the land each time it acquired additional piece of land. Accordingly, it concluded that the issuer should be able to do the same on a continuous basis.” Still, if the issuer’s argument has been comprehensively buried, at least it was laid to rest on a freshly cleaned corner of the earth.

The opinions expressed are solely those of the author