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February 27, 2012
SEC Needs "A Few More Months" Before Concluding On Whether to Permit Domestic Companies to Adopt IFRS
The SEC was expected to reach a final conclusion on whether to adopt International Financial Reporting Standards (IFRS) in the U.S. by the end of 2011. However, in February 2012, SEC Chief Accountant James Kroeker stated that the SEC staff needed a few more months before it can finalize a report on which the SEC will base its decision on whether to allow the use of IFRS by domestic U.S. companies. In December 2011, both Financial Accounting Standards Board (FASB) Chairman Leslie Seidman and International Accounting Standards Board (IASB) Chairman Hans Hoogervorst stated that the current arrangement whereby the FASB and the IASB work "side-by-side" in their standard setting efforts is not a sustainable long-term solution to global standard setting. Both Boards continue to work together on the revenue recognition, leases, financial instruments, and insurance projects. However, based on Seidman's and Hoogervorst's comments, it is doubtful that there will be additional joint projects once these four projects are completed.
Update on FASB and IASB Joint Leases Project
Lessor Accounting
The FASB and IASB (collectively, the Boards) continue to tentatively scope lessors of investment property out of the proposed receivable and residual lessor accounting model (R&R model). Given this tentative decision, lessors of investment property would continue to apply current operating lease accounting, with rental income recognized on a straight-line basis. It is important to note that this scope out is a tentative conclusion. At a Leases Working Group meeting on Jan. 24, 2012, it became clear that other lessors, as well as certain lessees, are pressing the Boards to expand the scope out to other assets/industries.
Lessee Accounting
The Boards continue to support the lessee accounting model as presented in the Leases exposure draft. That guidance provides for a front-loaded expense pattern similar to interest expense on amortizing debt. However, given the Boards' decision to scope all lessors of investment property out of the proposed Leases standard, there is a possibility that the Boards could revisit the accounting for lessees of investment properties. Additionally, constituents continue to question more broadly the proposed lessee accounting model that would result in accounting for a lease like amortizing debt on the income statement. Many preparers and users of financial statements favor the current straight-line amortization of rental expense in the income statement. Therefore, there is a possibility that the FASB and IASB may revisit the lessee accounting model prior to re-issuing the Leases exposure draft.
Outlook
The Boards expect to re-expose the proposed lease accounting standard for comment in the first half of 2012, and to finalize the standard by the end of 2012. However, we do not expect the standard to be effective prior to 2015. Once the Boards re-expose the proposed Leases standard, NAREIT will re-engage with its task force to establish consensus views and issue a comment letter to the Boards.
NAREIT Comments on FASB's Investment Property Entities Exposure Draft
On Feb. 15, 2012, NAREIT submitted a letter to the FASB on its Investment Property Entities exposure draft (the Proposed Update). The Proposed Update would provide criteria to determine whether an entity would be considered an investment property entity. Those entities that qualify as investment property entities would be required to measure their investment properties at fair value, with changes in fair value recorded in earnings. Additionally, rental revenue would be recognized on a contractual basis as opposed to the current straight-line basis in the income statement.
In the letter, NAREIT recommended that the FASB withdraw the Proposed Update and move to develop an activity-based standard that would: a) converge with International Accounting Standard No. 40 Investment Property (incorporating recommended changes); and, b) achieve consistency with the Board's operating principle to avoid issuing complex specialized industry accounting standards. Consistent with previous direction from the NAREIT Executive Board, NAREIT continues to believe that a U.S. Generally Accepted Accounting Principles (U.S. GAAP) standard for accounting for investment property should require that all investment property be reported at fair value with changes in unrealized value reported in net income and that IAS 40 should be clarified to make certain that it applies to lodging and health care REITs.
NAREIT provided the following arguments in support of its recommendation to the FASB:
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The Proposed Update does not converge with IFRS – a primary goal of developing the standard;
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The Proposed Update is contrary to a fundamental conclusion of the final report of the Advisory Committee on Improvements to Financial Reporting (CIFR) to the United States Securities and Exchange Commission dated Aug. 1, 2008 that accounting standards should "focus on the nature of the business activity itself, since the same activities, such as lending (or owning investment property), may be carried out by companies from different industries" – italicized wording inserted;
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The Proposed Update does not recognize the significant distinction between the business and relevant financial reporting of: a) owning and operating investment property; and, b) simply holding real estate as a passive investment;
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The Proposed Update creates an entirely false distinction as to whether an entity holds investment property for income only or for income and appreciation in the value of the property – because the goal of owners/operators of investment property is to maximize total financial return from the aggregate of operating cash flow and appreciation in value; and,
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The Proposed Update provides criteria to define an investment property entity (IPE) that are so unclear as to falsely create the impression that it requires the proposed accounting while in reality it provides preparers with implicit optionality.
Outlook
The FASB has not indicated when it expects to finalize the standard and therefore has not proposed an effective date.
The FASB and the IASB will host a series of joint public roundtable meetings to discuss their proposals on Investment Property Entities, as well as on Investment Companies. The U.S. roundtable is scheduled for March 16, 2012. NAREIT has requested a "seat" at this roundtable, while other members of the Real Estate Equity Securitization Alliance (REESA) plan on participating in the sessions being held in Canada and the United Kingdom.
NAREIT Comments on FASB's Investment Companies Exposure Draft
On Feb. 15, 2012, NAREIT submitted a letter to the FASB on its Investment Companies exposure draft (the Proposed Update). The Proposed Update would provide criteria to determine whether an entity would be considered an investment company for purposes of the accounting rules. Those entities that qualify as investment companies would measure all investments at fair value, including investments in investment property, with changes in fair value recorded in earnings. Additionally, the Proposed Update would eliminate the explicit REIT exception that is included in existing Investment Companies guidance. To the extent that it meets the scope criteria of both the IPE and Investment Companies standards, a REIT would follow the guidance included in the IPE guidance.
The major concerns of NAREIT are that, for those REITs that meet the criteria of a so-called investment company, a) changes in the unrealized value of investments would be reported in net income rather than in other comprehensive income outside of net income; and, b) the investment company label for financial standards is generally at odds with the facts and would be confusing, especially when the related International Standard is for investment entities.
NAREIT requested that the FASB preserve the REIT scope exception. If the FASB chooses not to follow NAREIT's recommendation to preserve the REIT scope exception, NAREIT recommended that the Board make the following amendments to the Proposed Update:
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Retain the current accounting model for available-for-sale securities currently applied by mortgage REITs; and,
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Add an illustrative example that addresses mortgage REITs.
Irrespective of whether the FASB chooses to follow NAREIT's aforementioned recommendations on the Proposed Update, NAREIT recommended that the Board make the following amendments to the Proposed Update:
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Adopt the IASB's definition of "fair value management."
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Add a seventh scope criterion on Transactions Priced at Net Asset Value for the Proposed Update.
NAREIT believes by following these recommendations, the FASB would address its concerns on ambiguous terminology, further differentiate mortgage REITs from investment companies, and provide for a consistent and coherent accounting framework that is based on the economics of the underlying transactions in the Proposed Update. Outlook
The FASB has not indicated when it expects to finalize the standard and therefore has not proposed an effective date.
As mentioned above, NAREIT has requested to participate in the public roundtable scheduled on March 16, 2012 in Norwalk, CT.
REESA Comments on FASB's Consolidation: Principal vs. Agent Analysis Exposure Draft
On Feb. 15, 2012, NAREIT and its global partners in the Real Estate Equity Securitization Alliance (REESA) submitted a letter to the FASB on its Proposed Accounting Standards Update on Consolidation (Topic 810): Principal versus Agent Analysis (the Proposed ASU). The Proposed ASU would amend the consolidation guidance for variable interest entities (VIEs) and voting interest entities. In so doing, the FASB would mandate the application of consolidation guidance to investment companies, which had previously been indefinitely deferred. The ASU could impact NAREIT member companies that: 1) are investment companies; 2) have limited partnerships when the REIT is the general partner (the GP) (such as Operating Partnerships in an UPREIT or DownREIT structure); or, 3) have investment funds that exhibit qualities of investment companies.
REESA expressed its general support of the FASB's efforts on the Proposed ASU. REESA indicated that the Proposed ASU would improve the comparability of financial statements and disclosures prepared in accordance with U.S. GAAP and IFRS. Therefore, REESA believes that the Proposed ASU is a step in the right direction in order to achieve ultimate convergence of U.S. GAAP with IFRS at some point in the future.
Proposed Guidance for Variable Interest Entities
The Proposed ASU would introduce a new qualitative assessment for companies to evaluate whether or not the company with the power to direct the most significant activities of the entity is acting in a principal or agent capacity. This determination would dictate whether the company would be required to consolidate the entity. Companies acting in a principal capacity would be required to consolidate, while companies acting in an agent capacity would not.
Proposed Guidance for Voting Interest Entities
The same qualitative analysis would be required for companies that operate under the voting interest model. For example, in a limited partnership, the presumption that the GP should consolidate the limited partnership could be overcome provided that the GP is acting in an agent capacity.
The Qualitative Principle versus Agent Assessment
The FASB developed three criteria to determine whether a decision maker is acting in a principal or agent capacity:
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The rights held by others;
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The compensation to which the decision maker is entitled in accordance with the compensation agreement(s); and,
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The decision maker's exposure to variability of returns from other interests that it holds in the entity.
Each of the criteria would be weighed differently based on the purpose and design of the entity subject to the consolidation assessment. The Rights Held by Others
Whether the company holds substantive kick-out rights ( i.e., removal rights) or participating rights may indicate that the decision maker is an agent versus a principal. For example, if the decision maker can be removed without cause, the decision maker would be considered an agent. Thus, the decision maker would not consolidate the entity. The Decision Maker's Compensation
If the decision maker's compensation: -
is not commensurate with the level of services provided; and,
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includes terms and conditions that are not customary for similar services,
then the decision maker would be deemed a principal, and thus would consolidate the entity. Variability to Other Interests
Careful consideration would need to be given to all of the decision maker's interests in the entity. The general presumption would be that the more exposure that the decision maker has to expected variable returns, the more likely that the decision maker would be considered a principal. Thus, the decision maker would consolidate the entity in this scenario. Outlook
The FASB intends on finalizing the Proposed ASU in the second half of 2012.
REESA Comments on IASB's Investment Entities Exposure Draft
On Jan. 5, 2012, NAREIT and its global partners in the REESA submitted a letter to the IASB on its Investment Entities exposure draft (the Exposure Draft or the Proposed Guidance). The Exposure Draft proposes criteria for an entity to qualify as an investment entity and provides guidance for making this assessment. The Proposed Guidance would require an investment entity to measure its investments in controlled entities at fair value on the balance sheet, with changes in fair value recognized in the income statement. Additionally, the Proposed Guidance would require additional disclosures intended to enable users of its financial statements to evaluate the nature and financial effects of its investment activities.
In the letter, REESA outlined why corporate property groups including equity REITs do not meet the criteria to be an investment entity, and therefore should be outside the scope of the proposed standard. Some of the reasons put forth included:
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Most corporate property groups that own, develop, actively manage and operate the underlying "bricks and mortar" property asset do not meet the criteria proposed in the exposure draft. More specifically, these property groups do not express an explicit commitment to invest for capital appreciation and/or investment income nor do they express an explicit exit strategy.
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Users of financial statements of corporate property groups are interested in separate reporting of rental revenue and rental expenses related to the real estate properties as key performance measures, among others. The proposed standard's requirement to report investments at fair value on the balance sheet with changes in value through the income statement, rather than consolidating the results on both the balance sheet and income statement that would provide granular results on rental income and expense, would undermine the transparency of financial reporting that investors and users require.
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Outlook
The IASB has not indicated when it expects to finalize the standard and therefore has not proposed an effective date. As mentioned above, REESA members have requested "seats" at the public roundtables.
NAREIT Clarifies FFO to Exclude Impairment Write-Downs in Certain Circumstances
On Oct. 31, 2011, and Nov. 4, 2011, NAREIT issued guidance for reporting Funds From Operations (FFO) that reaffirmed NAREIT's view that impairment write-downs of depreciable real estate should be excluded from the computation of NAREIT FFO. This view is based on the fact that impairment write-downs are akin to and effectively reflect the early recognition of losses on prospective sales of depreciable property or represent adjustments of previously charged depreciation. Since depreciation of real estate and gains/losses from sales are excluded from NAREIT FFO, it is NAREIT's view that it is consistent and appropriate for impairment write-downs of depreciable real estate to also be excluded.
Subsequent to issuing the guidance on Oct. 31 and Nov. 4, a number of NAREIT members asked if impairment write-downs of other assets should also be excluded from FFO. Of the fact patterns raised, NAREIT concluded that the only impairment write-downs consistent with the concept of write-downs of depreciable assets or the early recognition of losses on sale of depreciable real estate are the write-downs of investments in affiliates (e.g., joint ventures and partnerships), when there is clear evidence that the write-downs of the investor's investment in the affiliate have been driven by a measurable decrease in fair value of depreciable real estate held by the affiliate. NAREIT has concluded that these write-downs should be excluded from the FFO of the investor in the affiliate. This guidance was provided to NAREIT members in an SFO Alert on Jan. 6, 2012.
NAREIT discussed this modification in the treatment of these specific impairment write-downs with SEC staff. The staff informed NAREIT that it expects that a REIT excluding these write-downs from FFO would include clear and detailed disclosure of how it determined that the write-down was driven by a measurable decrease in the fair value of depreciable real estate held by the affiliate. The staff also informed us that they may request further clarification from the registrant if the reasonable basis for this conclusion is not clear in the filing.
NAREIT Discusses with the SEC Areas of Focus in 2011 Form 10-Ks
On Feb. 8, 2012, the staff of the SEC Division of Corporation Finance briefed NAREIT on the SEC's areas of focus in reviewing REIT 10-K filings for 2011 year end. NAREIT shared the SEC's areas of focus with its members in an SFO Alert dated Feb. 13, 2012.
The areas of focus in financial reporting for equity REITs include:
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Key Performance Indicators (KPIs)
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Net operating income (NOI) disclosure
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Same Store NOI
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Management's Discussion and Analysis (MD&A) disclosures
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Period over period changes in rental rates and occupancy and lease rollovers
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Key trends in new leases and lease renewals
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Material known trends for leases expected to terminate in the next year using current market rents
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General and administrative costs policies and types of costs capitalized or expensed
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Leasing Activities
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Amount of space leased
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Rents on new leases
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Tenant improvements and leasing commissions
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Statement of Cash Flows
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Granular presentation of capital expenditures.
The areas of focus in financial reporting for mortgage REITs include:
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Characteristics of asset types
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Collateral
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Interest rate
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Geographic diversification
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Vintage of assets
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Asset duration
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Loan size
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Loan seasoning
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Repurchase Agreements disclosures
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Trends and weighted-average haircut applied
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Collateral value
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Repurchase agreement lenders by name, if material
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Hedging disclosure
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Objective of hedging program
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Types of derivative instruments utilized (e.g., interest rate swaps)
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Gap between duration of swaps and the hedged item.
FASB and IASB Add Project to Explore Reducing Differences in Classification and Measurement Models for Financial Instruments
On Jan. 27, 2012, the Boards agreed to add a joint project to their respective agendas that will seek to reduce differences in their classification and measurement models for financial instruments.
Currently, there are key differences between the models that the FASB and IASB have proposed for the classification and measurement of financial instruments. The most pronounced difference is that the FASB has three classifications for financial instruments, while the IASB has only two. The FASB's proposed model includes financial instruments classified as:
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Amortized cost;
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Fair value, with changes in fair value recognized in other comprehensive income; and,
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Fair value, with changes in fair value recognized in net income.
Meanwhile, the IASB's proposed model includes financial instruments classified as: -
Amortized cost; and,
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Fair value, with changes in fair value recognized in net income.
The distinction in classification would dictate different treatment in both valuation on the balance sheet ( i.e., amortized cost or fair value) and revenue recognition on the income statement ( i.e., interest income/expense, or mark-to-market gains and losses recognized in net income or other comprehensive income). Outlook
NAREIT anticipates that the Boards will begin deliberations on reducing differences between their classification and measurement models during joint meetings in the ensuing months. The Boards have not indicated when they expect to finalize the standard and therefore have not proposed an effective date.
FASB Proposes Simplification to Indefinite-Lived Intangible Impairment Assessments
On Jan. 25, 2012, the FASB issued a Proposed Accounting Standard Update on Intangibles – Goodwill and Other (Topic 350) – Testing Indefinite-Lived Intangible Assets for Impairment (the Proposed ASU). The Proposed ASU would represent a change to existing U.S. Generally Accepted Accounting Principles (GAAP) that simplifies how a company tests indefinite-lived intangible assets (e.g., trademarks, licenses, and distribution rights) for impairment. The Proposed ASU would provide companies with an option to perform a qualitative assessment of the likelihood that the fair value of the indefinite-lived intangible asset is less than its carrying amount. The changes are intended to provide companies with potential cost savings and reduce the complexity that is involved with the current impairment model. The assessment is based on qualitative factors (e.g., events and circumstances) and the probability threshold would be based on a likelihood of greater than 50 percent. To the extent that companies determine that impairment is not probable, companies would not be required to perform the quantitative goodwill impairment test that is currently required by U.S. GAAP today. If, however, companies determine that impairment is probable, companies would be required to perform the quantitative goodwill impairment test.
Under current impairment guidance, companies are required to test indefinite-lived intangible assets for impairment quantitatively, at least on an annual basis, by performing a two-step analysis. The first step requires a comparison of the fair value of the indefinite-lived intangible assets with its carrying amount. To the extent that the fair value is less than the carrying amount, companies perform step two in order to measure the impairment loss.
The Proposed ASU would be effective for annual and interim impairment tests performed for fiscal years beginning after June 15, 2012, with early adoption permitted.
If you would like to participate in a Task Force that will evaluate the proposal, develop a consensus view, and consider issuing a comment letter to the FASB, please contact Christopher Drula, NAREIT's Senior Director, Financial Standards, at cdrula@nareit.com by COB March 2, 2012. The comment letter deadline is April 24, 2012.
Outlook
The FASB intends on finalizing the Proposed ASU in June 2012.
FASB Defers New Presentation Requirement for Reclassifications of Other Comprehensive Income
On Dec. 23, 2011 FASB issued Accounting Standards Update No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (ASU 2011-12). ASU 2011-12 defers the effective date of the presentation of other comprehensive income (OCI) reclassification guidance contained in Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-12 indefinitely defers the new requirements for how and where reclassification adjustments out of OCI to net income would be presented in the financial statements. The guidance in ASU 2011-05 would have required the presentation of reclassification adjustments out of OCI to net income to be presented alongside their components of net income and OCI. A number of U.S. constituents raised concerns of unnecessary complexity, undue effort and whether the costs of the proposed presentation requirements would outweigh the benefits. The FASB has issued the deferral in ASU 2011-12 in light of this feedback.
It is important to note that the FASB is not recommending the deferral of the requirement to report OCI either in a continuous statement with the income statement or as two separate and consecutive financial statements. Previously, on June 16, 2011, the Boards issued ASU 2011-05 and an amendment to International Accounting Standard No. 1, Presentation of Financial Statements (IAS 1), respectively. The new guidance issued by the Boards was intended to converge the reporting requirements for OCI, and thereby increase comparability of financial reporting.
For SEC registrants, ASU 2011-05 and ASU 2011-12 are effective for the first interim or annual period beginning on or after Dec. 15, 2011. Full retrospective application is required, and early adoption is permitted.
For entities not registered with the SEC, ASU 2011-05 and ASU 2011-12 are effective for annual periods ending after Dec. 15, 2012, including interim periods thereafter. Full retrospective application is required, and early adoption is permitted.
FASB Issues Disclosure Requirements for Balance Sheet Offsetting
On Dec. 16, 2011, the FASB issued Accounting Standards Update No. 2011-11, Disclosures about Offsetting Assets and Liabilities (the ASU). The ASU provides disclosure requirements to reconcile differences in offsetting requirements for financial assets and financial liabilities contained in U.S. GAAP and IFRS. The ASU requires that the following information be disclosed in the notes to the financial statements:
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a) The gross amounts of financial assets and liabilities;
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b) The amounts of financial assets and liabilities offset in the statement of financial position;
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c) The net amount after taking into account a) and b), which should be the same as the amounts reported in the statement of financial position;
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d) The effect of the rights of set-off that are only enforceable and exercisable in bankruptcy, default or insolvency of either party not taken into account in arriving at the amounts presented in the statement of financial position (including collateral); and,
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e) The net exposure after taking into account the effect of items in b) and d).
Under IFRS, financial assets and financial liabilities are required to be presented on a net basis only when both of the following criteria are met: -
The company has a legally enforceable right to set off the recognized amounts; and,
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The company intends either to settle on a net basis or to realize the financial asset and settle the financial liability simultaneously.
Meanwhile, the FASB elected to provide an exception to the rule for certain derivatives, repurchase agreements, and related collateral. Under U.S. GAAP, certain derivatives assets and derivative liabilities with the same counterparty subject to master netting arrangements are required to be presented on a net basis. IFRS does not contain this exception to the presentation requirements.
The ASU is effective for annual reporting periods beginning on or after Jan. 1, 2013, and interim periods within those annual periods.
REESA Comments on IASB Agenda Consultation 2011
On Dec. 13, 2011, NAREIT and its partners in REESA submitted a letter to the IASB on the Agenda Consultation 2011. In the letter, REESA recommended that the IASB's strategic priority must continue to be the development of a comprehensive set of principles based high quality financial reporting standards. Additionally, REESA suggested that IASB should increase its focus on reducing the complexity of financial reporting.
REESA also recommended that the IASB should finalize the joint revenue recognition, leases (including consequential amendments to International Accounting Standard (IAS) 40 Investment Property) and financial instrument projects with the FASB before further projects are undertaken. Thereafter, REESA said that it is critical to slow the rate of change to allow for a period of calm.
REESA recommended that the IASB's strategic areas of focus in the short to medium term (1 to 2 years) should include:
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The performance of timely post-implementation reviews;
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The development of a clear framework for disclosures; and,
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The establishment of a dedicated research network.
Finally, REESA recommended that priorities within the global real estate industry include: -
Investment properties and the need to ensure that the unique business and economic characteristics of companies that own and operate income-producing real estate are considered in standard setting by the IASB.
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Simplifying financial statement presentation and disclosures by developing a disclosure framework and refining disclosures in existing accounting standards.
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Standards for financial instruments with characteristics of equity and the equity method of accounting.
Outlook
In March 2012, the IASB plans on holding public round-table discussions on their agenda consultation document in Norwalk, Toronto, and London. The Norwalk roundtable will be held on March 13, 2012.
NAREIT Comments on PCAOB's Concept Release on Auditor Independence and Audit Firm Rotation
On Dec. 9, 2011, NAREIT responded to the Public Company Accounting Oversight Board's (PCAOB) Concept Release on Auditor Independence and Audit Firm Rotation. In its letter, NAREIT argued that mandatory audit firm rotation would not necessarily produce higher quality audits. NAREIT offered a number of factors supporting its position, including a lack of empirical evidence that the current audit structure is in need of reform. NAREIT also noted that mandatory audit firm rotation could lead to higher audit fees and an increase in the incidents of audit failures. Therefore, NAREIT requested that the PCAOB withdraw the Concept Release from its agenda.
Background
On Aug. 16, 2011, the PCAOB issued a Concept Release on Auditor Independence and Audit Firm Rotation for public comment. In the Release, the PCAOB explored mandatory audit firm rotation for public companies as a possible way to enhance auditor independence, objectivity and professional skepticism. The PCAOB reasoned that this approach would ultimately achieve its objective of increased quality in audits executed by public accounting firms, and thereby reduce the number of audit failures that the PCAOB has identified through its inspections process.
Outlook
The PCAOB will convene a public roundtable on March 21 - 22, 2012 to further explore constituents' views on the topic.
FASB Ratifies EITF Consensus for Derecognition of In Substance Real Estate
On Nov. 30, 2011, the FASB ratified the Emerging Issues Task Force (EITF) consensus for Issue 2011-10, Derecognition of in Substance Real Estate – A Scope Clarification. The guidance clarifies that ASC 360-20, Property, Plant, and Equipment - Real Estate Sales (ASC 360-20) (formerly FAS 66, Accounting for Sales of Real Estate) is the authoritative guidance when an investor loses control of real estate to a lender as a result of defaulting on a loan. Therefore, the investor is precluded from derecognizing the real estate until legal ownership has been transferred to the lender. Some accountants questioned whether this transaction should have been guided by ASC 810-10, Consolidation (ASC 810-10) (formerly FAS 160, Noncontrolling Interests in Consolidated Financial Statements). Under the Consolidation guidance, the investor would have been able to derecognize the real estate upon loss of control through default on the loan – in many cases prior to title passing to the lender.
The Accounting Standards Update (ASU) directly impacts NAREIT members who have previously questioned which accounting model should be applied to determine when a company should deconsolidate "in substance real estate," i.e., property held in a special purpose entity in the fact pattern described below.
The ASU applies to the following fact pattern: a company establishes a special purpose entity (SPE) that holds a real estate asset, which serves as collateral for its non-recourse debt. The company owns all of the equity in the SPE, and therefore consolidates the SPE in its financial statements. If the SPE endures economic hardship and defaults on the loan, the lender may take possession of the collateral. The question is which accounting model should be applied to the transaction: the accounting guidance in ASC 360-20 or ASC 810-10. The ASU states that the guidance in ASC 360-20 applies in this fact pattern.
The ASU is effective for public companies for fiscal years beginning on or after June 15, 2012. The ASU is effective for nonpublic companies for fiscal years ending after Dec. 15, 2013. Early adoption is permitted.
FASB and IASB Re-Expose Revenue from Contracts with Customers Proposal
On Nov. 14, 2011, the Boards issued their revised exposure draft on Revenue from Contracts with Customers (the Proposed Update). The Proposed Update would converge the financial reporting requirements for revenue recognition in U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
The Proposed Update would significantly impact the approach to accounting for all sales of real estate and result in the potential removal of FASB's current rules-based standard, Subtopic 360-20 or Statement of Financial Accounting Standards 66 (SFAS 66). NAREIT believes that the proposal would improve financial reporting for sales of real estate because it would require that companies recognize revenue according to a single principle: when the seller satisfies a performance obligation, which would be when the buyer takes control of the good or service.
The proposed revenue recognition guidance would also impact the accounting for services included in lease contracts. While the revenue recognition proposal would exclude from its scope the accounting for leases, the boards have tentatively decided, in connection with the lease accounting project, that lessors and lessees would be required to allocate lease payments between service and lease components. This allocation would be based on whether the service components are distinct from the lease components under the proposed revenue recognition guidance.
Outlook
NAREIT has re-engaged with its member task force to establish a consensus view and plans to issue a comment letter to the FASB in advance of the comment letter deadline of March 13, 2012. The FASB and the IASB will host a series of joint public roundtable meetings to discuss their proposal on Revenue from Contracts with Customers. The U.S. roundtable is scheduled for April 26, 2012.
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