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January 24, 2011
NAREIT Comments on FASB/IASB Lease Exposure Draft and Meets with the FASB
On Dec. 15, 2010, NAREIT submitted a comment letter to the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the “Boards”) in response to the Boards’ proposal on lease accounting. To read the letter, CLICK HERE. The proposal represents a fully-converged, comprehensive standard on accounting for leases from both the lessor and lessee perspective. Fundamental changes to the existing FASB lease accounting model would include:
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Requiring a lessee to account for rights and obligations under all leases on its balance sheet;
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Replacing the existing lessor accounting model with a hybrid model (derecognition and performance obligation);
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Mandating both lessees and lessors to estimate lease term and contingent rent at inception of the lease arrangement with ongoing reassessments throughout the entire lease term;
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Changing the classification of revenue from rental income/expense to interest income/expense; and,
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Modifying the revenue recognition pattern on the income statement from straight-line to a method that would front-load revenue/expense in a pattern similar to interest income/expense on amortizing debt.
In the comment letter, NAREIT strongly supported the IASB conclusion to not apply the proposed standard to lessors that report investment property at fair value.
NAREIT voiced concern over the derecognition and performance obligation accounting models for lessors, emphasizing that the proposed models do not represent a significant improvement over the existing model that exists in U.S. GAAP. Should the Boards continue to propose these models, NAREIT enumerated modifications to enhance the models as currently defined. These enhancements include: -
Providing for reporting total rental income pursuant to landlord/tenant leases as rental income rather than bifurcating payments as interest income and principal payments on a lease receivable;
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Excluding amounts of potential contingent rentals from the measurement of lease assets and liabilities;
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Excluding rents that would be paid under options to extend the lease term from the measurement of lease assets and liabilities;
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Amortizing the lessor's performance obligation (PO) in a manner that would result in straight-line aggregate lease revenue (interest income on the lease receivable and amortization of the PO) over the term of the lease. Likewise, amortize lessee's right-of-use (ROU) asset so that the aggregate charge to earnings (amortization of the ROU asset and interest on the lease liability) would result in an aggregate straight-line charge to earnings over the term of the lease;
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Requiring that service components of leases with both service and lease components be accounted for on a basis that is consistent with the proposals in the Boards' exposure draft Revenue from Contracts with Customers; and,
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Requiring that all measurements required by the standard represent management's best estimate based on all related factors and eliminate the "probability-weighted average approach."
NAREIT participates in FASB/IASB's Outreach Initiatives on Lease Project
NAREIT has actively engaged with the Boards with respect to the Lease Project. On Dec. 22, 2010, representatives from NAREIT, along with two REIT fund money managers and a valuation expert met with the FASB board members in Norwalk, CT. The purpose of the meeting was to discuss the negative implications that the proposed lease accounting standard would have on the financial reporting model currently used by the real estate industry and NAREIT’s views with respect to the FASB’s related investment property project. See further discussion of this meeting below.
NAREIT also participated in the Joint FASB/IASB Leases Public Roundtable Meetings that were held on Jan. 6, 2011 in Norwalk, CT. Additionally, NAREIT participated in the FASB/IASB Joint Working Group on Lease Accounting that was held on Jan. 7, 2011 in Norwalk, CT. Various constituents were represented from the lease community, ranging from preparers, users, auditors, regulators, academics, and standard setters.
Topics discussed at the meetings included the following: -
Definition of a lease
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Lessor accounting model
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Lease term
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Variable lease payments
While there was no consensus reached at the conclusion of the sessions, George Yungmann, NAREIT Senior Vice President, Financial Standards, expressed the following views to the Boards and fellow meeting participants: -
Opposition to including contingent rentals in the measurement of the lessee’s liability and the lessor’s receivable;
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Objection to utilizing the “probability-weighted average approach” to measuring contingent rents;
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Concerns about the ED’s proposed pattern of expense/revenue recognition that front-loads the lessee’s interest expense and the lessor’s interest income by utilizing an effective interest approach. There was extensive debate on this issue. IASB Board Member Patrick Finnegan indicated that all service components of service income/expense (including items that are reimbursable for real estate leases, such as common area maintenance, taxes, and insurance) should be included in the lessee’s liability and the lessor’s receivable. However, George contended that the pattern of revenue recognition for the lessee’s right-of-use asset and the lessor’s performance obligation should impact income statements on a straight-line basis over the term of the lease. This pattern of revenue recognition would represent a change from the current version of the ED consistent with NAREIT’s views.
A final lease accounting standard is expected to be issued by June 30, 2011; however, newly appointed FASB Chairman Leslie Seidman added a caveat that this deadline was subject to the nature and the extent of comments received. As of the time of the meeting, the FASB and IASB received over 700 comment letters on the proposed ED. Given the debate that the proposed ED has caused, Seidman assured constituents that the FASB would work through the issues thoughtfully and in the most efficient manner possible.
The Boards have yet to determine an effective date due to their Discussion Paper on the effective dates and transition methods for several of the final standards resulting from U.S. GAAP and IFRS convergence. NAREIT Joins Coalition Seeking Modifications to the Proposed Lessee Accounting Model Impacting Tenants
NAREIT joined a coalition of organizations led by the U.S Chamber of Commerce that is focused primarily on the impact of the proposed lease accounting standard on lessees - including investment property tenants. The coalition is generally resigned to the proposal that lessees will be required to report a liability for payments due under lease contracts. At the same time, members share strong views that the measurement of this liability should not include contingent rents or payments under lease extensions that are more than likely to be exercised by lessees. In addition, the coalition strongly believes that the front-loading and decreasing rent expense over the lease term should be eliminated from the proposed standard.
IASB Conclusion on New Lease Standard Triggers FASB Examination of Reporting Investment Property at Fair Value
As previously reported, the FASB and IASB have proposed significant modifications to the accounting for leases by lessors and lessees. In the context of this examination, the IASB has concluded that lessors of investment property reported at fair value under IAS 40 would be exempted from the proposed lease accounting rules. This IASB conclusion has forced the FASB to consider a standard that would mirror IAS 40 in order to achieve a converged lease accounting standard.
In March 2010, the FASB formally added an investment property project to its agenda, and on July 14, 2010, the FASB concluded that it would issue an exposure draft. A major difference between current FASB thinking and IAS 40 is that the FASB is leaning toward requiring fair value reporting rather than allowing it as an option to reporting investment property at depreciated cost. The FASB and its staff have been reaching out to financial statement preparers and users to determine the spectrum of real estate that would meet the scope of the FASB’s definition of investment property (currently under development) and therefore be covered by the standard.
The FASB expects to issue an exposure draft of its proposed standard in the first quarter of 2011 and issue a final standard by the end of 2011.
NAREIT has actively engaged with the Boards with respect to this project. On Nov. 5, 2010, NAREIT submitted a letter to the FASB and IASB on behalf of over 40 real estate industry investors and property sector analysts from the U.S. and Europe voicing their collective concern for a consistent global framework to evaluate investment property. In addition, the letter indicated support for the IASB’s decision to scope out lessors of investment property reported at fair value and for the FASB’s project that would allow investment property to be reported at fair value under U.S. GAAP. To read the letter, CLICK HERE.
On Dec. 22, 2010, representatives from NAREIT, along with REIT fund money managers and a valuation expert met with the FASB board members in Norwalk, CT to discuss the project’s impact on the real estate industry.
The discussion focused on three key points:
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the investment property business model, where the business objective is to generate maximum total returns from investment property, inclusive of cash flow and capital appreciation;
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that the proposed lessor accounting would diminish the usefulness of the industry's audited financial statements; and
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global convergence of reporting for investment property and investment property companies.
Currently, we understand that the FASB’s intention is to bring a scope definition to the FASB board members by the end of January, with a meeting to follow shortly thereafter between the Boards in early February. NAREIT is collaborating with its peers at the European Public Real Estate Association (EPRA) to ensure the proper scoping of the definition within the FASB standard, which may result in a standard on which the IASB will eventually base IAS 40 modifications from a global convergence perspective.
In addition, NAREIT is coordinating its efforts with the National Council of Real Estate Investment Fiduciaries (NCREIF). Members of NCREIF met with FASB board members in Norwalk, CT on Jan. 10, 2011 to share their views with respect to the Investment Property Project.
FASB/IASB Issue Revised Work Plan/Timeline for "Priority Projects"
On Nov. 29, 2010, the FASB and the IASB issued a revised work plan and timeline for their joint projects.
Currently, the Boards have sixteen joint projects that will fundamentally change the landscape for accounting and financial reporting. Due to resource constraints and complicated by the volume of these accounting projects that prove to be both complex and contentious, the Boards have reprioritized their agenda by focusing on their “Priority Projects.” The Boards have defined the “Priority Projects” to be completed by June 30, 2011 as follows: financial instruments, revenue recognition, leases, and insurance. Deliberations on the remainder of the projects will commence later in 2011.
SEC Issues Progress Report on the IFRS Work Plan
On Oct. 29, 2010, the Securities and Exchange Commission (SEC) published its first Progress Report on the IFRS Work Plan that was issued in Feb. 2010. The Work Plan was developed by the SEC in order to help the Commission assess “whether, when and how” IFRS should be adopted within the United States. The Work Plan considers the following factors:
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Sufficient development and application of IFRS for the U.S. domestic reporting system;
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The independence of standard setting for the benefit of investors;
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Investor understanding and education regarding IFRS;
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Examination of the U.S. regulatory environment that would be affected by a change in accounting standards;
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The impact on issuers, both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations, and litigation contingencies; and,
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Human capital readiness.
The SEC continues to monitor progress in each of these areas. Consistent with the Boards current status in evaluating the merits of the changes to the standards, the SEC has not finalized any conclusions related to the Work Plan. As Jim Kroeker, the SEC Chief Accountant, noted in his remarks at the annual American Institute of Certified Public Accountants (AICPA) National Conference on Current SEC and Public Company Accounting Oversight Board (PCAOB) Developments on Dec. 6, 2010, the SEC remains committed to convergence efforts that result in “standards that are improved, comprehensive and sustainable solutions…convergence without adequate due process and field testing in the standard-setting process will not serve us well in the long run.” To read the Progress Report in its entirety, CLICK HERE.
FASB Solicits Feedback on Effective Dates and Transition Methods for Convergence Projects
On Oct. 19, 2010, the FASB released a Discussion Paper requesting constituents’ comments on the effective dates and transition methods for the majority of the convergence projects. These projects include:
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Accounting for financial instruments and revisions to the accounting for derivative instruments and hedging activities, including netting of financial instruments - Exposure Draft issued in May 2010
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Revenue recognition: revenue from contracts with customers - Exposure Draft issued in June 2010
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Leases - Exposure Draft issued in Aug. 2010
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Financial Statement Presentation (including discontinued operations) - Exposure Draft has not been issued.
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Financial instruments with characteristics of equity - Exposure Draft has not been issued.
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Insurance contracts - Discussion Paper issued in Sept. 2010
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Comprehensive income - Exposure Draft issued in May 2010
With the intention of conducting this separate consultation, the FASB has not proposed effective dates in any of the Exposure Drafts that have been issued. The Board thought it would be most effective to seek input on the overall adoption of the converged standards, since so many of the standards are interrelated. In the discussion paper, the FASB requests views of preparers, auditors and users with respect to the expected time and effort involved in adopting these standards, including a recommended timetable for implementation and the preferred order that these standards should be adopted. To read the Discussion Paper, CLICK HERE. The deadline for comments is Jan. 31, 2011. If you would like to contribute to the comment letter that will be submitted by Real Estate Equity Securitization Alliance (REESA), please e-mail Christopher Drula, NAREIT Senior Director, Financial Standards, at cdrula@nareit.com. Feedback received from NAREIT’s members to date indicates that converged standards currently on the Boards’ joint agenda should be implemented simultaneously and be effective no earlier than 2014.
NAREIT/REESA Comment on FASB/IASB Revenue Recognition Exposure Draft
On Oct. 20, 2010, NAREIT submitted a comment letter on behalf of REESA to the FASB and IASB in response to the Boards’ proposal on revenue recognition. To read the letter, CLICK HERE. The proposal represents a fully-converged, comprehensive standard on accounting for revenue from contracts with customers to provide goods or services. This principles-based proposal would replace numerous industry-specific and transaction-specific rules currently being applied in the U.S. to account for revenue.
In the comment letter, REESA supported the general framework of the revenue recognition proposal because it would generally improve financial reporting, particularly for real estate sales accounting. The Boards’ control criterion for revenue recognition would more faithfully reflect the substance of real estate sales transactions as opposed to FASB’s current prescriptive guidance. REESA requested that the Boards provide further guidance or clarification with respect to:
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Whether the proposal would include sales of equity interests in entities whose assets substantially consist of real estate;
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The accounting for sales involving seller financing under the proposal; and
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The accounting for the sale and repurchase of an asset.
A final revenue recognition standard is expected to be issued in 2011. The Boards have yet to determine an effective date due to their Discussion Paper on the effective dates and transition methods for several of the final standards resulting from U.S. GAAP and IFRS convergence.
NAREIT Voices Concerns with the FASB Financial Instruments Exposure Draft
On Sept. 30, 2010, NAREIT submitted a comment letter to the FASB on the Financial Instruments Exposure Draft (ED). To read the letter, CLICK HERE. The ED dramatically changes the accounting treatment for financial instruments in the following areas:
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Classification and measurement;
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Credit impairment;
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Hedging activities; and
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Disclosure.
The exposure drafts issued by the FASB and IASB differ in the measurement of certain financial instruments. While the FASB ED requires substantially all financial instruments to be reported at fair value, the IASB ED permits certain financial instruments that are held for investment to be measured at amortized cost. NAREIT’s letter supported the IASB’s view that certain financial instruments such as those held or issued for collection or payment of principal and interest should be measured at amortized cost. NAREIT believes that amortized cost best reflects the business strategy for these financial instruments. NAREIT reasoned that to use fair value implies an intention to actively trade or hold the financial instruments for sale.
The FASB plans to issue a final standard on financial instruments in 2011. The Boards have yet to determine an effective date due to their Discussion Paper on the effective dates and transition provisions for several converged final standards discussed above.
NAREIT Comments on FASB’s Proposal on Loss Contingency Disclosures
On Sept. 15, 2010, NAREIT submitted a letter in response to the FASB's proposal on the disclosure of certain loss contingencies. To read the letter, CLICK HERE. The current Exposure Draft represents the second attempt by the FASB to provide a standard for disclosing information about loss contingencies. In the letter, NAREIT asserted to the Board that the proposal fails to address NAREIT’s primary concern over the disclosure of prejudicial information. NAREIT recommended that the Board should further extend its outreach and discussion with financial statement preparers and users in order to enhance existing disclosures without requiring the disclosure of prejudicial information. Subsequent to the release of the Exposure Draft, the Board has concluded that the proposed effective date of the proposed standard should be deferred until 2011.
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