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June 25, 2012
NAREIT meets with SEC’s Chief Accountant and FASB Members on Financial Standards Proposals
On May 4 and May 14, respectively, NAREIT met with the Securities and Exchange Commission’s Chief Accountant and Deputy Chief Accountant and members of the FASB to discuss its views on the Leases, Investment Companies, Investment Property Entities, and Discontinued Operations proposed accounting standards updates. Donald Wood, NAREIT Chair and Federal Realty President and CEO led the NAREIT delegation at the May 14 meeting with the FASB. Also representing NAREIT at the meetings were Steve Wechsler, President & CEO; Tony Edwards, Executive Vice President & General Counsel; George Yungmann, Senior Vice President, Financial Standards; and Christopher Drula, Senior Director, Financial Standards.
At these meetings NAREIT expressed its view that, if the FASB and IASB are not prepared to initiate a formal project to consider aligning accounting and reporting for investment property under U.S. GAAP with IAS 40 or a similar asset-based converged standard (with an option to report investment property at either fair value or historical cost), NAREIT believes that the FASB should take no further action with respect to reporting investment property at fair value for U.S. REITs and operating real estate companies; and that it should retain the REIT exception contained in the current Investment Companies standard. Under this approach, reporting for U.S. equity REITs and operating real estate companies would remain consistent with other U.S. businesses utilizing the historical cost basis of accounting, and reporting for U.S. mortgage REITs would remain consistent with other U.S. businesses that provide financing in a variety of ways.
In addition, NAREIT continued to communicate its views to the Board that lessors of investment property should be scoped out of the joint FASB/IASB proposed receivable and residual lessor accounting model and that the Board should move forward toward issuing the final harmonized standard, Reporting Discontinued Operations.
FASB and IASB Decouple Lease Accounting and Reporting for Investment Property
On June 13, NAREIT observed the joint meeting of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) that focused on lease accounting (see Agenda Paper 3) in London, UK. NAREIT member companies operating as equity REITs will be particularly interested in the Boards' revised approach to lease accounting.
The Boards revised their approach to both lessee and lessor accounting to address constituent views that there are more than one type of lease and that they should be accounted for differently. While the Boards reaffirmed that lessees should recognize lease obligations on their balance sheets, the Boards revised the expense and income recognition pattern on the income statement for both lessees and lessors depending on the nature of the underlying asset. Based on the Boards' tentative decisions, NAREIT believes that, for most property leases, lessors would recognize lease revenue on a straight-line basis and lessees would recognize rental expense on a straight-line basis. This income statement recognition for most property leases by both lessors and lessees would mirror current reporting. Most leases of assets other than property would result in a front-ended income (for lessors) and expense (for lessees) pattern. NAREIT has been advocating straight-line income statement recognition for lessors and lessees of real estate since the project began nearly six years ago.
Lessee Accounting
Leases of property, which is defined as land or building, or part of a building, or both, would be accounted for using a straight-line presentation in the income statement, unless:
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The lease term is for the major part of the economic life of the underlying asset; or,
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The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.
Leases of assets other than property ( e.g., automobiles, copiers, fax machines) having terms of more than 12 months would be accounted for under the approach proposed in the 2010 Leases exposure draft. These leases would be accounted for as financing transactions, which would result in front-loading expense by lessees unless: -
The lease term is an insignificant portion of the economic life of the underlying asset; or,
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The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.
Lessor Accounting
Given the decisions reached on lessee accounting, the Boards agreed to revisit previous decisions with respect to lessor accounting. The Boards agreed that symmetrical accounting as between lessees and lessors is most appropriate, and therefore decided to draw a distinction between leases of property and leases of assets other than property, similar to conclusions reached for lessee accounting. In so doing, the Boards reversed an October 2011 tentative decision that explicitly exempted lessors of investment property from the receivable and residual lessor accounting model. Depending on the terms of the lease in relation to the nature and economic characteristics of the underlying asset, the income recognition pattern could be either straight-line or be based on the Boards' proposed receivable and residual model. As indicated above, NAREIT believes that rental income for most property leases would be reported on a straight-line basis.
It is unclear what impact, if any, these decisions with respect to lessor accounting might have on the FASB's Investment Property Entities Project. NAREIT understands that the FASB intends to make a decision on the future of the project in July 2012. The Board's options with respect to this project include: -
Continue to develop an entity-based standard for reporting investment property;
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Develop an asset-based standard under US GAAP similar to International Accounting Standard No. 40 Investment Property; and,
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Provide guidance for accounting and reporting for investment property under the Board's proposed Investment Companies standard.
NAREIT has made its position with respect to reporting investment property clear to the Board that, if the FASB and IASB are not prepared to initiate a formal project to consider aligning accounting and reporting for investment property under U.S. GAAP with IAS 40 or a similar asset-based converged standard (with an option to report investment property at either fair value or historical cost), NAREIT believes that the FASB should take no further action with respect to reporting investment property at fair value for U.S. REITs and operating real estate companies. Outlook
The Boards plan to conduct one final decision-making meeting on lease accounting in July 2012 before moving to drafting of the second exposure draft. The Boards intend on issuing the exposure draft by the end of 2012 with a 120 day comment period, and issue a final standard by mid-2013. NAREIT expects that the effective date for the final standard would be no sooner than 2016. Once the Boards re-expose the proposed Leases standard, NAREIT will re-engage with its member task force to establish consensus views and issue a comment letter to the Boards.
Latest Developments on FASB’s Investment Property Entities Project
Given the substantial criticism the FASB received on its Investment Property Entities exposure draft, the Board is considering whether it should drop the project in its entirety and move the accounting for investment property within the Investment Companies proposal or develop an asset-based standard for investment property similar to International Accounting Standard No. 40 Investment Property (IAS 40). In its letter to the FASB dated February 15, NAREIT recommended that the FASB withdraw the Proposed Update and move to develop an activity-based standard that would: a) converge with IAS 40 (incorporating recommended changes to include healthcare and lodging REITs within scope); and, b) achieve consistency with the Board’s operating principle to avoid issuing complex specialized industry accounting standards.
Outlook
The FASB staff plan to bring a paper to the Board in July where the Board will decide which direction it should take with respect to accounting for investment property.
Status of FASB’s Investment Companies and IASB’s Investment Entities Exposure Drafts
On May 21, the FASB and the IASB commenced redeliberations of their Investment Companies and Investment Entities proposals. During the meeting, the IASB considered whether it should continue to utilize an entity-based approach or develop and asset-based approach for its Investment Entities proposal. Additionally, the Boards discussed whether modifications should be made to the definitions of investment companies (for U.S. GAAP) and investment entities (for IFRS). To view the staff papers that were discussed in the context of the joint Board meetings, see Agenda Paper 8.
Entity-based Model for Investment Entities
The IASB reaffirmed its previous decision to employ an entity-based approach for the proposed standard.
Definition of an Investment Company and Investment Entity
In response to constituent feedback that indicated the Boards’ criteria were too restrictive, the Boards revised their respective definitions. In order to qualify as an investment company or an investment entity, a company would be required to meet a definition and also consider additional factors to determine whether it would qualify as an investment company or an investment entity. In making this determination, the Boards agreed that companies would need to consider the purpose and design of the company.
The FASB and the IASB did not reach a converged definition of investment companies and investment entities. The Boards justified the difference due to the different purposes for their respective projects. While the IASB began the project as an exception to consolidation guidance, the FASB initiated their project to define which entities should report their assets on a fair value basis.
FASB Definition of Investment Companies
The tentative FASB definition of an investment company is a company that does all of the following:
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Obtains funds from an investor or investors and provides the investor or investors with professional investment management services;
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Commits to its investor or investors that its business purpose and only substantive activities are investing the funds for returns from capital appreciation, investment income or both.
Further, an investment company and its affiliates do not obtain, or have the objective of obtaining, returns or benefits from their investments that are either: -
Other than capital appreciation or capital appreciation and investment income; or,
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Not available to other non-investors or are not normally attributable to ownership interests.
The FASB decided that the criteria to manage investments on a fair value basis would be excluded from the definition of an investment company. This concept would be included as a factor to consider when making the determination of whether a company qualifies as an investment company in the proposed guidance. In evaluating whether a company manages its investments on a fair value basis, companies would need to consider how: -
The company manages and evaluates the performance of its investments;
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The company transacts with its investors; and,
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The asset-based fees are calculated.
IASB Definition of Investment Entities
The tentative IASB definition of an investment entity is an entity that does all of the following: -
Obtains funds from an investor or investors and provides the investor or investors with professional investment management services;
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Commits to its investor or investors that its business purpose and only substantive activities are investing the funds for returns from capital appreciation or capital appreciation and investment income; and,
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Manages and evaluates the performance of substantially all of its investments on a fair value basis.
Further, an investment entity and its affiliates do not obtain, or have the objective of obtaining, returns or benefits from their investments that are either: -
Other than capital appreciation or capital appreciation and investment income; or,
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Not available to other non-investors or are not normally attributable to ownership interests.
The IASB tentatively concluded that entities with more than an insignificant amount of investments that are not managed on a fair value basis or held for investment income only would not meet the definition of an investment entity. Outlook
The Boards plan to continue re-deliberations during the coming months, with a plan to issue final standards by the end of 2012. The Boards have not established effective dates for the proposals.
NAREIT Participates in Joint Roundtable Meeting on FASB’s Investment Companies and Investment Property Entities Exposure Drafts as well as IASB’s Investment Entities Exposure Draft
On March 16, George Yungmann, NAREIT's Senior Vice President for Financial Standards, participated in the Joint Roundtable Meeting on FASB’s Investment Companies and Investment Property Entities, as well as IASB’s Investment Entities, exposure draft. During the meeting, Yungmann raised the concerns that NAREIT expressed in its February 15 comment letters to the Boards on the exposure drafts. In summary, Yungmann noted that both Equity and Mortgage REITs are operating businesses, and thus, should not be within the scope of the Investment Companies and Investment Entities proposals. Further, he recommended that the FASB withdraw the Investment Property Entities proposal, and work with the IASB to converge accounting guidance for investment property with IAS 40 (incorporating recommended changes to include healthcare and lodging REITs within scope).
Outlook
The Boards plan to begin joint re-deliberations of their Investment Companies and Investment Entities proposals in the second quarter of 2012, with a goal of issuing final standards by the end of 2012. At the current time, the Boards have not included an effective date for the proposals.
REESA Comments on Revised Revenue from Contracts with Customers Proposal
On March 13, NAREIT and its global partners in the Real Estate Equity Securitization Alliance (REESA) submitted a comment letter to the FASB and the IASB on the Boards' joint Revenue from Contracts with Customers exposure draft. In the letter, REESA recommended that the boards make a series of revisions to the revised proposed update before issuing it as a final standard.
REESA requested that the Boards:
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Expand the scope of the revised proposed update to include all sales of real estate and investments in entities that represent "in substance" real estate to ensure that identical transactions, whether or not they represent outputs of an entity's ordinary activities, would result in similar accounting;
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Remain true to the boards' principles-based approach to revenue recognition, which is based on the notion of control, as opposed to a rule-based standard that includes a "bright-line;" and rescind the recently issued FASB Accounting Standards Update No. 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate - a Scope Clarification (a consensus of the FASB Emerging Issues Task Force) in its entirety;
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Clarify that services performed by the lessor to protect its own interests - instead of those performed for the benefit of the lessee, to maintain the quality, ongoing appeal, and value of the lessor's underlying asset (the investment property) - are outside the scope of the revised proposed update;
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Revise the criteria to determine whether a service is distinct, to ensure that services that are jointly negotiated and included in real estate leases are accounted for as one contract, i.e., the lease contract, and are therefore clearly outside the scope of the revised proposed update;
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Further explore appropriate guidance on sales involving put and call options, and consider including additional illustrative examples on this matter in the final standard; and,
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Simplify disclosure requirements on disaggregation of revenue, performance obligations and significant judgments in the revised proposed update.
Outlook
The Boards intend to begin joint re-deliberations in the second quarter of 2012. The Boards plan on finalizing re-deliberations in 2012, and issuing a final standard in early 2013. The Boards have not determined the effective date of the proposed revenue recognition standard. However, the Boards have stated in public meetings that the effective date would be no sooner than annual periods beginning on or after January 1, 2015.
Status of FASB and IASB Joint Financial Instruments Project
On April 17 - 18, NAREIT attended the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) joint meetings in London, UK. Of particular interest to NAREIT members were the deliberations on Impairment and Classification and Measurement. To view the staff papers that were discussed in the context of the joint Board meetings, see Agenda Paper 5 for Impairment and Agenda Paper 6 for Classification and Measurement.
Impairment
The Boards addressed constituent concerns that have questioned what the Boards mean by the term "expected value" in determining the estimated expected credit losses. The Boards tentatively agreed that an estimate of expected credit losses would include:
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All reasonable and supportable information considered relevant in making the forward-looking estimate;
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A range of possible outcomes and the likelihood and reasonableness of those outcome (i.e., it is not merely an estimate of the "most likely outcome"); and,
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The time value of money.
In making these estimates of expected credit loss, the Boards tentatively agreed that preparers would need to consider information that is reasonably available without undue cost and effort.
As previously reported, the Boards are considering a new approach where classification would determine the credit impairment as credit quality deteriorates during a financial asset's life cycle. Classification of financial assets would be made into one of three buckets. Financial assets would move between buckets depending upon changes in credit loss expectations. For example, a loan would move from Bucket 1 to Bucket 2 when there is deterioration in financial performance of the borrower which leads to increased uncertainty about the ability to fully recover the cash flows. A loan would move from Bucket 2 to Bucket 3 when there is deterioration in the financial performance of the borrower and recoverability is not expected.
During the April 19 meeting, the Boards clarified that the measurement approach for Bucket 1 would be defined as "expected losses for those financial assets on which a loss event is expected in the next 12 months." The Boards further tentatively agreed that expected credit losses are not only the cash shortfalls expected to occur over the next 12 months; rather, expected credit losses are all cash shortfalls expected over the full life of the financial instrument. The Boards also discussed the amount of effort that would be required to estimate lifetime credit losses, and tentatively agreed that there was not only one approach to estimating expected credit losses. Classification and Measurement
The Boards took another step forward in attempting to converge the accounting guidance for the classification and measurement of financial instruments. Amortized Cost Classification for Financial Assets
The Boards reached a joint tentative decision that would determine the types of debt instruments that should be measured at amortized cost as opposed to fair value. This determination would be based on whether the debt instruments are held within a business model whose objective is to hold the assets for the collection of contractual cash flows. The Boards tentatively agreed to include additional implementation guidance that would assist preparers in making this determination based on the types of business activities and the nature of sales that would prohibit amortized cost treatment. Bifurcation of Embedded Derivatives in Financial Assets and Financial Liabilities
The Boards reached a joint tentative decision that would prohibit separation of embedded derivatives in financial assets for those instruments that solely contain principal and interest. These financial assets would be measured in their entirety at fair value on the balance sheet, with changes in value recognized in net income. Additionally, the Boards tentatively agreed to continue requiring separate accounting ( i.e., bifurcation) for embedded derivatives contained in financial liabilities. The embedded derivative would be measured at fair value on the balance sheet, with changes in value recognized in net income. IASB Adds Fair Value through Other Comprehensive Income (FVOCI) Measurement Category for Debt Investments
The IASB agreed to converge with the FASB’s Classification and Measurement model by adding a third measurement category ( i.e., Fair Value through Other Comprehensive Income) for debt investments ( e.g., loans receivable and debt securities) to its proposal. Currently, the IASB’s Financial Instruments guidance contains only two measurement categories ( i.e., Fair Value through Profit or Loss (FVPL) and Amortized Cost). The IASB decided to expand its measurement categories in order to address constituent concerns that the current guidance is too restrictive and does not accurately reflect the economics of their business models. Additionally, the IASB sought to reduce differences between their guidance and the FASB’s corresponding proposal.
The IASB decided that interest income on debt investments should be recognized in the income statement using the effective interest method that is applied to financial assets measured at amortized cost. Additionally, the IASB decided that credit impairment losses and reversals should be recognized in the Profit or Loss using the same credit impairment methodology as for financial assets measured at amortized cost. Further, cumulative fair value gains and losses recognized in other comprehensive income should be recycled from other comprehensive income to Profit or Loss when the financial assets are derecognized. Boards Define FVOCI Business Model Assessment for Financial Assets, with FVPL being the Residual Category
The Boards decided to define the objective of the business model that results in classifying financial assets at FVOCI as a portfolio of financial assets that is managed with the objective of both collecting contractual cash flows and selling financial assets.
Financial assets that do not meet the business assessment for FVOCI would then be evaluated for amortized cost classification. Based on the decisions reached during the April 2012 joint board meetings, financial assets would be classified in the amortized cost category when the business model has an objective to hold financial assets for the collection of contractual cash flows.
Based on the Boards’ decision, financial assets that do not meet the business model assessment for FVOCI or amortized cost would be classified at FVPL. Thus, FVPL would be considered the residual category. Reclassification of Financial Assets
The FASB decided to converge with the IASB’s guidance which requires reclassification of financial assets. Under the FASB’s current proposal, reclassification of financial assets among categories was prohibited. The FASB decided to prospectively require financial assets to be reclassified when the business model changes, and be accompanied by robust disclosures. The Boards indicated that reclassifications would be very infrequent. Changes in the business model that require reclassifications would be: -
Determined by the entity's senior management as a result of external or internal changes;
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Significant to the entity's operations; and,
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Demonstrable to external parties.
Outlook
The Boards plan on finalizing re-deliberations on their Impairment and Classification and Measurement projects in the second quarter of 2012, and issuing exposure drafts in the second half of 2012.
NAREIT and U.S. Chamber of Commerce Comment on the PCAOB's Due Process and Mandatory Audit Firm Rotation Concept Release
On February 23, NAREIT joined other members of the U.S. Chamber of Commerce's Financial Instruments Reporting & Convergence Alliance (FIRCA) in submitting a letter to both the Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB). FIRCA requested that standard setters seek "a wide range of input to ensure the proper consideration of business operations and potential unintended consequences in the development and implementation of accounting and auditing standards."
The letters emphasized that the PCAOB's recent Concept Release on Auditor Independence and Audit Firm Rotation and Notice of Roundtable (PCAOB Release No. 2011-006, Aug. 16, 2011, PCAOB Rulemaking Docket Matter No. 37) was an example of "a failure to have sufficient broad based input before publicly moving forward on an issue." The letters observed that, as of Jan. 18, 2012, 92 percent of respondents on the Concept Release opposed mandatory audit firm rotation. NAREIT was among the 92 percent that vehemently opposed the Concept Release, and submitted a comment letter to the PCAOB to that effect. FIRCA questioned why the PCAOB would move forward with the Concept Release given the overwhelmingly negative response.
FIRCA requested that the PCAOB establish a business advisory group, which could have provided early input to the PCAOB on the Concept Release, and saved time and resources for other issues.
Another recommendation offered by FIRCA was to employ cost-benefit analysis when developing accounting and auditing standards. FIRCA indicated that this recommendation was originally made in 2008 by the SEC's Advisory Committee on Improvements to Financial Reporting.
On April 19, NAREIT joined a coalition of industry associations in reiterating concern to the PCAOB regarding potential mandatory audit firm rotation.
"In particular, we are troubled by the failure of the Public Company Accounting Oversight Board to demonstrate a factual record for the need for mandatory audit firm rotation or overcome previous rejections of the concept," the organizations wrote in an April 19 letter to the PCAOB. "Furthermore, we believe that mandatory firm rotation, if implemented, will harm overall corporate governance, reduce audit quality, diminish the role of audit committees, increase the incidence of undetected fraud and raise costs."
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