Financial reporting developments A comprehensive guide Real estate sales Accounting Standards Codification 360-20 (prior to the adoption of ASU 2014-09) Revised September 2017
To our clients and other friends We are pleased to provide you with this updated edition of our Financial reporting developments publication, Real estate sales. This publication addresses the guidance for real estate sales under Accounting Standards Codification (ASC) 360-20, Property, Plant and Equipment Real Estate Sales. While the guidance in ASC 360-20 was issued more than 30 years ago, determining if and when to recognize profit on real estate sales transactions and the amount of profit to recognize continues to be a challenge. ASC 360-20 is a complex, rules-based standard that requires companies to evaluate both the form and economic substance of a sales transaction. The evaluation has become more challenging as real estate transactions have continued to evolve and have become increasingly complex. The guidance for real estate transactions will change when an entity adopts the new revenue recognition standard and the new leases standard issued by the Financial Accounting Standards Board (FASB or Board). The new revenue recognition guidance, which is largely codified in ASC 606, Revenue from Contracts with Customers, will supersede ASC 360-20 for all real estate sales to customers, except those involving a sale and leaseback of real estate. The new revenue guidance also includes consequential amendments that modify the guidance in ASC 845, Nonmonetary Exchanges, for nonmonetary exchanges involving real estate. ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets, which the FASB created as part of the new revenue standard, will generally apply to sales of real estate to noncustomers that do not meet the definition of a business, including partial sales. All of the new revenue guidance is effective for public entities for fiscal years beginning after 15 December 2017, and for interim periods therein. Nonpublic entities are required to adopt the guidance for fiscal years beginning after 15 December 2018, and interim periods within fiscal years beginning after 15 December 2019. Early adoption is permitted. The new leases standard, which is codified in ASC 842, Leases, will supersede the guidance in ASC 840, Leases, and ASC 360-20 for sale and leaseback transactions. The new leases guidance is effective for public business entities and certain not-for-profit entities and employee benefit plans for fiscal years beginning after 15 December 2018, and for interim periods therein. For all other entities, it is effective for fiscal years beginning after 15 December 2019, and interim periods within fiscal years beginning after 15 December 2020. Early adoption is permitted for all entities. We hope this publication will help you understand and successfully apply the provisions of ASC 360-20. Ernst & Young professionals are prepared to assist you in your understanding and are ready to discuss your particular concerns and questions. September 2017
Contents 1 Scope... 5 1.1 Definition of real estate... 6 1.2 Sale of a business... 7 1.3 Integral equipment... 7 1.4 Transactions excluded from the scope of ASC 360-20... 9 1.5 In-substance real estate... 11 1.5.1 Applicability of ASC 360-20 to equity and cost method investments... 11 1.6 Nonmonetary exchanges... 11 1.6.1 Nonmonetary transactions involving boot... 12 1.6.2 Real estate ventures... 15 1.7 Accounting for real estate syndication income... 15 1.8 Loss of a controlling financial interest in in-substance real estate... 16 2 General principles... 17 2.1 Recognition of profit by the full accrual method... 17 2.1.1 Subsequent events... 19 2.2 Consummation of a sale... 19 2.2.1 Sale of an option to acquire real estate... 20 2.2.2 Consummation considerations specific to condominium sales... 21 2.3 Sales value... 21 2.3.1 Computation of sales value... 22 2.3.2 In substance additions to the sales price... 22 2.3.3 Discounting receivables... 22 2.3.4 Calculating the sales value of improvements subject to a land lease... 24 2.3.5 Calculating the sales value of partial sales of real estate... 25 2.3.6 Calculating the sales value of partnership interests... 25 2.3.7 Calculating the sales value of the sale of an option by an option holder... 26 2.3.8 Calculating the sales value when a transaction is initially accounted for using the deposit method... 26 2.4 Surrender of real estate in satisfaction of an entity s obligation... 27 3 Initial and continuing investments... 31 3.1 Buyer s initial investment... 31 3.2 Composition of buyer s initial investment... 31 3.2.1 Irrevocable letters of credit... 32 3.2.2 Applicability of the initial and continuing investment tests and the effects of various forms of financing... 34 3.2.3 Transfer of ownership interest as part of down payment... 39 3.3 Items excluded from buyer s initial investment... 39 3.3.1 Payments made for improvements to the property... 40 3.3.2 Funds provided or guaranteed by the seller to the buyer... 40 3.4 Size of buyer s initial investment... 43 3.4.1 Minimum initial investment requirements... 44 Financial Reporting Developments Real estate sales i
Contents 3.4.2 Calculation of minimum initial investment... 46 3.5 Buyer s continuing investment... 47 3.5.1 Customary amortization term... 49 3.5.2 Initial and continuing investment considerations specific to the homebuilding industry... 49 3.5.2.1 Interaction of ASC 360-20 with ASC 860... 55 3.5.2.2 Nontraditional financing terms... 55 3.5.3 Continuing investment considerations specific to condominium sales... 56 3.6 Release provisions... 56 3.7 Cumulative application of initial and continuing investment tests... 59 4 Future subordination and continuing involvement... 63 4.1 Receivable subject to future subordination... 63 4.2 Continuing involvement... 63 5 Recognition of profit when the full accrual method is not appropriate... 65 5.1 Sale not consummated... 65 5.1.1 Exception to consummation requirements for long-term construction projects... 66 5.1.2 Recognition of loss when sale not consummated... 66 5.2 Buyer s initial investment is not adequate... 66 5.2.1 Determining whether recovery of the cost of the property is reasonably assured... 67 5.2.1.1 Choosing the appropriate accounting method when recovery of the cost of the property is not reasonably assured... 67 5.2.1.2 Choosing the appropriate accounting method when recovery of the cost of property is reasonably assured... 68 5.3 Buyer s continuing investment is not adequate... 69 5.4 Receivable subject to future subordination... 71 5.5 Continuing involvement without transfer of risks and rewards... 72 5.5.1 Continuing involvement based on a contingency... 74 5.6 Obligation or option to repurchase... 74 5.6.1 Antispeculation clauses in real estate sales contracts... 75 5.6.2 Buy-sell clauses... 76 5.7 General partner holds a significant receivable from the buyer... 77 5.8 Guarantee of the return of the buyer s investment or a return on the buyer s investment... 78 5.9 Requirement to initiate or support operations... 80 5.9.1 Implied support... 82 5.9.2 Reasonable assurance that future rentals will be adequate... 82 5.9.3 Estimating future rent receipts... 83 5.9.4 Profit recognition on performance of services... 83 5.9.5 Application of the performance-of-services method when arrangement includes support versus a guarantee... 89 5.10 Requirement to provide management services without compensation or at compensation less than market rates... 93 5.11 Transaction is merely an option to purchase... 94 5.11.1 Sale of an option by an option holder... 94 5.12 Partial sales of real estate... 95 5.13 Condominium sales... 98 5.13.1 Construction is beyond a preliminary stage... 100 5.13.2 Refund requirement... 101 Financial Reporting Developments Real estate sales ii
Contents 5.13.3 Reversion to rental property... 101 5.13.4 Collectibility... 101 5.13.5 Aggregate proceeds and costs can be reasonably estimated... 104 5.13.6 Application of the percentage-of-completion method to a condominium project... 104 5.13.7 Applicability of the percentage-of-completion method to condominium sales... 106 5.14 Seller sells property improvements and leases the underlying land to the buyer... 106 5.15 Sale-leaseback transactions... 112 5.15.1 Sale of property subject to the seller s preexisting lease... 113 5.16 Sales contract requires seller to develop property... 113 5.16.1 Percentage-of-completion and home sales... 117 5.17 Seller participates in future profits from the property without risk of loss... 117 A Other recognition methods... A-1 A.1 Installment method... A-1 A.2 Cost recovery method... A-6 A.3 Deposit method... A-9 A.4 Financing method... A-11 A.5 Leasing method... A-15 A.6 Profit-sharing method... A-16 B Sales of real estate (other than retail land sales) decision tree... B-1 C Abbreviations used in this publication... C-1 D Index of ASC references in this publication... D-1 E Summary of important changes... E-1 Financial Reporting Developments Real estate sales iii
Contents Notice to readers: This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP). Throughout this publication references to guidance in the codification are shown using these reference numbers. References are also made to certain pre-codification standards (and specific sections or paragraphs of pre-codification standards) in situations in which the content being discussed is excluded from the Codification. This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions. Portions of FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A. Portions of AICPA Statements of Position, Technical Practice Aids, and other AICPA publications reprinted with permission. Copyright American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 10036-8775, USA. Copies of complete documents are available from the FASB and the AICPA. Financial Reporting Developments Real estate sales iv
1 Scope Excerpt from Accounting Standards Codification Property, Plant, and Equipment Real Estate Sales Scope and Scope Exceptions 360-20-15-1 This Subtopic establishes standards for recognition of profit on all real estate sales transactions, other than retail land sales (see Topic 976 for retail land sales), without regard to the nature of the seller s business. 360-20-15-2 Determining whether a transaction is in substance the sale of real estate requires judgment. However, in making that determination, one shall consider the nature of the entire real estate component being sold (that is, the land plus the property improvements and integral equipment), and not the land only, in relation to the entire transaction. Further, that determination shall not consider whether the operations in which the assets are involved are traditional or nontraditional real estate activities. For example, if a ski resort is sold and the lodge and ski lifts are considered to be affixed to the land (that is, they cannot be removed and used separately without incurring significant cost), then it would appear that the sale is in substance the sale of real estate and that the entire sale transaction would be subject to the provisions of this Subtopic. Transactions involving the sale of underlying land (or the sale of the property improvements or integral equipment subject to a lease of the underlying land) shall not be bifurcated into a real estate component (the sale of the underlying land) and a non-real-estate component (the sale of the lodge and lifts) for purposes of determining profit recognition on the transaction. 360-20-15-3 The guidance in this Subtopic applies to the following transactions and activities: a. All sales of real estate, including real estate with property improvements or integral equipment. The terms property improvements and integral equipment as they are used in this Subtopic refer to any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost. Examples include an office building, a manufacturing facility, a power plant, and a refinery. b. Sales of property improvements or integral equipment subject to an existing lease of the underlying land should be accounted for in accordance with paragraphs 360-20-40-56 through 40-59. c. The sale or transfer of an investment in the form of a financial asset that is in substance real estate. d. The sale of timberlands or farms (that is, land with trees or crops attached to it). e. Real estate time-sharing transactions (see Topic 978). f. Loss of a controlling financial interest (as described in Subtopic 810-10) in a subsidiary that is in substance real estate because of a default by the subsidiary on its nonrecourse debt. ASC 360-20 establishes guidance for recognizing profit on all real estate transactions (other than retail land sales) regardless of the nature of the seller s business. That is, ASC 360-20 applies equally to a financial services entity selling its corporate headquarters as it does to a homebuilder selling a recently completed home or a real estate investment trust selling a pre-existing building. Financial Reporting Developments Real estate sales 5
1 Scope The guidance in ASC 360-20 should not be applied to retail land sales. ASC 976, Real Estate-Retail Land, defines retail land sales as sales, on a volume basis, of lots that are subdivisions of large tracts of land. These types of sales are generally speculative in nature and are characterized by very small down payments. The risk to the seller in these types of transactions is high because the seller is unable to enforce the buyer s note against the buyer s general credit and the buyer is generally entitled to a full refund if the contract is cancelled within an established cancellation period. Retail land sales do not include sales of lots to builders; sales of homes, buildings, and parcels of land to builders and others; sales of time-sharing interests if the sales are in substance sales of real estate; and sales of options to purchase real estate. We believe it will be rare for sales of real estate to qualify as retail land sales. Therefore, detailed guidance on retail land sales has not been included in this publication (refer to ASC 976-605 for guidance on retail land sales). Note: The Financial Accounting Standards Board (FASB) issued a new revenue recognition standard (ASU 2014-09, Revenue from Contracts with Customers) and a new leases standard (ASU 2016-02, Leases). The guidance in ASU 2014-09 will replace ASC 360-20 for all real estate sales transactions, except those involving a sale and leaseback of real estate. The guidance in ASU 2016-02 will replace the guidance in ASC 360-20 for sale and leaseback transactions involving real estate. ASU 2014-09 also includes consequential amendments that modify the guidance in ASC 845, Nonmonetary Exchanges, for nonmonetary exchanges involving real estate. Effective date ASU 2014-09 (codified in ASC 606 and ASC 610-20) will be effective for public entities for annual reporting periods beginning after 15 December 2017 (2018 for calendar-year public entities) and interim periods therein. Nonpublic entities will be required to adopt the standard for annual reporting periods beginning after 15 December 2018, and interim periods within annual reporting periods beginning after 15 December 2019. Public and nonpublic entities are permitted to adopt the standard as early as annual reporting periods beginning after 15 December 2016 and interim periods therein. ASU 2016-02 (codified in ASC 842) will be effective for public business entities (PBEs) for annual periods beginning after 15 December 2018 (2019 for calendar-year PBEs), and interim periods within those years. For all other entities, the standard is effective for annual periods beginning after 15 December 2019 (2020 for all other calendar-year entities), and interim periods beginning after 15 December 2020 (2021 for all other calendar-year entities). Early adoption is permitted for all entities. Please refer to our Financial Reporting Developments, Revenue from contracts with customers (ASC 606) and Lease Accounting (ASC 842) for further information on these standards Unless otherwise noted, the ASC 360-20, Real Estate Sales and 970-605 Revenue Recognition-Real Estate General, and certain sections of ASC 845-Nonmonetary Exchanges will be superseded after the effective dates of ASUs 2014-09, 2016-02 and 2017-05. 1.1 Definition of real estate ASC 360-20 applies to all real estate sales transactions, and clarifies that the real estate sales guidance should be applied to sales of real estate with property improvements or integral equipment that cannot be removed and used separately from the real estate without incurring significant costs. For example, improvements made to land so that the land can be used for waste disposal (i.e., a landfill) cannot be separated from the land. Other examples of property improvements or integral equipment that would be subject to ASC 360-20 include office buildings, manufacturing facilities, power plants, and refineries. Pursuant to ASC 360-20-15-2, transactions involving the sale of land and property improvements or integral equipment should not be bifurcated into a real estate component and a nonreal estate component to determine profit recognition on the transaction. Financial Reporting Developments Real estate sales 6
1 Scope Additionally, sales of options to purchase real estate in the future, including the sale of an option by a property owner and the resale of an option by an option holder that is not the property owner, are sales of real estate and are subject to ASC 360-20 (see Section 2.2.1 and Section 5.11 for additional guidance on accounting for transactions involving the sale of options or in substance options). Determining whether a transaction involves real estate is a matter of judgment that depends on the relevant facts and circumstances. Companies should focus on the physical attributes of the combined asset being sold (i.e., land with improvements or integral equipment) to determine if the nature of the combined asset is more like real estate (e.g., long-lived, non-removable, such as a building) or equipment (e.g., temporary, movable, such as a vehicle). 1.2 Sale of a business ASC 360-20 does not differentiate between the sale of real estate and the sale of a business. That is, a transaction is not excluded from the scope of ASC 360-20 simply because it involves the sale of a business. Shopping centers, hotels, motels, marinas, and mobile home parks, which could be considered businesses, are all specifically mentioned in ASC 360-20 as being within its scope. ASC 360-20 also should be applied to the sale of the stock or net assets of a subsidiary or a segment of a business that contains real estate if the transaction is, in substance, the sale of real estate (ASC 360-20-15-10(b) see Section 1.4). Companies must use judgment to determine whether a transaction is, in substance, the sale of real estate. The nature of the entire real estate component being sold (i.e., the land plus improvements and integral equipment), and not the land alone, should be considered in relation to the entire transaction to determine whether the substance of the transaction is the sale of real estate. For example, if a company transfers the stock of an operating hotel to a third party in exchange for cash, the real estate component (i.e., the land and the hotel, which cannot be removed and used separately from the land without incurring significant cost) represents a large portion of the entire transaction. The combined assets being sold are, in substance, real estate, and the transaction is subject to the provisions of ASC 360-20. However, if the company sells all of its hotels in Europe, including the rights to the brand name, the real estate component may represent a smaller portion of the entire transaction. The substance of the arrangement does not appear to be, in substance, the sale of real estate, and the transaction would not be subject to ASC 360-20. 1.3 Integral equipment Excerpt from Accounting Standards Codification Integral equipment Integral equipment is any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost. Property, Plant, and Equipment Real Estate Sales Scope and Scope Exceptions 360-20-15-4 The determination of whether equipment is integral equipment shall be based on the significance of the cost to remove the equipment from its existing location (which would include the cost of repairing damage done to the existing location as a result of the removal), combined with the decrease in the fair value of the equipment as a result of that removal. Financial Reporting Developments Real estate sales 7
1 Scope 360-20-15-5 At a minimum, the decrease in the fair value of the equipment as a result of its removal is the estimated cost to ship and reinstall the equipment at a new site. If there are multiple potential users of the leased equipment, the estimate of the fair value of the equipment as well as the costs to ship and install the equipment shall assume that the equipment will be sold to the potential user that would result in the greatest net cash proceeds to the seller (current lessor). 360-20-15-6 The nature of the equipment, and the likely use of the equipment by other potential users, shall be considered in determining whether any additional diminution in fair value exists beyond that associated with costs to ship and install the equipment. 360-20-15-7 When the combined total of both the cost to remove plus the decrease in fair value (for leasing transactions, the information used to estimate those costs and the decrease in fair value shall be as of lease inception) exceeds 10 percent of the fair value of the equipment (installed) (for leasing transactions, at lease inception), the equipment is integral equipment. 360-20-15-8 The phrase cannot be removed and used separately without incurring significant cost contains both of the following distinct concepts: a. The ability to remove the equipment without incurring significant cost b. The ability of a different entity to use the equipment at another location without significant diminution in utility or fair value. Integral equipment is defined as any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost. Companies should base their assessment of the significance of costs to remove and use equipment separately on an estimate of: The cost to remove the equipment from its existing location, which includes the cost of repairing damage done to the existing location as a result of the removal, and The decrease in the value of the equipment as a result of the removal, which, at a minimum, should include the cost to ship and reinstall the equipment at a new site. Companies should consider the nature of the equipment and the likely use of the equipment by other potential users in determining whether any additional decrease in value exists beyond that associated with the costs to ship and install the equipment. If there are multiple potential users of the equipment, companies should assume the equipment will be sold to the potential user that would result in the greatest net cash proceeds to the seller (i.e., the least decrease in value). Once the costs to remove equipment from its existing location and the decrease in value of the equipment have been calculated, the seller must determine if these costs are significant. When the combined total of both the cost to remove plus the decrease in value exceeds 10% of the fair value of the equipment (installed) the equipment is integral equipment. The following illustrates the integral equipment calculation: (Costs incurred on removal including repairs) + (The greater of loss in fair value upon removal or cost to ship and reinstall) = Total costs Equipment would be integral if: Total costs > 10% of fair value of equipment (installed) Financial Reporting Developments Real estate sales 8
1 Scope Illustration 1-1: Facts: Integral equipment Company X sells an already constructed cellular tower located on a plot of land owned by Company X to Company Y for $1,100,000. The selling price is presumed to be fair value for purposes of this example. The companies enter into a concurrent 30-year lease agreement for the land on which the tower is located with Company X serving as the lessor. Company X estimates that the cost to remove the tower, including the cost to repair damage to the existing location as a result of the removal, will be $50,000, and the cost to ship and reinstall the tower at a new location will be $70,000. Company X does not anticipate a diminution in the fair value of the equipment beyond that associated with the cost to ship and reinstall the equipment. Analysis: Because the cost of removal combined with the diminution in value exceeds 10 percent of the fair value of the tower (($50,000 + $70,000) $1,100,000 = 10.9 percent), the cost to remove the tower and use it separately is deemed to be significant. Therefore, the tower is integral equipment and its sale is subject to the provisions of ASC 360-20. The sale of the integral equipment and the concurrent lease of the land should be evaluated together in accordance with ASC 360-20 (see 5.14 for guidance on accounting for sales of property improvements or integral equipment with an underlying lease of the land). 1.4 Transactions excluded from the scope of ASC 360-20 ASC 360-20 identifies specific transactions that are excluded from its scope: Excerpt from Accounting Standards Codification Property, Plant, and Equipment Real Estate Sales Scope and Scope Exceptions 360-20-15-10 The guidance in this Subtopic does not apply to the following transactions and activities: a. The sale of only property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, except for sales of property improvements or integral equipment with the concurrent lease (whether explicit or implicit in the transaction) of the underlying land to the buyer b. The sale of the stock or net assets of a subsidiary or a segment of a business if the assets of that subsidiary or that segment, as applicable, contain real estate, unless the transaction is, in substance, the sale of real estate c. Exchanges of real estate for other real estate (see Topic 845) d. The sale of securities that are accounted for in accordance with Topic 320 (Sales of such securities are addressed in Topic 860.) e. Retail land sales f. Natural assets such as those that have been extracted from the land (for example, oil, gas, coal, and gold). Mineral interests in properties include fee ownership or a lease, concession, or other interest representing the right to extract oil or gas subject to such terms as may be imposed by the conveyance of that interest. Mineral interests in properties also include royalty interests, production payments payable in oil or gas, and other nonoperating mineral interests in properties operated by others. See Topic 932. Financial Reporting Developments Real estate sales 9
1 Scope Pending Content: Transition date: (P) December 16, 2017; (N) December 16, 2018 Transition guidance ASC 825-10-65-2 360-20-15-10 The guidance in this Subtopic does not apply to the following transactions and activities: a. The sale of only property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, except for sales of property improvements or integral equipment with the concurrent lease (whether explicit or implicit in the transaction) of the underlying land to the buyer b. The sale of the stock or net assets of a subsidiary or a segment of a business if the assets of that subsidiary or that segment, as applicable, contain real estate, unless the transaction is, in substance, the sale of real estate c. Exchanges of real estate for other real estate (see Topic 845) d. The sale of securities that are accounted for in accordance with Topic 320 or Topic 321 (Sales of such securities are addressed in Topic 860.) e. Retail land sales f. Natural assets such as those that have been extracted from the land (for example, oil, gas, coal, and gold). Mineral interests in properties include fee ownership or a lease, concession, or other interest representing the right to extract oil or gas subject to such terms as may be imposed by the conveyance of that interest. Mineral interests in properties also include royalty interests, production payments payable in oil or gas, and other nonoperating mineral interests in properties operated by others. See Topic 932. The guidance in ASC 360-20 does not apply to the sale of property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, unless there is a concurrent lease of the underlying land to the buyer. For example, if a manufacturer sells a customer a cellular tower (integral equipment) that will be placed on land already owned by the customer, the sale would not be subject to the provisions of ASC 360-20. However, if the cellular tower is located on land owned by the manufacturer and the manufacturer sells the tower and the land or sells the tower with a concurrent lease (explicit or implicit) of the land, the entire transaction is subject to ASC 360-20. See Section 5.14 for additional discussion of sales of property improvements or integral equipment with a concurrent lease of the underlying land. Two of the other exclusions from the scope of ASC 360-20 are discussed further in Section 1.2 and Section 1.5. Additionally, sales of natural assets that have been removed from the land (e.g., mined ore and harvested timber) are not subject to ASC 360-20. However, the sale of land inclusive of these assets is within the scope of ASC 360-20. Financial Reporting Developments Real estate sales 10
1 Scope 1.5 In-substance real estate Transactions should be considered real estate sales if they are in substance sales of real estate. Examples of transactions that could be in substance the sale of real estate include the sale of corporate stock of enterprises with substantial real estate, sales of partnership interests, and sales of time-sharing interests. ASC 976-10-15-4 provides an example of a sale of a partnership interest that is in substance a sale of real estate. A sale of a partnership interest that should be considered a sale of real estate would involve a company forming a partnership, arranging for the partnership to acquire property directly from third parties, and selling an interest in the partnership to investors who become limited partners. Additionally, the sale or transfer of an investment in the form of a financial asset that is in substance real estate is in the scope of ASC 360-20. 1.5.1 Applicability of ASC 360-20 to equity and cost method investments ASC 360-20-15-10 (see Section 1.4) provides one exception to the requirement that the sale or transfer of in-substance real estate that is in the form of a financial asset should be accounted for in accordance with the provisions in ASC 360-20 (i.e., under the exception the sale is not treated as a sale of real estate, but rather as a sale or transfer or a financial asset). This exception applies to sales or transfers of marketable investments that are accounted for in accordance with ASC 320, Investments-Debt and Equity Securities. Such sales or transfers should be accounted for in accordance with ASC 860, Transfers and Servicing, as opposed to ASC 360-20. Consequently, if a marketable investment in a real estate investment trust (or REIT) is accounted for in accordance with ASC 320, any sales or transfers of that ownership interest in a REIT must be accounted for in accordance with ASC 860. The sale of an investment in a consolidated entity, an investment accounted for under the equity method, or a cost method investment that is outside the scope of ASC 320 (i.e., a cost method investment in a nonmarketable security) that is in substance real estate is subject to the provisions of ASC 360-20. 1.6 Nonmonetary exchanges Exchanges of real estate for other real estate are not within the scope of ASC 360-20. Instead, such transactions should be accounted for in accordance with ASC 845, Nonmonetary Transactions. ASC 845 addresses the measurement of a nonmonetary transaction (i.e., fair value versus book value), but does not address the timing of profit recognition. Therefore, although nonmonetary exchanges of real estate are excluded from the scope of ASC 360-20, we would question whether it is appropriate to recognize profits on nonmonetary exchanges of real estate when the criteria for recognizing profit in ASC 360-20 have not been satisfied (e.g., if continuing involvement exists). In general, the accounting for a nonmonetary transaction should be based on the fair values of the assets exchanged. Thus, the cost of a nonmonetary asset received in exchange for another nonmonetary asset ordinarily is measured based on the fair value of the asset given up or, if more clearly evident, the fair value of the asset received. A gain or loss is recognized if the cost of the nonmonetary asset recognized differs from the carrying amount of the asset given up. If one of the parties in a nonmonetary transaction could have elected to receive cash instead of the nonmonetary asset, the cash that could have been received may be evidence of the fair value of the nonmonetary assets exchanged. See our Financial Reporting Developments publication, Fair Value Measurement, for additional guidance on determining fair value. ASC 845-10-30-3 provides for three exceptions to the general principle of accounting for nonmonetary transactions at fair value. If one of these three exceptions is met, the transaction is accounted for based on the book value of the asset given up (after reduction for impairment, if applicable), which results in no gain or loss recognition. The three exceptions identified are: When neither the fair value of the nonmonetary asset received nor the fair value of the nonmonetary asset relinquished can be determined within reasonable limits. Financial Reporting Developments Real estate sales 11
1 Scope When the transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers other than the parties involved in the exchange. When the transaction lacks commercial substance. Commercial substance exists if the entity s future cash flows are expected to significantly change as a result of the exchange. Future cash flows are evaluated for significance by comparing the configuration (risk, timing, and amount) of the future cash flows of the asset received to those of the asset relinquished and by comparing the entityspecific values of the assets exchanged. The following example excerpted from the AICPA Technical Practice Aid TPA 6600.07, illustrates the appropriate accounting for an exchange of real estate held for sale in the ordinary course of business for real estate to be sold in the same line of business to facilitate sales to customers: Excerpt from TPA 6600.07 Inquiry: A real estate company is engaged in developing residential communities, but they occasionally sell undeveloped parcels of land. The company has entered into an agreement whereby it will exchange land zoned for industrial use having a cost basis of $10,000 for residential land having a fair value of $50,000. Is it proper to record the land received at $50,000 and recognize a gain of $40,000? Reply: APB Opinion No. 29, paragraph 20(b), indicates that an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers does not culminate an earnings process. This exchange represents only a shift in real estate held as inventory. Therefore, the exchange should be reported on the basis of the recorded amount of the nonmonetary asset given up, $10,000. Although the above TPA was issued prior to the elimination of the concept of culmination of an earnings process from the guidance for nonmonetary transactions codified in ASC 845, the conclusion reached in this TPA does not change as a result of that concept being eliminated. As discussed above, the timing of profit recognition is not addressed in ASC 845. Therefore, we would question whether it is appropriate to recognize profits on nonmonetary exchanges of real estate when the criteria for recognizing profit in ASC 360-20 have not been satisfied. 1.6.1 Nonmonetary transactions involving boot Nonmonetary transactions are exchanges and nonreciprocal transfers that involve little or no monetary assets or liabilities. Some exchanges of nonmonetary assets involve a small portion of monetary consideration, referred to as boot, even though the exchange is essentially nonmonetary. Excerpt from Accounting Standards Codification Nonmonetary Transactions-Overall Scope and Scope Exceptions 845-10-15-15 Paragraph 360-20-15-10(c) indicates that the accounting for exchanges of real estate is covered by this Topic and not by that Subtopic 360-20. However, under paragraph 845-10-25-6, an exchange of nonmonetary assets that would otherwise be based on recorded amounts under paragraph 845-10-30-3 but that involves boot shall be considered a monetary (rather than nonmonetary) transaction if the boot is at least 25 percent of the fair value of the exchange. As a result, the guidance is different for exchanges of real estate held for sale in the ordinary course of business [or] for real estate to be sold in the same line of business when the boot is at least 25 percent of the fair value of the exchange (referred to as exchanges of similar real estate). Financial Reporting Developments Real estate sales 12
1 Scope 845-10-15-16 For the receiver of boot, the monetary portion shall be accounted for under Subtopics 360-20 and 976-605 as the equivalent of a sale of an interest in the underlying real estate, and the nonmonetary portion shall be accounted for in accordance with this Subtopic. 845-10-15-17 For the payer of boot, the monetary portion shall be accounted for as an acquisition of real estate, and the nonmonetary portion shall be accounted for pursuant to this Subtopic. Recognition 845-10-25-6 An exchange of nonmonetary assets that would otherwise be based on recorded amounts but that also involves monetary consideration (boot) shall be considered monetary (rather than nonmonetary) if the boot is significant. Significant shall be defined as at least 25 percent of the fair value of the exchange. If the boot in a transaction is less than 25 percent, the pro rata gain recognition guidance in paragraph 845-10-30-6 shall be applied by the receiver of boot, and the payer of boot would not recognize a gain. 845-10-25-7 A transaction involving an exchange of similar real estate that is considered a monetary transaction because boot is at least 25 percent of the fair value of the exchange shall be allocated between two components: a monetary portion and a nonmonetary portion. 845-10-25-8 See Section 360-20-15 for guidance on when an asset is considered real estate. Initial Measurement 845-10-30-23 Paragraph 845-10-25-7 addresses allocation of certain transactions between two components: a monetary portion and a nonmonetary portion. The allocation between the monetary and nonmonetary portions of the transaction shall be based on their relative fair values at the time of the transaction. ASC 845-10-25-6 describes the amount of boot that would cause an exchange of nonmonetary assets to be considered monetary. If the monetary consideration is less than 25 percent of the fair value of the exchange, the transaction is considered nonmonetary. If monetary consideration equals or exceeds 25 percent, the transaction is considered monetary. In applying this guideline, fair value of the exchange is the estimated fair value of the consideration given up or, if more clearly evident, the fair value of the consideration received. ASC 845 provides special guidance for exchanges of real estate involving boot. If an exchange of real estate meets one of the conditions of ASC 845-10-30-3 (see Section 1.6) for measurement on a carryover basis, but is considered a monetary transaction because boot is at least 25 percent of the fair value of the exchange, the transaction should be allocated between two components: a monetary portion and a nonmonetary portion. The basis of the consideration given up should be allocated between the monetary and nonmonetary portions based on the relative fair value of each component at the time of the transaction. The receiver of boot should account for the monetary portion of the transaction under ASC 360-20, as the equivalent of a sale of an interest in the underlying real estate. The nonmonetary portion of the transaction should be accounted for based on the recorded amount (after reduction, if appropriate, for Financial Reporting Developments Real estate sales 13
1 Scope an indicated impairment in value) of the nonmonetary asset relinquished pursuant to ASC 845. For the payer of boot, the monetary portion of the transaction should be accounted for as an acquisition of real estate, and the nonmonetary portion should be accounted for based on the recorded amount of the nonmonetary asset relinquished pursuant to ASC 845. Illustration 1-2: Exchanges of real estate involving monetary consideration Facts: Company A transfers ten condominium units held for sale in the ordinary course of business with a fair value of $1,000,000 and a net book value of $800,000 to Company B. Company B transfers $300,000 cash and eight condominium units held for sale in the ordinary course of business in a different geographical area, with a fair value of $700,000 and a net book value of $500,000 to Company A. The fair value of each of the condominiums exchanged is clearly evident. Both companies are in the same line of business and have entered into the exchange to facilitate sales to customers (i.e., to offer units in different geographical areas). Neither party has any continuing involvement with the real estate transferred to the other. Analysis: Because the boot in this transaction is more than 25 percent of the fair value of the exchange ($300,000 cash received $1,000,000 fair value of the exchange = 30%), the transaction should be allocated between a monetary portion and a nonmonetary portion. This transaction should be accounted for by each party as follows: Company A The monetary portion of the transaction represents 30 percent of the fair value of the exchange. Therefore, the transaction should be allocated to the monetary portion of the transaction as follows: Total consideration: $1,000,000 * 30% = $300,000 Net book value of asset given up: $800,000 * 30% = $240,000 A gain of $60,000 should be recognized on the monetary portion of the transaction ($300,000 $240,000). The nonmonetary portion of the transaction does not qualify for gain recognition because it involves an exchange of property held for sale in the ordinary course of business for property to be sold in the same line of business to facilitate sales to customers. The new basis of the real estate acquired in the transaction will be $560,000 ($800,000 net book value of real estate given up less $240,000 monetary portion). Company B The monetary portion of the transaction represents an acquisition of real estate for the monetary consideration paid of $300,000. The nonmonetary portion of the transaction does not qualify for gain recognition because it involves an exchange of property held for sale in the ordinary course of business for property to be sold in the same line of business to facilitate sales to customers. The accounting basis of the new property equals $800,000 ($500,000 net book value of the real estate given up plus $300,000 total monetary consideration paid). When an exchange includes boot that is less than 25 percent of the fair value of the exchange and the transaction does not qualify to be accounted for at fair value, ASC 845 allows the receiver of the boot to record a gain on the exchange to the extent the money received exceeds a proportionate share of the book value of the asset surrendered. Financial Reporting Developments Real estate sales 14
1 Scope 1.6.2 Real estate ventures Although nonmonetary transactions may involve a direct exchange of real estate, in practice, nonmonetary transactions are most often seen in the formation of a real estate venture. For example, a company may contribute real estate to a venture in exchange for a 50 percent non-controlling interest in the venture. The other party in the venture may contribute cash, real estate, or other assets. Regardless of the form of the contribution of other parties to a transaction, ASC 845-10-15-20 excludes contributions of real estate to a real estate venture from the scope of ASC 845 (see ASC 970-323, Real Estate-General Investment Equity Method and Joint Ventures, for the accounting guidance for equity method investments and joint ventures). ASC 970-323 provides guidance on contributions of real estate to a real estate venture. In accordance with ASC 970-323-30-3, an investor that contributes real estate to the capital of a real estate venture should generally record its investment at the book value of the real estate contributed and not recognize a profit on the transaction, because the economic substance of the transaction is a contribution of capital and not a sale of real estate. However, ASC 970-323-30-3 notes that some transactions that are structured as capital contributions are actually, in economic substance, sales. These types of transactions are subject to the provisions of ASC 360-20. For example, Investor X enters into a transaction with Investor Y in which Investor X contributes real estate with a fair value of $5,000 and Investor Y contributes $2,500 in cash, which Investor X immediately withdraws. The only asset in this venture is the real estate and following the contributions and withdrawals, each investor has a 50 percent interest in the venture. Assuming Investor X is not committed to reinvest the $2,500 in the venture, the substance of this transaction is a sale of a one-half interest in the real estate by Investor X for $2,500 in cash, and the transaction should be accounted for in accordance with ASC 360-20. See Section 5.12 for additional guidance on accounting for partial sales of real estate. 1.7 Accounting for real estate syndication income Syndication activities are efforts to directly or indirectly sponsor the formation of entities that acquire interests in real estate by raising funds from investors. Entities that perform syndication activities earn commissions and fees performing a variety of services and activities, including organizing partnerships, selling real estate to the partnerships, and arranging for the partnerships to purchase real estate directly from (or sell it directly to) third parties. ASC 970-605, Real Estate-General Revenue Recognition, provides guidance for recognizing income from real estate syndication activities, including the following guidance related to the recognition of profit on the sale of real estate by syndicators to partnerships: Excerpt from Accounting Standards Codification Real Estate General Revenue Recognition Recognition 970-605-25-5 Subtopic 360-20 applies to the recognition of profit on the sale of real estate by syndicators to partnerships. The guidance in that Subtopic shall also be applied to the recognition of profit on real estate syndication transactions even if the syndicators never had ownership interests in the properties acquired by the real estate partnerships. For purposes of applying the profit recognition criteria in that Subtopic to transactions in which syndicators never had such ownership interests, the syndicators should recognize profit on the transactions in the same way that they would have recognized such profit had they acquired the real estate and sold it to the partnerships. Financial Reporting Developments Real estate sales 15
1 Scope ASC 970-605 provides that all sales of real estate arranged by syndicators are subject to the scope of ASC 360-20, even if the syndicators never had ownership of the real estate. The sales value used to calculate profit on the transaction (see Section 2.3 for discussion of sales value) should include all fees charged by the syndicators except fees for future services and syndication fees (i.e., compensation for selling debt or equity interests in partnerships, including commissions and reimbursements of expenses). Refer ASC 970-605 for detailed guidance on accounting for real estate syndication income. 1.8 Loss of a controlling financial interest in in-substance real estate The deconsolidation and derecognition guidance in Subtopic 810-10 specifically excludes from its scope transactions that result in a loss of a controlling financial interest in in-substance real estate, including insubstance real estate (or any real estate) that meets the definition of a business. Instead entities should apply the sale of real estate guidance in ASC 360-20 and ASC 976-605 (see Section 19.2.1 of our Financial Reporting Development publication, Consolidation: Determination of a controlling financial interest and accounting for changes in ownership interests). We believe the exclusion from ASC 810-10 and applicability of ASC 360-20 and 976-605 applies generally to all losses of controlling interests (e.g., sale, transfer, foreclosure, dilution of ownership interest and other arrangements in which control is surrendered) in in-substance real estate. See section 2.4 below for guidance specific to the application of the sale and profit recognition requirements to losses of control of real estate and in-substance real restate in satisfaction of an entity s non-recourse obligation and upon default of non-recourse debt. Financial Reporting Developments Real estate sales 16