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July 28, 2010
Standard Setters Alter Work Plan Toward Convergence
On June 24, 2010, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued a joint progress report providing more details to their previously announced plans to modify their strategy toward convergence. The Boards revised their work plan in response to constituents' concerns over the large number of significant exposure drafts originally scheduled to be issued in the second quarter of 2010.
Under the modified strategy, the Boards intend to: 1) prioritize the major convergence projects based on the most critical issues and greatest potential to improve and converge US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS); 2) stagger the publication of exposure drafts and related consultations (i.e., public round tables) and release no more than four significant exposure drafts in any one quarter; and, 3) seek stakeholder input about effective dates and transition methods. CLICK HERE to read the quarterly progress report.
Based on the June 24 quarterly report, the Boards are committed to completing the following projects in June 2011 or earlier: financial instruments, revenue recognition, leases, the presentation of other comprehensive income and fair value measurement. With the exception of leases, the Boards have already issued exposure drafts on these high-priority projects. The Leases Exposure Draft is expected in August 2010.
The remaining projects that the Boards believe are of less priority or may require additional research and analysis are expected to be completed in the second half of 2011. These projects include financial statement presentation (including discontinued operations), financial instruments with characteristics of equity and consolidations. In May, the Boards decided to make the timing of the discontinued operations project parallel with the completion date of the financial statement presentation project, which is planned for the second half of 2011.
Although the revised work plan is expected to only extend the completion dates of certain projects for six months, the Boards indicated that they believe the revised plan would allow constituents to more effectively respond to the upcoming proposals.
Prior to the Boards' announcement to revise their strategy, NAREIT submitted a letter, on behalf of its global partners of the Real Estate Equity Securitization Alliance (REESA), that expressed concerns regarding the current pace of global convergence of accounting standards. The letter indicated that: 1) REESA continues to be committed to supporting the development of a single set of high quality global accounting standards; 2) REESA has been fully engaged in the Boards' due process toward achieving convergence; and, 3) REESA urges the Boards to modify the timetable with respect to completing their due process for over 20 exposure drafts to be issued in the near term. CLICK HERE to read the May 26, 2010 letter.
FASB and IASB Issue Revenue Recognition Exposure Draft
On June 24, 2010, the FASB and IASB released their Exposure Draft on recognition of revenue from contracts with customers, including revenue or gains resulting from contracts for all sales of real estate. The overarching principle of this contract-based model is that revenue would be recognized in the amount of consideration expected to be received when goods or services transfer to the customer. This proposal generally excludes leases, insurance contracts and financial instruments. To read the Exposure Draft, CLICK HERE. Comments on the Exposure Draft are due by October 22, 2010. As mentioned above, the Boards' project plan indicates that a final standard will be issued in the first half of 2011.
The revenue recognition proposal would significantly impact the approach toward 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.
As previously reported in NAREIT's May 2010 SFO Report, the FASB's examination of this issue included an invitation to NAREIT to present its views of the potential removal of SFAS 66 at a FASB Education Session in April 2010. At the meeting, NAREIT asserted that all sales of real estate should be accounted for under the proposed revenue recognition standard whether or not they are outputs of a company's ordinary activities. The Boards' preliminary revenue recognition views would have applied the proposed standard only to those sales of real estate representing outputs of ordinary activities. For more information on NAREIT's views of this issue, CLICK HERE to access the May 2010 SFO Report.
Another proposed change that may impact the industry is the accounting for services included in lease contracts. While the revenue recognition proposal excludes 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 principles.
According to the Exposure Draft on revenue recognition, a service is distinct if either: 1) the entity (or another entity) sells an identical or similar service separately; or, 2) the entity could sell the good or service separately because it has a distinct function and a distinct profit margin. If the service is distinct, total payments would be allocated between service and lease components using the proposed revenue recognition principles. If the service component is not considered distinct, total payments would be accounted for as a lease under the lease accounting project.
NAREIT will monitor the Boards' progress with respect to accounting for services, as well as continue to examine the revenue recognition proposal to determine further impacts that it would have on the industry. A task force to develop the industry's views on this proposal is underway. If you would like to join the task force, please contact Sally Glenn at sglenn@nareit.com.
FASB Leans toward Requiring Fair Value Reporting for Investment Property
At its July 14, 2010 meeting, the FASB concluded that it should issue a proposed Accounting Standards Update (exposure draft) that would require that investment property be reported at fair value. This FASB examination of investment property reporting is being pursued in connection with the IASB's conclusion that lessors of investment property would be exempt from the Boards' proposed lease accounting standard if the properties are reported at fair value pursuant to International Accounting Standard No. 40 Investment Property (IAS 40). This international accounting standard provides a choice to report investment property at cost or fair value. Since there is no such standard in US GAAP, the FASB is compelled to develop a US GAAP standard similar to IAS 40 to facilitate the issuance of a converged lease accounting standard. Most significant to NAREIT member companies, the FASB concluded that its proposed standard would require rather than allow a choice to report investment property at fair value.
The Board's discussion was based on a paper developed by the staff. CLICK HERE to read the issues in the staff paper regarding investment property, which are addressed on pages 7 through 18. This staff paper focused on the definition of investment property and included the following questions:
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Should the project's scope only include real estate investment properties?
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Should the definition of investment property be limited to only land and buildings?
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Whether owner-occupied properties qualify as real estate investment property?
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Can properties partially occupied by owners qualify for real estate investment property?
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Can rental properties qualify as real estate investment property if leases provide property-related services to lessees?
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Does real estate property held for sale in the ordinary course of business qualify as investment property?
The views and conclusions with respect to these questions could result in a definition of investment property that would be inconsistent with IAS 40. The conclusion of this discussion was that the proposed US GAAP standard should mirror IAS 40 to the greatest extent possible and, therefore, the Board should issue a proposed Accounting Standards Update similar to IAS 40 and not open up these broader questions at this time. Eventually, the Boards may choose to modify both the US and international standards. The proposed Accounting Standards Update is expected to be issued in the third quarter of 2010.
NAREIT will form a task force to develop a response to the FASB's Exposure Draft. If you would like to participate in this task force, please contact George Yungmann at gyungmann@nareit.com.
FASB Proposes Financial Instruments Overhaul
On May 26, 2010, the FASB released an Exposure Draft: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. The primary objective of the proposal is to provide financial statement users with a more relevant and accurate understanding of an entity's financial instruments. The Board's focus is on the characteristics of the instruments and an entity's business strategy – two underlying factors in determining the proper accounting for financial instruments. To read the Exposure Draft, CLICK HERE. Comments are due by September 30, 2010 and a final standard is expected in the first half of 2011 with an estimated effective date of 2013.
Although the FASB and IASB intend to converge their accounting for financial instruments, differences currently exist in the proposed models developed by each Board. The FASB's proposal would result in more financial instruments being measured at fair value than the proposals of the IASB. In its Exposure Draft, the FASB would require that most financial instruments be measured at fair value in the balance sheet at each reporting date with changes in fair value during the reporting period recognized in net income (loss).
However, for certain financial instruments that meet the Exposure Draft's specified criteria, a portion of the change in fair value would be recognized in other comprehensive income. All of the following criteria must be met to qualify for other comprehensive income recognition: 1) there is an amount transferred to the debtor at inception that will be returned to the creditor at maturity; 2) the contractual terms of the debt instrument identify any additional contractual cash flows to be paid to the creditor either periodically or at the end of the instrument's term; 3) the debt instrument cannot contractually be prepaid or be settled in such a way that the investor would not recover substantially all of its initial investment, other than through its own choice; 4) an entity's business strategy is to hold certain financial instruments for collection or payments of contractual cash flows; and, 5) it is not a hybrid instrument which would require that the embedded derivative be accounted for separately from the host contract.
A portion of the change in fair value of those financial instruments that meet the above criteria would be recognized in other comprehensive income each reporting period. This portion would represent the change in fair value less changes from interest accruals, credit impairments and realized gains (losses). Additionally, on the face of the balance sheet, a reconciliation from amortized cost to fair value would be required for these financial instruments.
Although most financial instruments are measured at fair value under the proposal, certain financial instruments that meet the criteria for other comprehensive income recognition are permitted to be measured at amortized cost in the balance sheet. These instruments include short-term receivables and payables and financial liabilities in which the fair value measurement would create (or increase) a mismatch in the measurement of other recognized assets and liabilities. For example, mortgage debt would continue to be recognized at amortized cost because it is contractually linked to property that is measured on a cost basis.
In addition to the proposed changes discussed above, the FASB's proposal addresses changes in a variety of other areas related to financial instruments, including impairment, hedge accounting and equity investments. The proposal provides a common approach for credit impairments of financial assets and removes the current probable threshold for recognizing credit impairments. A credit impairment would be recognized in net income (loss) for a financial asset when the company does not expect to collect all contractual amounts due for originated financial assets and all amounts originally expected to be collected upon acquisition for purchased financial assets.
With regard to derivatives, the FASB proposal would generally: 1) add more qualitative guidance to the qualifications for hedge accounting; 2) reduce the threshold to qualify for hedge accounting from highly effective to reasonably effective; 3) eliminate the shortcut and the critical terms match methods; 4) prohibit the discontinuation of hedge accounting based on the removal of a hedge designation; and, 5) retain existing guidance to designate hedge relationships by risk. CLICK HERE to read NAREIT's August 2008 letter to the FASB recommending the retention of the bifurcation-by-risk model and supporting the change from highly effective to reasonably effective hedging relationships.
For those entities that currently account for equity investments under the equity method of accounting, the proposal would continue to require that the entity has significant influence over the investee. Currently, investors may choose to report these equity investments at cost or fair value. However, the proposal would add a new requirement before the cost basis may be applied. The additional criteria would be that the operations of the investee are considered related to the investor's consolidated operations. If only one of the two criteria is met, the equity investment would be required to be reported at fair value with changes in fair value recognized in net income (loss). This proposal may significantly change the accounting for those equity investments that have operations that are not related to the operations of the consolidated investor.
For more details of these issues, please refer to the Exposure Draft. If you are interested in participating on a task force to assist in the development of the industry's views on this proposal, please contact Sally Glenn at sglenn@nareit.com.
FASB Releases Fair Value Measurement and Disclosure Exposure Draft
On June 29, 2010, the FASB issued a proposal on the Amendments for Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs. The proposal is a product of a joint FASB and IASB project to consistently define fair value under both sets of standards and to converge fair value measurement and disclosure guidance. The Exposure Draft is not intended to change the scope of existing fair value guidance or establish new or modified requirements for items that should be measured at fair value.
The Exposure Draft would impact certain aspects of measurement and disclosure for those items currently required to be reported at fair value, such as:
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Highest and best use and valuation premise: highest and best use valuation premise would only apply to measuring the fair value of non-financial assets;
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Measuring the fair value of an instrument classified in shareholders' equity: a company would measure the fair value of its own equity instrument from the perspective of a market participant who holds the instrument as an asset; and,
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Additional disclosures about fair value measurements: disclosures would be expanded, such as: 1) including the measurement uncertainty inherent in fair value measurements categorized within Level 3 of the fair value hierarchy (a sensitivity analysis); 2) disclosing when the highest and best use of an asset differs from its current use; and, 3) providing the fair value by level for items that are not measured at fair value in the balance sheet but are reported at fair value in the disclosures.
The Exposure Draft also provides proposed guidance on the application of blockage factors and other premiums and discounts in measuring fair value and measuring the fair value of financial instruments that are managed within a portfolio. To read the Exposure Draft, CLICK HERE.
NAREIT, along with its REESA global partners, are currently evaluating this proposal and will submit a comment letter to the Boards by the September 7, 2010 comment deadline. A final standard is expected in the first quarter of 2011. If you have certain issues with respect to this Exposure Draft that you would like to discuss with NAREIT, please contact George Yungmann at gyungmann@nareit.com.
FASB and IASB Tentatively Arrive at a Hybrid Lessor Accounting Model
At their joint meeting on June 17, 2010, the FASB and IASB tentatively concluded to apply a hybrid lessor accounting model that would use: 1) a performance obligation approach for leases that expose the lessor to significant risks and benefits associated with the underlying asset; and, 2) a derecognition approach for all other leases. NAREIT believes that the accounting for most leases of investment property would generally fall under the performance obligation approach – unless the property is reported at fair value.
In addition to maintaining the leased asset on the balance sheet, the performance obligation approach would require lessors to recognize: 1) a lease receivable for the right to receive lease payments; and, 2) a liability, or performance obligation, for the obligation to provide leased space. Both the receivable and the performance obligation would be based on the lease payments (including contingent rentals that can be reliably measured) to be received over the longest possible term that is more likely than not to occur. The receivable and liability would be initially measured at the present value of the lease payments using the rate the lessor is charging the lessee. In addition, the receivable would include initial direct costs incurred by the lessor.
Under the hybrid lessor accounting model, the derecognition approach would require the lessor to remove the leased asset from the balance sheet and recognize: a) a lease receivable for the right to receive lease payments; and, 2) a residual asset representing the lessor's rights to the underlying leased asset at the end of the lease term. The lease receivable would initially be measured in a manner similar to the performance obligation approach.
On the income statement, the performance obligation approach would result in the bifurcation of lease payments received by the lessor into rental revenue and interest income (under the effective interest method). The rental revenue portion would be recognized when performance obligations are satisfied, which would typically be on a straight-line basis over the lease term. However, under the derecognition approach, the rental revenue portion of lease payments would be recognized at inception of the lease when the lessor transfers the leased asset to the lessee and removes it from its accounts. This approach would also result in interest income related to the lease receivable being recognized using the effective interest method.
As reported in previous issues of NAREIT's SFO Report, the IASB has tentatively decided to exclude from the proposed hybrid lessor accounting model, leases of investment property where the lessor/landlord measures the investment property at fair value. Since IFRS currently allows investment property to be measured at fair value, the FASB has added an investment properties project to its agenda to determine whether to permit or require investment properties to be carried at fair value. See above for more information on the investment properties project.
The Boards expect to issue exposure drafts on both leases and investment properties in the third quarter of 2010 and final standards in June 2011.
NAREIT Discusses Proposed Lease Standard with IASB Members
On July 7, 2010, NAREIT, along with other real estate and retailer organizations, met with Patricia McConnell and Patrick Finnegan of the IASB to discuss the views of real estate lessors and lessees on the Board's proposed lease accounting model (please refer to the above article). Industry participants expressed a general concern that the proposed accounting would not accurately reflect the economics of leasing transactions.
Participants also shared the view that, while lessees generally do not object to reporting contractual amounts on the balance sheets created by leases, they are very concerned about the negative impact of the proposed accounting on lessees' earnings. In addition, especially for lessees of ground leases, NAREIT asserted that the proposal would require extensive use of estimates (covering multiple years) to determine rental amounts reported in the financial statements.
NAREIT further commended the Board members' tentative decision to exclude from the proposed lease accounting model lessors of investment property that elect to report investment property at fair value. At the same time, NAREIT expressed a concern that, under the proposed standard, income statements and earnings of companies that choose to report investment property at depreciated cost would not be comparable to earnings of companies that report investment property at fair value.
The Board members were receptive to understanding participants' views and sought input on several issues, including accounting for service components of leases. NAREIT will gain more information from the Boards' staff regarding their specific concerns and reach out to members to provide more insight to the Boards.
FASB Seeks Input on Financial Statement Presentation
On July 1, 2010, the FASB released a draft of the FASB staff's financial statement presentation proposal – a proposal that has not been officially approved by the FASB or IASB. The purpose of issuing the staff draft is to solicit feedback from preparers and users on the current views of the Boards prior to the Exposure Draft, which is expected to be issued in the first quarter of 2011. A final standard is anticipated to be issued toward the end of 2011.
The objective of the overall joint FASB and IASB project is to provide a standard that will direct the content and presentation of information in the financial statements to improve the usefulness for financial statement users. The FASB staff's draft proposal reflects the Boards' current tentative decisions after consideration of the comments received on their original preliminary views issued in October 2008. To read the FASB staff draft, CLICK HERE.
This staff draft is part of the Boards' outreach program to gain more information in the following areas: 1) the perceived benefits and costs of the proposals; and, 2) the implications of the proposals for financial reporting by financial services entities. In obtaining this information, the Boards' staff plan includes:
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asking users of financial statements to evaluate how the proposed changes to the organization of and information presented in financial statements would benefit their analysis and resource allocation decisions;
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asking preparers of financial statements to evaluate the effort and costs involved in adopting these proposed changes in their unique circumstances; and,
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gathering additional information about benefits and costs by doing more field work on the proposals in the staff draft, including additional field testing and/or experimental research.
Although this draft proposal is not a formal invitation to comment, the Boards welcome input from constituents. NAREIT and its REESA global partners intend to provide input to the Boards on their draft proposal. If you would like to participate on a task force to help develop views for the industry with respect to the staff proposal, as well as provide cost-benefit information, please contact George Yungmann at gyungmann@nareit.com.
2010 NAREIT Financial Standards Events
SFO/IRO Workshop
NAREIT's 2010 Senior Financial Officers/Investor Relations Officers Workshop will be held on September 20 and 21 at the Mandarin Oriental Hotel in Washington, DC. Attendance at this program is by invitation only. The workshop is specifically designed for NAREIT corporate members that are senior officers in the fields of accounting, financial reporting, capital markets, investor relations and risk management. The workshop focuses on the latest developments and trends impacting these areas of real estate companies.
This year's program directors are Steve Broadwater, Senior Vice President and CAO; Simon Property Group and Steve Riffee, Executive Vice President and CFO; Corporate Office Properties Trust. The topics being considered include: 1) a discussion of the current capital markets; 2) financial reporting hot topics (i.e., SEC comments and SEC reporting trends); 3) US GAAP and IFRS convergence projects including lease accounting, investment properties and revenue recognition, as well as NAREIT/REESA advocacy with respect to global convergence projects; 4) an economist's view of the impact of current and forecasted economic factors on the industry; and, 5) understanding the Boards' perspective and oversight of companies' Enterprise Risk Management programs.
Workshop registration materials have been distributed.
Internal Audit Forum
The 2010 Internal Audit Forum will be held on August 17 and 18 at the Ritz Carlton Hotel in Denver, CO. Attendance at this program is by invitation only. The event will be hosted by ProLogis and UDR, Inc. The Internal Audit Forum is designed exclusively for NAREIT corporate members that are internal audit directors or other senior level financial professionals responsible for a company's internal audit function.
This annual event has proven to be successful in providing useful information in improving the internal audit function. This year's program will include sector breakouts and cover topics, such as: 1) IT risk assessment; 2) REIT tax risks for internal audit; 3) real estate fraud and mitigating risk; 4) process definition and risk strategy mapping; and, 5) the latest developments in financial standards and reporting. The special guest speaker will be Walter Rakowich, CEO, ProLogis. For registration information for this event, please contact Sarah Anastas at sanastas@nareit.com or (202) 739-9433.
Retail Sector Operations Accounting Forum
The Retail Sector Operations Accounting Forum will not take place this year. NAREIT conducted a member survey that indicated a low level of interest for a 2010 event. NAREIT and representatives from retail sector member companies will reconsider this event for 2011.
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