What it means
In accounting, the purpose for which a property is held decides how it is classified. A building a company uses for its own operations is property, plant and equipment, a building held to earn rent or rising value is investment property, and a building built or bought for resale is inventory.
A developer's unsold flats are therefore inventory, in the same way that a shop's unsold goods are. Property inventory is normally recorded at cost, which includes the land, construction costs and borrowing costs directly linked to the development.
It is then carried at the lower of cost and net realisable value (the expected selling price less the costs of completion and sale). If the market falls and the expected sale price drops below cost, the business must write the inventory down.
This matters because property is a large and illiquid asset. A developer may have tens of millions of dollars tied up in unsold units, and the speed at which they sell determines cash flow and the cost of the loans funding them.
Lenders and analysts therefore watch how much inventory is held and how long it takes to sell. Managers track measures such as months of inventory, which is the number of months it would take to sell the current stock at the present sales rate.
A rising figure can signal weak demand, over-building or pricing that is too high. In the separate rental meaning, a property inventory is a detailed record of the furniture, fittings and condition of a property at the start of a tenancy.
It helps landlords and tenants settle disputes over damage and deposit deductions, and a dated, signed copy with photographs is the best protection for both sides.
In practice
Real-world examples.
Example
A homebuilder has 40 unsold houses on its balance sheet at a total cost of $16,000,000. Sales slow, and the finance team calculates that net realisable value is $14,800,000, so it writes down inventory by $1,200,000.
Example
A land company buys a large site for $5,000,000, divides it into plots and sells them over several years. Each sale moves a share of the land cost out of inventory and into cost of sales.
Example
A landlord's agent prepares a property inventory for a furnished flat, listing every item and photographing the condition. When the tenant leaves, the report helps settle a $450 dispute about a damaged sofa.
Formula
Calculation
Under the lower of cost and net realisable value rule, the amount shown on the balance sheet is:
Net realisable value = Expected selling price - Costs to complete and sell
Carrying amount = Lower of cost and net realisable value
Suppose a developer holds a completed apartment that cost $1,200,000 to build. The market weakens, and the expected selling price falls to $1,100,000, with selling costs of $80,000.
Net realisable value = $1,100,000 - $80,000 = $1,020,000.
Because $1,020,000 is lower than the cost of $1,200,000, the carrying amount is $1,020,000.
Write-down = $1,200,000 - $1,020,000 = $180,000, which is charged as an expense.
If the price had instead been expected at $1,350,000 with costs of $100,000, net realisable value would be $1,250,000, above cost, and no write-down would be needed.Case study
Seen in the real world.
Summit Homes is an illustrative, fictional developer that completed a block of 30 apartments just as local demand weakened. Each apartment cost $400,000 to build, so inventory stood at $12,000,000.
After six months only eight had sold, and the finance team reviewed the value of the remaining 22. The expected selling price had fallen to $380,000 each, with $15,000 of selling costs, so net realisable value was $365,000 per unit.
The company wrote down the inventory by $35,000 per apartment, a total of $770,000, and used the lower price to launch a marketing campaign. The write-down hurt profit but gave honest figures to the bank. The illustrative lesson is that property inventory is carried at the lower of cost and net realisable value, so falling markets reduce reported profit before the units are sold.
Watch out
Common mistakes.
- Classifying property held for sale as a fixed asset or investment property, which gives the wrong accounting treatment.
- Failing to write inventory down when the expected selling price drops below cost, which overstates assets and profit.
- Skipping a detailed inventory when letting a property, which makes deposit disputes hard to resolve.
Questions
People also ask.
What is the difference between property inventory and investment property?
Inventory is held for sale in the ordinary course of business, while investment property is held to earn rent or for long-term price growth.
Which costs go into the cost of property inventory?
Typically the land, construction, professional fees and directly attributable borrowing costs, but not general administrative overheads or selling costs.
Can a write-down be reversed?
Under many accounting frameworks, yes, if the selling price recovers, but only up to the original cost.
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