Topic 16K: Presentation of Financial Statement Disclosures Subsequent Events Disclosure

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1 Discussion What footnote format is the most useful to lenders and other financial statement readers for disclosing information about a not-for-profit organization s subsequent events? GAAP Requirements Management is responsible for evaluating and disclosing significant events that occur after the balance sheet date until the date that the financial statements are available to be issued. There are two types of subsequent events: those that relate to conditions existing as of the balance sheet date (recognized subsequent events), and those that relate to conditions occurring after the balance sheet date (nonrecognized subsequent events). Nonrecognized subsequent events require disclosure, if material, since the financial impact of the event is not recognized in the financial statements. Examples from FASB s Codification of each type follow: Recognized Subsequent Event Settlement of litigation liability for an event that occurred prior to balance sheet date Write-off of receivable caused by creditor s bankruptcy subsequent to balance sheet date (since deterioration of creditor s condition is likely to have existed at the balance sheet date) Refinancing of short-term debt to obtain noncurrent classification on the balance sheet, supported by a lender s or investor s agreement (1) Nonrecognized Subsequent Event Settlement of litigation liability for an event that occurred after the balance sheet date Write-off of receivable caused by creditor s major casualty, such as fire or flood, occurring after the balance sheet date Plans to refinance short-term debt without obtaining a lender s or investor s agreement (1) See Strength Matters paper Presentation of Financial Statement Disclosures Notes Payable for a sample disclosure which includes construction loans that will be refinanced subsequent to year end. The examples above compare subsequent events which are indicative of conditions existing on the balance sheet date (recognized subsequent events) with conditions arising after the balance sheet date (nonrecognized subsequent events). Additional examples of nonrecognized subsequent events more commonly encountered by nonprofit affordable housing developers include: Issuing new debt or equity instruments; Purchase of a business; Discontinued operations; Entering into significant commitments or contingencies such as guaranties; Loss of property or inventory as a result of fire or flood; and, Transactions with subsidiaries in which control is maintained, gained or lost. 1

2 Generally, subsequent event disclosures are required when the event s effect on the financial statements is significant and that effect is not otherwise reflected within the financial statements. Analysis/Input The most common nonrecognized subsequent events that affordable housing entities consider disclosing are material real estate purchases, significant guaranties, write-off of predevelopment costs, and year-15 buyouts of tax credit investors. The length of time between the balance sheet date and the date that audited consolidated financial statements are available to be issued can be as much as four to six months, resulting in a large volume of subsequent activity to be evaluated for potential disclosure. The CFO Working Group observes that certain of the items listed as nonrecognized subsequent events are routinely encountered by large developers as part of the development process. For a large developer, property is often acquired and financed by new debt or equity. Construction completion and tax credit benefits are guaranteed. Projects in predevelopment may often be identified as being impractical to pursue. Although each of these subsequent events could be disclosed, since they are undertaken in the normal course of business, it is impractical to do so. However, for a large developer, a single transaction involving a group of properties may warrant disclosure. For a smaller developer, a single property acquisition may be significant enough to disclose as a subsequent event. Most required disclosures identify material adverse events that occurred subsequent to the balance sheet date. Organizations should also consider disclosing material favorable events, even if not required by GAAP, in order to provide more balanced reporting. Examples of favorable subsequent events include the settlement of a lawsuit where the plaintiff is the reporting organization, receipt of a grant award and collection of a material receivable. Lenders are interested in subsequent events that are unusual in nature and particularly any transactions that result in a material change to cash or other current assets/liabilities, either from the parent s standpoint or from a consolidated standpoint. 2

3 Sample Financial Statement Disclosures As is the case with most financial statement disclosures, materiality of the account balance should be considered when determining the amount of detail to provide in the disclosure. Disclosures need not repeat information that is included in the basic financial statements, however disclosures required by GAAP will not be satisfied by including the information in the supplementary information section of the financial statements. The first sample disclosure illustrates each of the following nonrecognized subsequent events: A large developer acquiring a portfolio of multiple properties; Litigation arising subsequent to year-end; and Payout under a guaranty resulting in an advance to a consolidated subsidiary caused by an event occurring after year-end. NOTE X SUBSEQUENT EVENTS Portfolio of Properties Acquired In April 2016, a subsidiary of ABC Developer, Inc. acquired a portfolio of 15 properties from an unrelated property owner. The properties consist of 2,300 affordable multifamily and senior apartments. ABC plans to transfer ownership of each property to an affiliated partnership and rehabilitate the properties, using proceeds from refinancing and tax credit equity. A summary of the April 2016 transaction follows: Cost of properties acquired 2-year bridge loan financing obtained Cash down payment from ABC Developer, Inc. $ 47 million 37.6 million 9.4 million The bridge loan will mature on April 19, 2018 and requires monthly payments of interest only at 4.5% per annum. Management estimates that rental income generated by the portfolio will be sufficient to pay operating costs including debt service until tax credit investors are identified and the properties are transferred to affiliates by the end of Litigation In March 2016, an affiliate of ABC and ABC Property Management Company were named as defendants in a lawsuit arising from a resident s injuries sustained during a January 2016 fire at one of ABC s properties. ABC s liability insurance policy has a $200,000 deductible and management settled the claim in April 2016 for $150,000. Guaranty Payment In connection with a loan between DEF, Inc. (an entity under ABC s common control) and a third party lender, ABC Developer, Inc. is contingently liable, up to a maximum of $3,000,000, to satisfy the claims of creditors of DEF, Inc. should income or working capital of DEF, Inc. fall below a specified minimum. In April 2016, ABC Developer, Inc. paid $250,000 to DEF creditors. This payment is structured as a five-year loan from ABC to DEF bearing interest at 4.5% per annum. 3

4 The second sample disclosure illustrates a smaller developer s acquisition of a single property, receipt of a major grant and collection of a significant receivable balance. NOTE Y SUBSEQUENT EVENTS Property Acquisition In February 2016, XYZ Developer acquired real property consisting of 75 affordable residential units. The purchase price was $7,500,000, of which $3,000,000 was funded with available cash and the remainder was financed by a $3,000, year conventional mortgage bearing interest at 4.5% and a $1,500,000 interestfree loan from the County of Santa Clara. The cash portion of the purchase price is expected to be repaid to XYZ from syndication proceeds when a tax credit investor is identified by the end of $2,000,000 City Grant In March 2016, XYZ Developer was awarded a $2,000,000 cost-reimbursement grant from the City of San Francisco. The grant will be used to acquire and begin to develop affordable housing sites throughout the City. The properties will be transferred to affiliated limited partnerships in order to obtain additional financing and tax credit equity during 2016 and Advances Reimbursed XYZ Developer advanced funds to cover the operating deficits of an affiliate during the past ten years, totaling $700,000 in the aggregate as of December 31, In April 2016, the affiliate obtained $700,000 from property refinancing and reimbursed XYZ for the advances. 4

5 Acknowledgements STRENGTH MATTERS gratefully acknowledges the work of S. Scott Seamands, CPA from Lindquist, von Husen & Joyce LLP and the following individuals that contributed to this paper: Allison Adduci, Vice President of Finance and Accounting, Preservation of Affordable Housing Ingrid Avots, Senior Credit Officer, Community Housing Capital Diane Borradaile, SVP, National Markets and Capital Solutions, Low Income Investment Fund Kent Hawkins, Senior Director Financial and Offsite Analysis, NeighborWorks America Jenny Ho, Controller, MidPen Housing Cade Scholl, Controller, Mercy Housing, Inc. Mary White Vasys, Principal, Vasys Consulting Ltd Last Updated: November 2016 DISCLAIMER This paper contains certain recommended financial statement presentation best practices for nonprofit affordable housing organizations that develop and own affordable housing in the United States. This paper was developed by a working group comprised of chief financial officers from certain leading nonprofit affordable housing organizations active in the networks of NeighborWorks America, Housing Partnership Network, and Stewards of Affordable Housing for the Future, as well as representatives of socially responsible lenders, working in conjunction with a representative from Lindquist, von Husen & Joyce LLP, an independent public accounting firm. This publication should not be construed as accounting of other advice on any specific facts or circumstances. The contents of this paper are intended for general informational purposes only, and you are urged to consult your accountants and other professional advisors concerning your specific situation and any financial reporting or accounting questions you may have. For further information, contact info@strengthmatters.net. 5