This paper investigates the factors influencing managerial choice between the fair value and cost models for investment property (IP) under International Accounting Standard 40 (IAS 40). Focusing on the European real estate sector a decade after the initial adoption of International Financial Reporting Standards (IFRS), the study employs a logistic regression analysis on a sample of 212 listed firms, comprising 1,513 firm-year observations from 2014 to 2023. The analysis reveals that the accounting choice for IP is systematically driven by a combination of factors. Key findings indicate that contractual efficiency motives, such as leverage and firm size, asset-pricing incentives related to information asymmetry and the materiality of IP, and the institutional characteristics of a firm's home country are all significant determinants of the valuation decision. These results offer an updated perspective on the ongoing application of the fair value model under IAS 40, providing valuable insights for standard-setters, investors, and analysts.

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1. Introduction

1.1. Context and Strategic Importance

The valuation of investment property (IP) is a cornerstone of financial reporting within the real estate industry. For many firms in this sector, IP represents the most significant asset on their balance sheets, making its valuation a critical determinant of financial health and performance. International Accounting Standard 40 (IAS 40) permits a significant accounting policy choice: the subsequent measurement of these assets at either fair value or historical cost. This decision is not merely a technical exercise; it directly impacts reported earnings, a firm's stated financial position, key performance metrics, and the overall quality of information available to investors, creditors, and other stakeholders for their decision-making processes. The choice shapes the financial narrative of a company, influencing investor confidence and the cost of capital.

1.2. Research Problem and Question

While IAS 40 provides a choice between two distinct valuation models, the long-term factors that influence this critical management decision, particularly after a decade of experience with IFRS, remain underexplored. As managers and markets have matured in their understanding and application of fair value principles, it is unclear whether the initial drivers of this accounting choice have persisted or evolved. This study seeks to fill this research gap by examining the contemporary determinants of IP valuation in a post-implementation IFRS environment. The primary research question is therefore formally stated as:

What factors continue to shape the managerial decision between fair value and cost for investment property under IAS 40 in European real estate firms, ten years after the initial adoption of IFRS?

1.3. Contribution and Structure

This paper makes several important contributions to the accounting literature. This is the first study to analyze the accounting choice for IP within the real estate industry using an extended and recent dataset spanning from 2014 to 2023. This updated perspective provides timely empirical evidence directly relevant to the ongoing debate among standard-setters, such as the IASB, regarding the potential mandating of the fair value model for investment property. Furthermore, this research integrates contractual, asset-pricing, and institutional motivations into a single, comprehensive analytical framework to better explain the complexity of managerial decision-making. The paper proceeds as follows: Section 2 outlines the regulatory framework of IAS 40. Section 3 develops the theoretical framework and hypotheses. Section 4 describes the research design, and Section 5 presents the empirical results. Finally, Section 6 concludes with a summary of findings, implications, and avenues for future research.

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2. The Regulatory Framework: IAS 40 Investment Property

2.1. Defining Investment Property

A clear understanding of the regulatory landscape is essential to analyzing the accounting choices available to management. International Accounting Standard 40, in paragraph 5, defines Investment Property as property (land, a building, or part of a building) held (by the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation, or both. This classification distinguishes it from owner-occupied property, which is used in the production or supply of goods or services and is accounted for under IAS 16 Property, Plant and Equipment, and from property held for sale in the ordinary course of business, which falls under IAS 2 Inventories.

According to IAS 40, paragraph 8, examples of investment property include:

  • Land held for long-term capital appreciation rather than for short-term sale in the ordinary course of business.
  • Land held for a currently undetermined future use.
  • A building owned by the entity (or a right-of-use asset relating to a building held by the entity) and leased out under one or more operating leases.
  • A vacant building that is held to be leased out under one or more operating leases.
  • Property that is being constructed or developed for future use as investment property.

2.2. The Accounting Policy Choice: Fair Value vs. Cost Model

Subsequent to initial recognition at cost, IAS 40 permits entities to choose an accounting policy for all of their investment property: either the fair value model or the cost model. The selected policy must be applied consistently. The key differences between these two models are summarized below.

Feature

Fair Value Model

Cost Model

Measurement Basis

Remeasured to fair value at each reporting date.

Measured at cost less accumulated depreciation and accumulated impairment losses.

Impact on Profit or Loss

Gains or losses from changes in fair value are recognized directly in profit or loss.

No fair value gains or losses in profit or loss. Depreciation and impairment are charged to profit or loss.

Subsequent Changes

Changes in fair value are recognized in Profit or Loss.

Depreciation and/or impairment are charged to Profit or Loss.

Depreciation

No depreciation is charged.

Depreciation is charged over the asset's useful life.

Disclosure

Requires a detailed reconciliation of the carrying amounts from the start to the end of the period.

Requires disclosure of the investment property's fair value in the notes to the financial statements.

Under the cost model, the property is accounted for in accordance with the requirements of IAS 16 Property, Plant and Equipment.

2.3. The IASB's Rationale and Preference

The International Accounting Standards Board's (IASB) rationale for permitting this accounting choice was to provide a transitional period, allowing less-developed property markets and valuation professions time to mature. The Board intended to reconsider the option at a later time, presumably mandating the use of fair value. Despite offering this option, the standard expresses a clear preference for the fair value model. IAS 40, paragraph 31, explicitly states that it is "highly unlikely that a change from the fair value model to the cost model will result in a more relevant presentation," effectively discouraging a switch away from fair value. This stated preference from the IASB, however, does not fully account for the firm-level and institutional pressures that shape accounting choices in practice, which we theorize in the following section.

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3. Theoretical Framework and Hypotheses Development

The extensive literature on accounting choice identifies several categories of incentives that drive management's selection of accounting methods. This paper analyzes the choice for investment property through the lens of three primary categories of motivations: contractual efficiency, asset-pricing, and institutional factors.

3.1. Contractual Efficiency Motives

3.1.1. Leverage and Debt Covenants

A firm's level of debt can exert a powerful influence on its accounting choices, though the direction of this influence is subject to competing arguments. On one hand, debt holders often favor conservatism, as the use of historical cost can reduce the likelihood of managers overstating assets and making dividend payments at the expense of creditors. From this perspective, the cost model is seen as a mechanism to reduce agency costs and better protect the interests of debt holders. On the other hand, fair value provides a more timely and relevant measure of asset values, which can reflect a firm’s real solvency capacity more accurately. This transparency can facilitate more efficient debt covenant negotiations and may be demanded by creditors who require current information on the value of collateral.

3.1.2. Firm Size and Political Costs

Firm size is often used as a proxy for political costs, which are the potential costs arising from political or regulatory scrutiny. The traditional view suggests that larger, more visible firms might prefer the cost model to report lower profits and asset values, thereby reducing their public profile and minimizing the risk of adverse political actions like increased taxes or regulation. However, this argument must be considered within the specific context of the real estate industry. Unlike many other sectors, markets for investment property are often relatively liquid, making fair value estimates more verifiable and reliable. In such an environment, the use of the fair value model may not significantly increase the risk of shareholder litigation or political costs, even for larger firms, as the valuations are perceived to be robust.

3.2. Asset-Pricing Motives

3.2.1. Information Asymmetry and Market-to-Book Value

A primary motivation for accounting choices is the desire to reduce information asymmetry between well-informed managers and less-informed external investors. The market-to-book value (MTBV) ratio is a common proxy for this information asymmetry, where a higher ratio suggests a greater gap between the market's perception of a firm's value and its book value. To bridge this gap, managers may choose the fair value model. By bringing the book value of investment property closer to its market value, fair value accounting can convey more relevant and timely information to the market, thereby reducing information asymmetry and potentially lowering the firm's cost of capital.

3.2.2. Performance Measurement and Materiality of Investment Property

The fair value model may also be chosen because it facilitates more accurate performance measurement, particularly for firms whose core business is real estate. For these companies, earning rental income and realizing capital gains from trading investment property is central to their business model. Fair value accounting, which recognizes changes in value in profit or loss as they occur, provides a more accurate and timely measure of periodic income than the historical cost model. Therefore, it is hypothesized that firms will prefer the fair value model when investment property represents a material component of their total assets, as it better reflects the performance of these core operations.

3.3. Institutional Factors

Even with the widespread adoption of IFRS, a significant body of research documents the persistence of national differences in accounting practices. A country's institutional context—including its legal origin, the sophistication of its capital markets, its pre-IFRS accounting traditions, and broader societal characteristics—continues to shape financial reporting choices. Therefore, this study expects that the institutional environment of a firm's home country will significantly influence the managerial choice between the fair value and cost models for investment property. The following section details the research methodology designed to empirically test these multifaceted hypotheses.

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4. Research Design

This section details the methodology employed to empirically test the hypotheses developed from the theoretical framework. A logistic regression model is used to analyze the factors influencing the accounting choice for investment property among European real estate firms.

4.1. Sample Selection and Data

The data for this analysis were hand-collected from the annual reports of 212 listed real estate companies domiciled in nine European countries: the United Kingdom, Ireland, Sweden, Finland, Spain, Italy, France, Germany, and Greece. The sample period covers the years 2014–2023, resulting in a final dataset of 1,513 firm-year observations. This selection of countries is intentional, as it includes jurisdictions with differing pre-IFRS traditions for investment property valuation—some of which mandated fair value (e.g., UK, Ireland) while others required historical cost (e.g., Italy, Spain, Germany).

4.2. Model Specification

To analyze the dichotomous choice between the fair value and cost models, a logistic regression model is specified. The dependent variable is a binary variable that equals 1 if the firm uses the fair value model for its investment property and 0 if it uses the cost model. The key independent variables included in the model to test the hypotheses are:

  • LEV: Leverage, measured as the ratio of total debt to total assets. This variable tests for contractual efficiency motives related to debt covenants.
  • SIZE: Firm size, measured as the natural logarithm of total assets. This variable serves as a proxy for political costs.
  • MTBV: Market-to-book value of equity, used as a proxy for information asymmetry between managers and investors.
  • IP_TA: Materiality of investment property, measured as the ratio of investment property to total assets. This variable tests for performance measurement incentives.
  • FAC_1 to FAC_4: Four latent factors representing country-level institutional characteristics, capturing attributes related to governance, capital market development, political processes, and societal openness.

The model also includes control variables for firm activity, membership in the European Public Real Estate Association (EPRA), and Real Estate Investment Trust (REIT) status, along with year fixed effects. These controls are included for their theoretical importance. Membership in EPRA is expected to be positively associated with the fair value choice, as the association promotes the use of fair value to improve uniformity and comparability. REIT status is included as a control because these entities often operate under specific regulatory regimes that may influence or mandate particular valuation choices. The subsequent section presents the empirical results derived from this model.

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5. Empirical Results and Analysis

The empirical analysis reveals significant and systematic patterns in the accounting choices made by European real estate firms for their investment property. The multi-motivation logistic regression model explains approximately 45% of the variance observed in the selection between the fair value and cost models, underscoring the combined influence of contractual, asset-pricing, and institutional factors.

5.1. Descriptive Statistics

Across the entire sample, the descriptive data show a strong overall preference for the fair value model, which accounts for 84.3% of all firm-year observations. However, a closer look at the country-level data reveals crucial differences. Firms in the United Kingdom, Sweden, Finland, and Ireland almost exclusively use the fair value model. In stark contrast, the cost model remains the prevalent choice in Italy and Spain, where a majority of firms continue to use it. This pronounced variation across jurisdictions provides initial evidence that, even a decade after IFRS adoption, a firm's institutional context and national accounting traditions continue to play a significant role in shaping accounting policy choices. This preference may reflect the institutional context of these countries, a hypothesis our regression analysis will later confirm, showing that factors related to capital market development and political processes are potent drivers of this choice.

5.2. Analysis of Regression Results

The results from the logistic regression analysis provide robust support for the hypotheses, clarifying the specific drivers behind the choice between the fair value and cost models.

  • Leverage and Contractual Incentives The analysis reveals a strong, negative, and statistically significant association between a firm's leverage (LEV) and its choice to use the fair value model. This finding supports the hypothesis that contractual incentives related to debt are a powerful driver. It suggests that debt holders prefer the conservatism of the cost model, as it is perceived to reduce agency costs and offer greater protection of their interests by preventing potential overstatement of assets.
  • Firm Size in the Real Estate Context A positive and significant relationship exists between firm size (SIZE) and the adoption of the fair value model. This positive association supports our hypothesis that in the unique context of the real estate industry, where liquid markets render fair value estimates more verifiable, the political costs traditionally associated with larger firm size are mitigated, allowing the informational benefits of the fair value model to prevail.
  • Information Asymmetry and Performance The regression results show a negative association between the market-to-book value ratio (MTBV) and the choice of the fair value model, supporting the hypothesis that firms use fair value to reduce information asymmetries and align book values more closely with market perceptions. Furthermore, there is a positive and highly significant relationship between the materiality of investment property (IP_TA) and the adoption of the fair value model. This confirms the hypothesis that the fair value model is the preferred method for performance measurement when IP is a core asset, as it provides a more accurate and timely reflection of value creation.
  • The Enduring Impact of Institutional Context All four latent institutional factors, representing dimensions such as governance, capital market development, political processes, and societal openness, are highly significant in the model. This provides powerful evidence that country-level characteristics remain potent drivers of accounting choices long after the formal harmonization of standards through IFRS. National accounting legacies and institutional environments continue to exert a strong, persistent influence on how firms report financial information.

These findings collectively demonstrate that the choice of valuation model for investment property is a complex decision influenced by a confluence of interconnected factors.

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6. Conclusion

6.1. Summary of Findings

A decade post-IFRS adoption, the choice of valuation for investment property is not converging on the standard-setter's preferred model but remains a complex negotiation between contractual pragmatism, market signaling, and deeply embedded national institutional DNA. This study demonstrates that the managerial decision to adopt either the fair value or the cost model under IAS 40 is systematically influenced by a compelling mix of contractual efficiency motives (leverage and size), asset-pricing incentives (information asymmetry and performance measurement), and, critically, the enduring impact of country-level institutional factors.

6.2. Implications for Standard-Setters and Stakeholders

The results of this research have important practical implications. For standard-setters like the IASB, the findings raise questions about the universal acceptance and application of the fair value model under IAS 40. The continued preference for the cost model in certain institutional contexts and under specific firm-level conditions suggests that a "one-size-fits-all" mandate for fair value may not be optimal without addressing the underlying drivers of this choice. For investors and analysts, this study underscores the critical importance of looking beyond the face of the financial statements. Understanding the motivations behind a firm's accounting choices allows for a more nuanced assessment of its financial performance, risk profile, and the overall quality of its reporting.

6.3. Limitations and Avenues for Future Research

This study is subject to certain limitations, most notably its focus on a specific set of nine European countries and the real estate sector. While this focus provides depth, it may limit the generalizability of the findings. Future research could build upon this work by expanding the analysis to other IFRS-adopting regions, such as Asia or Latin America, where institutional contexts differ significantly. Additionally, examining the accounting choices for investment property in other industries where it is a material asset could provide valuable comparative insights and further enhance our understanding of the drivers of accounting policy under IAS 40.