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November 10, 2009
FASB/IASB Tentative Conclusions
Highlights
FASB/IASB Reach Tentative Decisions on Global Convergence Projects
At their joint meeting on October 26-28, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) (collectively the Boards) agreed on a number of positions that will be included in exposure drafts to be issued over the next six months on:
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Lease Accounting
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Reporting Discontinued Operations
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Financial Statement Presentation
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Revenue Recognition
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The exposure drafts will represent the Boards' proposed accounting standards. After considering comments from constituents on the exposure drafts, the Boards' goal is to issue final standards in 2011; except that a final standard for reporting discontinued operations is intended to be issued by the end of 2009. The final conclusions developed in these projects will have a dramatic impact on accounting and financial reporting for all industries, including the real estate industry.
The final standards with respect to these joint projects listed above would become both U.S. Generally Accepted Accounting Standards (GAAP) and International Financial Reporting Standards (IFRS). The impacts on U.S. GAAP are not dependent on the U.S. adopting IFRS for financial reporting.
FASB/IASB Confirm Right-of-Use Approach for Lessees
At the October 2009 joint meeting, the Boards reaffirmed their previous conclusion that lessees, including real estate tenants, would recognize at lease inception a liability for all rents to be paid during the lease term and a "right-of-use" asset. The asset would be depreciated over the term of the lease and the lessees' rent payments would be allocated between interest expense and payments on the liability recognized at lease inception. This accounting could have a materially negative impact on the earnings of lessees/tenants.
While NAREIT has primarily focused on the Boards' proposals for the accounting of leases by lessors, it continues to examine the potential impacts of the proposed lessee accounting model on the industry. The Boards' tentative conclusions with respect to a new model for lessees could have implications for owners/lessors of investment property. These impacts may include:
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Tenants may negotiate for shorter term leases. This implication would minimize the liability that the lessee would be required to recognize at the inception of a lease. It is important to note that the Boards' tentative conclusions would require the tenant to estimate the full term of the occupancy, including that provided by options to extend the lease.
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Because tenants would be recognizing a depreciable asset and a liability on their statements of financial position, tenants may prefer to own the property rather than lease it. This decision may especially occur in the case of single tenant property.
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Tenants may desire to own space in multi-tenant property through condominium regimes.
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Adding significant liabilities to a tenant's statement of financial position could have negative impacts on the tenant¡¦s credit rating. This result could compound into generally lower credit underlying a project's future cash flows and, therefore, affect any financing secured by the property's cash flow stream.
NAREIT is asking members to provide additional issues that the real estate industry may encounter as a result of the Boards' proposed lessee model. The Boards will consider this input as they develop a new converged global standard for the accounting of leases that is expected to be issued in 2011. The exposure draft is expected to be issued in the second half of 2010.
FASB/IASB Favor the Performance Obligation Approach for New Accounting by Lessors
Although the Boards' staff provided several approaches in applying a "right-of-use" model to account for leases by lessors, the Boards primarily debated two approaches: the derecognition and performance obligation approaches. On a real estate company's statement of financial position, the derecognition approach would replace investment property with: 1) a lease receivable; and, 2) the lessor's interest in the leased asset's residual value, as if the lessor has transferred a portion of the rights to a leased asset to the lessee for the lease term. On the statement of comprehensive income, the majority of the rental payment would be recognized as revenue at inception of the lease contract, as if the transfer of rights represents a sale of the leased asset. Additionally, the remaining portion of the rental payments would be recognized as interest income on the lease receivable.
On October 28, 2009, the Boards tentatively agreed to adopt the alternative approach to lessor accounting - the performance obligation approach. The performance obligation approach would continue to report the investment property on the statement of financial position. However, this approach would add an asset representing a receivable for the right to receive lease payments and a liability representing the company's obligation to provide the leased space. This alternative would inflate a company's assets and liabilities. To avoid this inflation on the statement of financial position, particularly in terms of inflating reported liabilities, a possibility discussed by the Boards would be to offset the receivable and the liability. NAREIT will continue to closely monitor the Boards' consideration of this possibility, since it may lessen the negative consequences of the performance obligation approach on the statements of financial position of real estate companies.
On the statement of comprehensive income, the performance obligation approach would present the same issue discussed above under the derecognition approach in terms of reporting a portion of the rental payments as interest income rather than the entire rental payments as rental revenue. Although a portion of the rental payments would be recognized as interest income, the performance obligation approach would allow most of the rental payments to be recognized over the lease term (as the performance obligation is satisfied) rather than at lease inception.
REESA has advocated directly with the FASB and IASB a view that neither of these approaches would result in relevant financial reporting to industry investors and other financial statement users. REESA shared its views on the Board's lessor accounting proposals through meetings held with both Boards and through comment letter submissions. At the October 2009 joint meeting, it was clear that a number of Board members understand that neither of these approaches would appropriately report the rents earned from tenants of investment property. To read REESA's letter click HERE and to read NAREIT's letter (which reiterates REESA's views, as well as provides specific views of NAREIT member companies) click HERE.
The FASB and IASB will continue their discussion on lessor accounting issues and NAREIT and REESA will continue to closely follow their progress. A new lessor accounting model may be developed under the lease accounting project, the revenue recognition project or under a separate project. If the Boards decide to create a lessor accounting model in connection with the lease accounting or revenue recognition projects, a final standard for lessor accounting may be released in 2011.
FASB/IASB Agree on Definition of a Discontinued Operation
On October 26, 2009, the Boards tentatively concluded that the converged definition of a discontinued operation should mirror the current definition under IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, which is as follows:
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A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and
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(a) represents a separate major line of business or geographical area of operations,
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(b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations or
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(c) is a subsidiary acquired exclusively with a view to resale.
The FASB and IASB staff will evaluate the possibility of adopting the definition of a discontinued operation in accordance with IFRS 5 and will develop a proposal for related disclosures.
If finalized, this conclusion would generally eliminate the need to report sales of individual investment properties as discontinued operations - an objective of NAREIT's recent initiative and REESA's comment letter submitted to the FASB in January 2009 (click HERE to read the letter). A final standard is expected to be issued before the end of 2009 and would be effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2009. It appears that early application would be permitted and, therefore, the new standard may be available for 2009 reporting.
FASB/IASB Make Significant Changes to Financial Statement Presentation Proposal
In October 2008, the Boards released a preliminary views document (PVD) on financial statement presentation that would dramatically alter the format and content of the financial statements reported under U.S. GAAP and IFRS. Under the Boards' proposal, each financial statement would be categorized into the following major sections: business, financing, taxes and discontinued operations. An additional category for equity would be included in the statements of financial position and cash flows. For more background information on the financial statement presentation proposal, please refer to the December 2008 Financial Standards Update by clicking HERE.
At the October 2009 joint meeting, the Boards reached tentative decisions that would significantly modify their original financial statement presentation proposal. If certain of the tentative decisions that have been reached by the Boards are finalized as currently indicated, REESA may need to consider modifications to the real estate financial statement model. For example, the Boards have tentatively concluded that the financial impact of a company's operating activities should be reported in a section of the financial statements separate from all financing activities. If this tentative conclusion is finalized "as is", it would not be possible to explicitly report a single metric similar to Funds From Operations in the statement of comprehensive income. At the same time, the tentative conclusions with respect to this project would allow real estate companies to report net operating income.
The exposure draft is expected to be issued in 2010 and the final standard is planned for 2011.
Tentative Decisions Applicable to Each Financial Statement
On October 27, 2009, the Boards decided that the business section of the financial statements would consist of operating and investing categories that are defined differently from the definitions provided in the Boards' original proposal. The Boards discussions indicate that the operating category would include day-to-day business operations - those operations that would generate revenue through the use of the entity's interrelated net resources. The investing category would comprise of business activities that generate non-operating income.
For the financing section of the financial statements, which would include a company's activities to obtain or repay capital, the Boards decided that the section would be comprised of two categories: debt and equity.
The Boards also decided that the exposure draft for financial statement presentation would propose that a company consider the disaggregation of financial information by function, nature and measurement bases for each financial statement.
Statement of Cash Flows
In the PVD, the Boards proposed to require a cash flow reconciliation schedule that preparers would regularly provide in the notes. The schedule would reconcile cash flows to comprehensive income on a line-by-line basis and would disaggregate the sources of each income and expense item in terms of cash, accruals (other than remeasurements), recurring remeasurements and nonrecurring remeasurements. In its April 2009 letter to the Boards, REESA strongly opposed the inclusion of this schedule in the notes. To read the letter, click HERE.
On October 27, 2009, the Boards reached a preliminary decision to eliminate the proposed reconciliation schedule from the notes. Rather than requiring the reconciliation schedule, the Boards tentatively decided to require a variance analysis of account balances for all significant asset and liability line items. The analysis would differentiate the change in balance of each significant asset and liability based on the following components:
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changes due to cash inflows and outflows;
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changes resulting from noncash transactions that are repetitive and routine in nature;
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changes resulting from noncash transactions that are nonrepetitive and nonroutine in nature;
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changes resulting from accounting allocations;
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changes resulting from accounting provisions/reserves; and,
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changes resulting from remeasurements.
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While the Boards decided to remove the reconciliation schedule from the notes, the Boards agreed to require the presentation of an indirect reconciliation of operating income to operating cash flows in the notes. At the meeting, the Boards also maintained their position to present a cash flow statement under the direct cash flow method - a proposal that REESA agreed with in its comment letter.
Statement of Comprehensive Income
At the joint meeting, the Boards reinforced their proposal in the PVD that a company would disaggregate income and expenses by function and by nature in the statement of comprehensive income. Additionally, the Boards decided that a company with one reportable segment would present disaggregated information on the face of the statement of comprehensive income and a company that has more than one reportable segment would present the disaggregated information in the notes.
The Boards also agreed that items of "other comprehensive income" would be reported, along with all other income and expense items, in a single statement of comprehensive income.
FASB/IASB Focus on Contract Segments to Allocate Revenue
In December 2008, the Boards issued a PVD on revenue recognition in contracts with customers. The Boards' proposed a contract-based revenue recognition model that would allocate the transaction price to each performance obligation in the contract. Once the company satisfies a performance obligation, revenue would be recognized according to the allocation. For more information on the proposal, refer to NAREIT's July 2009 Financial Standards Update by clicking HERE. To read REESA's letter in response to the Boards' proposal, click HERE.
At the October 2009 joint meeting, the Boards decided that the transaction price would be allocated to segments of a contact rather than to performance obligations. A segment would include one or more performance obligations for which a market exists. By the Boards' definition, a market exists for a segment of a contract when it could be sold separately. In segmenting a contract, a company would consider the timing of transfer of goods or services, the margins for those goods or services and materiality. A company would also maximize the use of observable inputs in allocating the transaction price to segments. Standalone selling prices would be estimated when observable inputs are not available.
The Boards will continue to discuss the issues related to the new revenue recognition model and intend on releasing the related exposure draft in 2010. A final standard is expected to be finalized in 2011.
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