Accounting for Real Estate Transactions

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3 Accounting for Real Estate Transactions

4 Wiley Corporate F&A Series Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers professional and personal knowledge and understanding. The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their company, from accounting and finance to internal controls and performance management.

5 Accounting for Real Estate Transactions A Guide for Public Accountants and Corporate Financial Professionals Second Edition MARIA K. DAVIS John Wiley & Sons, Inc.

6 Copyright # 2012 by Maria K. Davis. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. First Edition published by John Wiley & Sons, Inc. in No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) , fax (978) , or on the Web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hobok en, NJ 07030, (201) , fax (201) , or online at m/go/ permissio ns. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor the author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. Portions of Financial Accounting Standards Board documents included in this work are copyrighted by the Financial Accounting Foundation (FAF), documents, 401 Merritt 7, PO Box 5116, Norwalk, CT , and are reproduced with permission. Complete copies of those documents are available from the FAF. Portions of various AICPA documents are used and/or adapted with permission. Copyright American Institute of Certified Public Accountants, Inc. All rights reserved. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at Library of Congress Cataloging-in-Publication Data: Davis, Maria K. Accounting for real estate transactions: a guide for public accountants and corporate financial professionals/maria K. Davis. -- 2nd ed. p. cm. Includes bibliographical references and index. ISBN (hardback); ISBN (ebk); ISBN (ebk); ISBN (ebk) 1. Real property--accounting. 2. Real estate investment--accounting. I. Title. HF5686.R3D dc Printed in the United States of America

7 To my parents an ocean apart, close nevertheless

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9 Contents Preface About the Author List of Abbreviations xiii xv xvii PART 1 ACCOUNTING FOR REAL ESTATE TRANSACTIONS GENERAL 1 Chapter 1: Acquisition, Development, and Construction of Real Estate Overview Acquisition, Development, and Construction Costs Preacquisition Costs Project Costs Cost Allocation Change in Estimates or Project Plans and Abandonments of Projects Costs Incurred to Sell or Rent a Real Estate Project Costs Incurred to Sell a Real Estate Project Costs Incurred to Rent a Real Estate Project Incidental Operations Accounting for Costs Incurred Subsequent to Project Completion Determining the Date of Project Completion Costs Incurred Subsequent to Project Completion Purchase of Income-Producing Property Purchase of a Business Purchase of an Asset/Asset Group Recognition of Intangible Assets Acquired Measurement of Property, Plant, Equipment, and Intangibles Allocation of Acquisition Cost Accounting for Intangibles Subsequent to Acquisition Key Differences: Business versus Asset Acquisitions Special Accounting Issues Costs of Amenities Start-up Costs Land Options Financing as Part of a Purchase Transaction Environmental Costs and Liabilities Transactions with Related Parties 54 vii

10 viii & Contents 1.8. Financial Statement Presentation and Disclosure Cash Flow Statement Presentation Segment Disclosures for Public Companies Other Presentation and Disclosure Requirements International Financial Reporting Standards IAS 16, Property, Plant and Equipment IAS 40, Investment Property IFRS 3, Business Combinations Synopsis of Authoritative Literature (Pre-Codification References) 72 Chapter 2: Nonmonetary Exchanges of Real Estate Overview Section 1031 Exchange Nonmonetary Exchanges Not Governed by Topic 845 (APB Opinion No. 29) Exchange with Continuing Involvement of the Transferor In-Substance Sale and Purchase Transaction Nonmonetary Exchange Involving Business Involuntary Conversion Accounting for Nonmonetary Exchanges General Principle Fair Value Exceptions to the Fair Value Principle Nonmonetary Exchange of Real Estate Involving Monetary Consideration Accounting by Receiver of Monetary Consideration Accounting by Payer of Monetary Consideration Special Accounting Issues Exchange-Leaseback Transactions between Related Parties Financial Statement Presentation and Disclosure International Financial Reporting Standards Commercial Substance of Exchange Transaction Fair Value Measurement Synopsis of Authoritative Literature (Pre-Codification References) 101 Chapter 3: Real Estate Sales Overview Applicability of the Real Estate Sale Guidance Sale and Profit Recognition Sale of Real Estate with Long Construction Periods Profit Recognition under the Accrual Method General Rule Specific Criteria Failure to Meet Criteria for the Application of the Accrual Method Inadequate Initial Investment Inadequate Continuing Investment Receivable Subject to Future Subordination Continuing Involvement Application of Other Accounting Methods Deposit Method Installment Method 146

11 Contents & ix Cost Recovery Method Reduced Profit Method Percentage-of-Completion Method Financing Method Leasing Method Profit-Sharing Method Performance-of-Services Method Special Accounting Issues Impairment and Loss on Sale Extinguishment of Debt with the Sale of Property Wrap-around Mortgage Effect of Nonrecourse Financing on Profit Recognition Financial Statement Presentation and Disclosure Presentation of Gain on Sale of Land Option Presentation of Properties as Held for Sale Discontinued Operations Presentation Disclosures upon Recognition of Impairment Loss Cash Flow Statement Presentation International Financial Reporting Standards IAS 18, Revenue IAS 11, Construction Contracts IFRIC 15, Agreements for the Construction of Real Estate Synopsis of Authoritative Literature (Pre-Codification References) 182 Chapter 4: Real Estate Leases Overview Definition of a Lease Right to Use Specified Property, Plant, or Equipment Stated Period of Time Reassessment of the Arrangement Lease Classification General Lease Classification Lessee Lease Classification Lessor Lease Classification Criteria Lease Classification Leases Involving Real Estate Leases Involving Land Only Leases Involving Land and Building Leases Involving Equipment as Well as Real Estate Leases Involving Part of a Building Accounting for Leases Accounting for Leases Lessee Accounting for Leases Lessor Special Accounting Issues Extensions and Renewals of a Lease Modifications to the Provisions of a Lease Lease Termination Purchase and Sale of Leased Asset before the End of the Lease Term 230

12 x & Contents Rent Holiday and Scheduled Rent Increases/Decreases Contingent Rentals Lease Incentives in Operating Leases Subleases and Lease Substitutions Leases and Leasehold Improvements Acquired in a Business Combination Impairment of Assets under Lease and Losses on Leasing Activities Build-to-Suit Leases Leases between Related Parties Financial Statement Presentation and Disclosure Presentation and Disclosure Lessee Presentation and Disclosure Lessor International Financial Reporting Standards Lease Classification Accounting and Disclosures Lessee Accounting and Disclosures Lessor Synopsis of Authoritative Literature (Pre-Codification References) 258 Chapter 5: Sale-Leaseback of Real Estate Overview Accounting for Sale-Leaseback Transactions Involving Real Estate Accounting by the Seller-Lessee Accounting by the Buyer-Lessor Specific Accounting Issues Unusual Terms of Sale-Leaseback Transactions Impairment of Property Minor Subleases Sale of a Partial Interest Leaseback of a Portion of the Property Sold Sale-Leaseback of Multiple Assets Contribution-Leaseback Transactions Wrap Lease Transactions Leaseback with Fixed-Price Renewal Options for Substantially All of the Property s Economic Life Sale-Leaseback Transactions by Regulated Enterprises Sale-Leaseback Involving Related Parties Financial Statement Presentation and Disclosure International Financial Reporting Standards Synopsis of Authoritative Literature (Pre-Codification References) 305 PART 2 ACCOUNTING FOR REAL ESTATE INDUSTRY-SPECIFIC TRANSACTIONS 311 Chapter 6: Interests in Real Estate Ventures Overview Methods of Accounting for Interests in Real Estate Ventures Consolidation Equity Method of Accounting 333

13 Contents & xi Pro Rata Consolidation Cost Method Change between the Cost and Equity Method of Accounting Measuring Interests in Real Estate Ventures at Fair Value Accounting for Transactions with a Real Estate Venture Capital Contributions Loans and Advances to a Venture Sales of Real Estate Service Arrangements Sale of Interest in Real Estate Venture Special Accounting Issues Related to Consolidation Noncontrolling Interest Special Considerations Real Estate Entities Special Accounting Issues Related to the Equity Method of Accounting Other than Common Stock Investments in Corporate Ventures Differences between Accounting Principles of Investor and Venture Recognition of Losses by the Investor Investments in an Investee after Suspension of Loss Recognition Cash Distributions in Excess of Investment Hypothetical Liquidation at Book Value Method Impairment Interest Capitalization Financial Statement Presentation and Disclosure Consolidated Investments Equity Method Investees Items Measured at Fair Value International Financial Reporting Standards Investments in Subsidiaries Interests in Joint Ventures Investments in Associates Synopsis of Authoritative Literature (Pre-Codification References) 380 Chapter 7: Time-Sharing Transactions Overview Types of Time-Sharing Arrangements Deeded Structures Accounting for the Sale of Time-Sharing Intervals Application of the Accrual and Percentage-of-Completion Methods Accounting for Costs to Sell Time-Sharing Intervals Special Accounting Issues Uncollectibility of Receivables Incentives and Inducements Incidental Operations Upgrade and Reload Transactions Seller Support of Operations Division of Project into Phases Financial Statement Presentation and Disclosure Synopsis of Authoritative Literature (Pre-Codification References) 419

14 xii & Contents Chapter 8: Retail Land Sales Overview Accounting for Retail Land Sales Revenue Recognition Profit Recognition Special Accounting Issues Change from the Installment to the Percentage-of- Completion Method Accounting for Repossessed Land Financial Statement Presentation and Disclosure Synopsis of Accounting Literature (Pre-Codification References) 434 Glossary 435 Index 455

15 Preface WHAT IS REAL ESTATE? Land and structures, brick and mortar to some, a bundle of rights and obligations to others. Real estate can be sold outright or it can be securitized. Investors can buy real estate properties or invest in real estate investment trusts. The many facets of real estate and the size of the real estate market trillions of U.S. dollars in the United States alone make it so intriguing. The past few years were marred by a global financial crisis and depressed real estate markets throughout the United States. Homebuilders let real estate purchase options expire; homeowners walked away from their homes or lost them in foreclosures; and corporate investors handed the keys to commercial real estate properties to the lenders that had granted loans on a nonrecourse basis. Accounting for Real Estate Transactions addresses accounting issues that have become prevalent in the wake of the crumbling real estate markets, such as impairment and consolidation considerations for special-purpose entities. It is a comprehensive reference guide that provides financial professionals with a tool to evaluate the accounting consequences of specific deals, enabling them to structure transactions with the accounting consequences in mind and to account for them in accordance with U.S. GAAP. It helps members of audit committees and oversight boards better understand the applicable accounting literature, assess the proper application of the accounting rules, and evaluate the conclusions reached by their companies management. The book is divided into two parts: & & Part I of Accounting for Real Estate Transactions explains the rules governing a variety of real estate transactions applicable to companies of all industries, the acquisition and development of real estate properties, real estate sales and exchanges, and lease and sale-leaseback transactions. Part II of the guide covers accounting for interests in real estate ventures, timesharing transactions, and retail land sales, which are specific to companies operating in the real estate industry. Accounting is not static. New revenue and leasing standards are on the horizon both are joint projects of the Financial Accounting Standards Board and the International Accounting Standards Board, and both standards will replace a myriad of rules under U.S. Generally accepted accounting principles (GAAP). The accounting for financial instruments is being overhauled, and fair value measurement is expected to increase in xiii

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