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NCREIF Accounting Update

Dan Clemmens

October 12, 2006

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Agenda

FASB Update

– FASB Statement No. 157 – FIN 48 –

Fair Value Measurement Accounting for Income Taxes-Uncertain Tax Positions

– FASB Statement No. 158 –

Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans

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EITF Update

– Issue 06-6 (Debt modifications or exchanges) – Issue 06-7 (Conversion options in convertible debt) – Issue 06-8 (Sales of condominiums) – Issue 06-9 (Fiscal year-end differences of parent and subsidiary) •

SEC Update

– SAB No. 108 (Considering the effects of prior year misstatements) – Comment Letter Trends

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FASB UPDATE

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FASB Update

FASB Statement 157 - Fair Value Measurement

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Addresses “how to” measure fair value, not the “when”

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Applies to financial/nonfinancial assets and liabilities

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FASB Update

FASB Statement 157 - Fair Value Measurement (Cont’d) Fair Value Definition

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Price that could be received for an asset or paid to transfer a liability in a current transaction between marketplace participants at measurement date-exit price from seller’s viewpoint

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FV measurement should reflect assumptions that market participants would use and exclude factors specific to reporting entity

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FASB Update

FASB Statement 157 - Fair Value Measurement (Cont’d) Fair Value Hierarchy

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Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has access to at the measurement date.

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Level 2 – Other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly through corroboration with observable market data.

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Level 3 – Inputs that reflect the reporting entities own assumptions about the assumptions market participants would use in pricing the asset or liability.

FASB Update

FASB Statement 157 - Fair Value Measurement (Cont’d) Expanded Disclosures

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Both quantitative (both interim and annual financial statements) and qualitative (annual financial statements only)

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For items remeasured at fair value, examples of required quantitative disclosures include:

– – –

the category into which items fall within the fair value hierarchy details about total gains or losses during a period (regardless of whether the items are still held at the reporting date) unrealized gains or losses for certain items held at period end 7

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FASB Update

FASB Statement 157 - Fair Value Measurement (Cont’d)

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Effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

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Earlier application is encouraged if the reporting entity has not yet issued financial statements (annual or interim) for the fiscal year in which the Statement is initially applied.

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions

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The Board adopted a benefit recognition model with a two-step approach

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Step One: Recognition threshold Step Two: Measurement of the benefit

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Recognition - A tax benefit is recognized when it is “more-likely-than-not” of being sustained based on the technical merits of the position

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Measurement – largest amount of benefit that is more likely-than-not to be realized

FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions

Measurement: Scenario 1 Possible Estimated Outcome ($) $ 100 $ 80 $ 60 $ 50 $ 40 $ 20 $ Individual Probability of Occurring (%) 5% 25% 25% 20% 10% 10% 5% 100% Cumulative Probability of Occurring (%) 5% 30% 55% 75% 85% 95% 100% $60 is the largest amount of tax benefit that is greater than 50% likely of being realized

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions

Measurement: Scenario 2 Possible Estimated Outcome ($) $ 100 $ 75 $ 50 Individual Probability of Occurring (%) 25% 50% 25% 100% Cumulative Probability of Occurring (%) 25% 75% 100% $75 is the largest amount of tax benefit that is greater than 50% likely of being realized

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d)

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Example One:

– Uncertain tax position of $100 has 40% likelihood of being sustained – The best estimate of what is more likely than not to be ultimately payable and above the tax return position is $45

FAS 5 analysis – net “asset” of $55

– $100 benefit based upon the filing position, less – $(45) contingent liability under FAS 5 – $ 55 net tax “asset” •

FIN 48 Analysis – asset of $0

– Step 1 - Recognition: • Is the asset more likely than not to be realized (>50%)?

• No - $0 asset to be recorded

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Example Two:

– Uncertain tax position of $100 is 60% likely of being sustained – The best estimate of what is more likely than not to be ultimately payable and above the tax return position is $45 – The likelihoods of possible outcomes are as follows: – 10% likelihood of realizing $100 – 30% likelihood of realizing $60 – 40% likelihood of realizing $30 – 20% likelihood of realizing $0

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Example Two (cont’d):

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FAS 5 analysis – net “asset” of $55

– $100 benefit based upon the filing position, less – $(45) contingent liability under FAS 5 – $ 55 net tax “asset” •

FIN 48 Analysis – asset of $30

– Step 1 - Recognition: • Is the asset more likely than not to be realized (>50%)?

• Yes – go onto measurement – Step 2 - Measurement: • Cumulative likelihood of 80% relates to an asset of $30

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Subsequent Recognition/Derecognition

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Subsequent recognition is required in the interim period in which one of the following events occurs:

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The “more-likely-than-not” recognition threshold is subsequently met The tax matter is ultimately resolved favorably The applicable statute of limitations has expired

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Derecognition occurs when it is “more likely than not” that the position will not be sustained

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Use of a valuation allowance is not permitted 15

FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Change in Judgment

• A change in judgment that relates to a position taken in a prior annual period is treated as a discrete item in the period in which the change occurs.

• A change in judgment that relates to a position taken in a prior interim period within the same fiscal year is taken into account over the remaining periods in the fiscal year pursuant to APB 28 and FIN 18.

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Classification

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The difference between the benefit of the tax position as reflected in the tax return and the amount recorded in the financial statements should be classified as either:

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A reduction of deferred tax assets resulting from a deductible temporary difference or tax NOL or tax credit carryforward, or

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A current or noncurrent liability, based on the expected timing of cash flows (not a deferred tax liability) 17

FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Interest and Penalties

• Interest is a period cost.

• Accrue statutory penalties when a tax position does not exceed the minimum statutory threshold required to avoid penalties.

• Classification of interest and penalties is an accounting election.

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FASB Update

FIN 48 – Accounting for Income Taxes – Uncertain Tax Positions (Cont’d) Disclosures

• At the end of each annual reporting period, disclose: – A tabular rollforward of the total amounts of unrecognized tax benefits at the beginning and end of the period; – The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate; – The total amount of interest and penalties recognized currently (in the Statement of Operations) and in the aggregate (in the Balance Sheet) – Positions where it is reasonably possible the total amount of unrecognized tax benefit will significantly increase or decrease within 12 months of the reporting date; • Interim disclosures may be required

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FASB Update

Statement No. 158 – Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans

Represents the completion of the first phase in the FASB’s postretirement benefits accounting project – Does not change the amount of net periodic benefit cost included in net income or address the various measurement issues • Primary Requirements of Statement 158 – Recognition of the funded status • No longer a requirement to recognize a minimum pension liability – Recognition of accumulated amounts (actuarial gains/losses, prior service costs, etc.) • Recognize as a component of accumulated other comprehensive income • Adjust as they are subsequently recognized as components of net periodic benefit cost – Elimination of early measurement date option

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FASB Update

Statement No. 158 – Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (Cont’d)

• Significant Changes Between the Exposure Draft and Statement 158 – Method of recognition of the funded status • Retrospective application not permitted; recognition of the funded status to be accounted for prospectively – Elimination of transition amounts • Originally proposed as an adjustment to opening retained earnings with no further amortization of these amounts • Final Statement requires recognition in equity as a component of other comprehensive income – Statement 158 allows for these amounts to continue to be amortized

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FASB Update

Statement No. 158 – Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (Cont’d)

• Effective Date – The requirement to recognize the funded status of a defined benefit postretirement plan and the disclosure requirements are effective for fiscal years ending after December 15, 2006, for public entities, and at the end of the fiscal year ending after June 15, 2007, for all other entities. – The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. – Earlier application of the recognition or measurement date provisions is encouraged; however, early application must be for all of an employer’s benefit plans.

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EITF UPDATE

EITF Update

Tentative Conclusions – September 2006

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Issue 06-6: Debtors Accounting for Modification (or Exchange) of Convertible Debt Instruments

– Issue 05-07 provides guidance to determine whether a debt instrument has been extinguished in accordance with Issue 96-19 – Supersede Issue 05-07 when ratified by the FASB – Issue 1 • Change in fair value of an embedded conversion option upon the modification or exchange should not be included in the analysis of cash flows performed under Issue 96-19.

• A change in fair value of an embedded conversion option that is at least 10 percent of the carrying value of the debt instrument immediately prior to the modification, would be deemed a substantial modification or exchange.

• Modification or exchange that either adds or eliminates a substantive conversion option would always be considered substantial and extinguishment. In this case, the assessment of whether a conversion option is substantive, based on the guidance in EITF Issue No. 05-1, “Accounting for the Conversion of an Instrument That Became Convertible upon the Issuer's Exercise of a Call Option,” should be made as of the

modification date

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EITF Update

Tentative Conclusions – September 2006

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Issue 06-6: Debtors Accounting for Modification (or Exchange) of Convertible Debt Instruments (Cont’d)

– Issue 2 • When a debt instrument is modified (or exchanged) in a transaction that is not accounted for as an extinguishment, an increase in the fair value of an embedded conversion option resulting from the modification should reduce the carrying amount of the debt instrument (i.e., increasing a debt discount or reducing a debt premium) with a corresponding increase in additional paid-in capital. • Decrease in the fair value of an embedded conversion option resulting from a modification (or exchange) should not be recognized. – The guidance in this consensus (if ratified) should be applied prospectively to future modifications or exchanges of debt instruments that occur in the first interim or annual reporting period beginning after the Board’s ratification of the consensus.

• Early application of this guidance is permitted for modifications or exchanges of debt instruments in periods for which financial statements have not yet been issued.

• Retrospective application to previously issued financial statements is not permitted.

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EITF Update

Tentative Conclusions – September 2006

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Issue No. 06-7: Issuer’s Accounting for a Previously Bifurcated Conversion Option in a Convertible Debt Instrument When the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement No. 133, Accounting for Derivative Instruments

and Hedging Activities

– Reassessment of whether an embedded conversion option must be bifurcated under Statement 133 is conducted at each balance sheet date.

– The carrying value of the liability for a previously bifurcated conversion option should be reclassified to shareholders’ equity with no impact on the accounting for the convertible debt instrument. • The debt discount recorded at issuance as a result of the bifurcation of the conversion option should continue to be amortized over the remaining term of the instrument.

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EITF Update

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Tentative Conclusions – September 2006

Issue No. 06-7: Issuer’s Accounting for a Previously Bifurcated Conversion Option in a Convertible Debt Instrument When the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging

Activities (Cont’d)

– Conclusion reached (if ratified) would be effective for interim or annual periods beginning after December 15, 2006. – The consensus should be applied prospectively to all previously bifurcated conversion options in convertible debt instruments that no longer meet the bifurcation criteria of Statement 133.

• Early application of this guidance will be permitted for periods for which financial statements have not yet been issued. • Elective retrospective application consistent with Statement 154 also will be permitted. • The following disclosures should be made as a result of this consensus when an embedded conversion option no longer meets the bifurcation criteria of Statement 133: – A description of the principal changes causing the embedded conversion option to no longer require bifurcation under Statement 133.

– The amount of the liability for the conversion option reclassified to shareholders’ equity.

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EITF Update

Tentative Conclusions – September 2006

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Issue 06-8 – “Applicability of the Assessment of a Buyer’s Continuing Investment under FASB Statement No. 66, Accounting for Sales of Real Estate, for Sales of Condominiums

– Statement 66 provides specific guidance for accounting for the sale of condominiums which allows for the percentage of completion method of profit recognition.

• The adequacy of the buyer’s continuing investment should be evaluated when determining whether to recognize profit under the percentage of completion method.

• If the buyer does not meet the continuing investment test, any proceeds received from the buyer must be accounted for as deposits until the criteria for profit recognition, including the continuing investment test, are met. – The guidance in this consensus (if ratified) would be effective for annual periods beginning after March 15, 2007, with early application permitted as of the beginning of an entity’s fiscal year.

• The consensus should be applied as a change in accounting principle recognized through a cumulative effect adjustment to retained earnings, or to other components of equity or net assets in the statement of financial position, at the beginning of the year of adoption.

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EITF Update

Tentative Conclusions – September 2006

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Issue 06-9 – Reporting a Change in (or the Elimination of) a Previously Existing Difference between the Fiscal Year-End of a Parent Company and That of a Consolidated Subsidiary or an Equity Method Investee

– Statement 154 requires a change in accounting principle to be recognized through retrospective application unless it is impracticable to do so. – The parent should report the elimination of a lag in reporting the subsidiary’s financial results (or in reporting the results of an equity method investment) in the parent’s consolidated financial statements as a change in accounting principle through retrospective application pursuant to the provisions of Statement 154, subject to the impracticability exception included in that Statement. – The guidance in this consensus (if ratified) should be applied prospectively for future changes to, or the elimination of a previously existing difference between, the reporting period of a parent and a consolidated subsidiary or equity method investee, beginning in the first interim or annual period following Board ratification (expected in November 2006).

• Early application will be permitted in periods for which financial statements have not yet been issued.

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SEC UPDATE

SEC Update

SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements

• Issued September 13, 2006 • Does not change the SEC staff’s previous positions in SAB 99 • Registrants and Auditors must quantify the effects of errors under both the “rollover” and “iron curtain” methods • Special transition provision in circumstances where its application would have altered previous materiality conclusions – Cumulative effect adjustment to retained earnings as of the beginning of the first fiscal year ending after November 15, 2006 – Expanded disclosure required – Not acceptable in situations where previous assessments did not consistently follow an acceptable methodology or did not reach reasonable conclusions

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SEC Update

• Comment Letter Trends – Segments – Goodwill Impairment – Derivatives – Legal Contingencies – Classification in Financial Statements

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