Our Real Estate team would like to highlight some key accounting updates, risks and opportunities for real estate companies. The Financial Accounting Standards Board (FASB) has issued many Accounting Standards Updates (ASU) reflected in the Accounting Standards Codification (ASC) that are important to understand. The Security Exchange Commission (SEC) also has been active in reporting implications for real estate entities related to the guidance.
Here are a few key areas that may be impactful to many organizations:
Revenue from Contracts with Customers
During 2020, and in light of coronavirus pandemic, the FASB issued an ASU that allows companies to defer adoption of the Board’s new standards on revenue recognition (ASC 606) and leasing (ASC 842).Most private entities have already been operating under the new standard, and those real estate business leaders report little impact on their financials, but there are some important areas to keep top of mind.
Variable consideration is an area that may be overlooked, especially by those impacted during a recession. Companies are required to continually assess the impact of variable consideration at each reporting date.
Companies may also have to reassess whether collection is still considered probable for ongoing contracts. Owners and operators have been approached to renegotiate the terms of existing contracts, add special provisions to new agreements or supplement arrangements in process. Revenue treatment is based on the effective terms of contracts with customers, and modifications can significantly affect those recognition principles.
In the identification of performance obligations, sellers may remain involved with a property or continuing contracts may need to analyzed in a different criteria than prior GAAP. Any future participation in expenses, operations or revenue streams will have varying results. Some new criteria may accelerate revenue or gain recognition, limiting prior real estate sales that may have been recognized over time.
Regardless of your resulting revenue recognition treatment, the standard’s new and modified quantitative and qualitative disclosure guidance significantly increases the information required in your footnotes. Publically-traded companies must further detail these disclosure areas.
Recognition of Expense: Compensation Arrangements
Many companies are unfortunately faced with the difficult decision of restructuring their organization through workforce reductions. These organizations will have to carefully analyze whether they are providing one-time termination benefits or severance, according to pre-established contractual language or practices. The timing and estimation of liabilities and recognition of expense can vary significantly depending on the termination plan.
Furthermore, companies that incentivize their employees through equity awards may be inclined to modify performance conditions tied to vesting or reduce the strike price of options. The accounting for share-based compensation modifications carries several complexities that will have to be considered under the specific circumstances.
FASB Relief for Rent Concessions Offered as a Result of COVID-19 and Lease Modification Accounting
Due to the COVID-19 pandemic, work-from-home arrangements and overall office revamp requirements, landlords are providing lease concessions to tenants in the form of rent abatement, extensions and escalations, and in-kind transfers. Pre-COVID, these concessions would generally result in lease modification accounting. The FASB staff released “Q&A” guidance under ASC 842 allowing companies to make certain elections to make accounting less complex for some of the common concessions, such as payment deferrals and avoid re-measurement of lease liability and right of use assets.
Fair value and Impairment
Most real estate assets are long-term in nature. While private equity and investment company requirements will likely require ongoing fair value reporting, operating entities with real estate require consideration for impairment. Assets value volatility may become more stable in early to mid-2021, but valuations need to be assessed at year-end. Vacant assets, or assets with tenants in default positions, will have the most difficult assessment requirements. Many variables are difficult to predict but should take into account the governments restrictions imposed and the related compliance of tenants and stakeholders, as well as the type and effectiveness of lender or government assistance.
Impairment tests for long-lived assets require recoverability models that rely on the development of these cash flow projections. The newly-established cost basis for the assets do not permit the subsequent reversal of the recorded impairment. Although many companies have policies in place that contemplate an annual impairment test, technically these impairments should be performed when there is a noted downturn to the market or negative unforeseen events. If favorable developments occur in subsequent periods, the recognized impairment would no longer be indicated, but also would not be reversed.
Accounting for Financial Assets
Although the stock market has mystified us all with its V-Shape from March to December 2020, there are continued areas of volatility and continued net declines in the fair value of many financial assets. Most debtors received forbearance, in accordance with provisions of their lending agreements, or by laws enacted. However, they will need to continue to comply with the terms of loans.
Other adversely affected financial instruments and contracts may be at risk of reductions to future cash flow streams. Each contract, instrument and security will need to be carefully considered for appropriate impairment and loss recognition guidance. Additionally, companies that have historically held debt and equity investment securities to maturity may have to consider classification as available-for-sale securities.
Accounting for PPP Loans
Many public and private companies received stimulus money from the federal government through stimulus programs, including the Paycheck Protection Program (PPP) through the Small Business Administration (SBA). There are a variety of options that acceptable for accounting for these types of cash infusions, but typically fall into two option categories: 1) Treatment as a loan until it is actually forgiven, or 2) Accounted for deferred revenue from a government grant, if the company can evidence that forgiveness is reasonably assured. The differences in these two possible treatments include how interest expense is recorded and how the relief of the liability is recorded through the income statement. Many businesses will find it easier to utilize the debt treatment, as there are less assumptions and support that the entity must provide to auditors, and it may offer more clarity to the readers of the financial statements.
Most internal controls teams have been forced to change in this new environment, as companies move virtual or significant physical changes have been made to work flows. Fraud risks are heightened in these new internal control environments, as there may be unknown gaps in the control framework. It is increasingly difficult to use financial analytics in many categories, as operations are not likely comparable from period to period. Companies should analyze the current environment and in some cases implement new control designs, approval processes and inspect month end reconciliations.
Going Concern During Downturns and Recessions
During an economic downturn, it becomes increasingly difficult for entities to prove they will meet financial obligations based on static historical financial statements. This is because many impairing activities can occur during the year in a turbulent economy. Auditors are going to expect management to support their assertions.
An initial assessment will require an entity to consider the extent of business disruption, new product and service demand forecasts, contractual obligations due within the one-year period, current liquidity requirements, as well as any shortfalls and existing sources of financial support. Companies must assess all of these items before considering its management’s plans. These plans can only be based on information that is available as of the issuance date of the financial statements.
Management must be prepared to provide broad disclosures in its financial statements, when they identify events and conditions that raise substantial doubt about the entity’s ability to continue as a going concern. Management’s plans may alleviate this doubt, but they would need to be equally disclosed.
Although many private (non-public) companies may be able to push these good-faith assessments of future cash flows until year-end to produce compliant financial statements, the design and agreement with auditors is something to start now. The requirements to produce comprehensive documentation supporting the basis for such estimates could be significant.
We acknowledge companies are in survival mode, and thus impacts of financial reporting might not be the first priority for many. However, we all hope for normalcy as we approach the end of 2020, when compliance issues will resurface.
The FASB issued ASU 2018-17in October 2018, which amends related-party guidance under ASC 810. First, private companies have a scope exception to the variable interest entity (VIE) guidance for entities under common control. Private companies that wish to elect this scope exception are required reassess the qualifications of the new guidance each reporting period. As a final point, it removes the requirement for evaluation of fees paid to decision makers as an arrangement considered a variable interest (a sentence in ASC 810-10-55-37D).
BPM’s Technical Accounting group is ready to help you navigate these changes. Contact us today to learn more.
BPM for Real Estate
BPM’s Real Estate group is skillfully positioned to provide comprehensive “one-stop” accounting, tax and consulting services to those in the real estate industry, such as investors, developers, managers, REITs and family-owned real estate enterprises. Our real estate accountants and consultants understand the regulatory and business challenges facing your industry and are dedicated to staying ahead of the curve to help you navigate a changing market. Our experience enables us to assist you with complex transactions involving formation of real estate funds, acquisitions, development, disposition, investment and management of properties. Devoted professionals are focused on private equity, family office, hospitality, construction, development, property management and CRE-Tech. Contact us today or visit us at www.bpmcpa.com/RealEstate.