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NCREIF Accounting Update
June 2007
Anthony Wallace
Manager, PricewaterhouseCoopers LLP
PwC
Topics Today
Accounting Issues/Trends
• International Convergence
• Continuing trend toward fair value accounting
• SFAS 157 – Fair Value Measurements
• SFAS 159 - Fair Value Option
• Scope Project – Update
• FSP FIN 46(R)-7
• Proposed legislation for SEC registration by RE advisors
• Joint IASB / FASB Lease Accounting Project
International Convergence an Accelerating Trend
In the summer of 2006, the FASB and IASB both approved a “Memorandum of
Understanding”, which represents the “Roadmap” for convergence between IFRS and
US GAAP over a targeted period of 2006-2008
Movement in this direction includes:
• Efforts to resolve existing differences
• Delays in issuance in new standards as differences are resolved so that no “new
differences” are created by currently proposed standards, and
• Increasing number of “Joint Projects”
Recently the SEC has agreed to accept IFRS reporting without complex reconciliations
to U.S. GAAP by Foreign Issuers
Recently the SEC has reportedly been considering allowing all registrants to
utilize IFRS. While likely years off, this has been viewed by some as the
potential indicator that U.S. GAAP will eventually cease to exist over the longterm. However, by then, given all the convergence activity, will it really matter?
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 3
Continuing trend toward fair value accounting
Recently, FASB issued SFAS No. 157, Fair Value Measurements and SFAS
159, The Fair Value Option for Financial Assets and Financial Liabilities.
Both statements are effective for fiscal years beginning after 11/15/07 unless
early adoption elected
At first glance, the guidance provided by FAS 157 may not seem like it will
significantly impact companies' financial statements, because the standard's
provisions are definitional and disclosure oriented. However, after a closer
look, it becomes apparent that the effect of adopting FAS 157 will be extensive
given the pervasiveness of fair value measures throughout accounting
standards. This is demonstrated in part by the number of accounting
standards amended by FAS 157.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 4
SFAS 157 – Fair Value Measurements
FAS 157 defines fair value as "the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date."
Market Participants: Market participants are buyers and sellers in
the principal (or the most advantageous) market for the asset or
liability. These market participants are (1) unrelated (as that term
is used in FASB Statement No. 57, Related Party Disclosures);
(2) knowledgeable about factors relevant to the asset or liability
and the transaction; (3) able to transact (i.e., have the legal and
financial ability to do so); and (4) willing to transact (i.e.,
motivated but not forced or otherwise compelled to transact).
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 5
IASB - Discussion Paper “Fair Value Measurements”
In November 2006, the IASB issued Part 1:
Invitation to Comment on relevant IFRS guidance
Key Issues for discussion:
1. For liabilities, the definition of fair value in SFAS 157 rests on
the notion that the liability is transferred (the liability to the
counterparty continues; it is not settled). The definition in
IFRS refers to the amount at which a liability could be settled
in an arm’s length transaction.
2. Are transaction costs to sell an asset or transfer a liability an
attribute of the transaction and not of the asset or liability
NCREIF Presentation
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June 2007
Slide 6
FAS 157 on Transaction/Transportation Costs
• Transaction costs are NOT included in the fair value estimate.
They are incremental costs to sell an asset and not an
attribute of the asset.
• Transportation costs should be considered in fair value if
location is an attribute of the asset or liability (e.g.
commodities).
• Concept: If the cost can be directly transferred to a 3rd party, it
should be included in FV.
NCREIF Presentation
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June 2007
Slide 7
Fair Value Option (SFAS 159)
SFAS 159 allows optional fair value application for financial
assets and liabilities
Option is an irrevocable election to initially and subsequently
measure certain assets and liabilities at fair value
Companies that early adopt the provisions of FAS 159 must also
early adopt FAS 157
NCREIF Presentation
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June 2007
Slide 8
Adoption of the FVO
Upon election and adoption of the FVO, the difference between
the instrument's fair value and its carrying value is recorded as a
component of the cumulative effect adjustment to beginning
retained earnings.
The SEC staff has expressed concern about a strategy under
which a company would apply the transition provisions of FAS
159 that allow unrecognized losses to be taken directly to
retained earnings, when the company does not intend to apply
FAS 159's fair value provisions to financial instruments going
forward.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 9
Accounting Impact of Electing the FVO on Upfront Fees and
Costs
FAS 159 requires that upfront costs and fees related to items for
which the FVO is elected must be recognized in current earnings
and not be deferred.
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June 2007
Slide 10
Required Recurring Disclosures
Key disclosure objectives include:
• Discuss the extent to which the FVO is used
• Discuss the impact of the FV changes on current earnings
Specific required disclosures:
• Reasons for electing only a portion of similar items for the
FVO
• Line item disclosures of those items under the FVO election
and the related impact on earnings
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 11
Scope SOP Update
• FASB cleared the Statement of Position on September 13,
2006
• Issuance of FSP FIN 46(R)-7 on May 11, 2007, Application of
FASB Interpretation No. 46(R) to Investment Companies.
• AcSEC expects to issue in mid June 2007 SOP 07-1,
Clarification of the Scope of the Audit and Accounting Guide
Investment Companies and Accounting by Parent Companies
and Equity Method Investors for Investments in Investment
Companies
• The SOP will be effective for fiscal years beginning on or after
December 15, 2007, with earlier application encouraged
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 12
FSP No. FIN 46(R)-7, Application of FASB Interpretation No.
46(R) to Investment Companies
This FASB Staff Position (FSP) addresses the application of
FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities, by an entity that
accounts for its investments in accordance with the specialized
accounting guidance in the AICPA Audit and Accounting Guide,
Investment Companies.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 13
FSP No. FIN 46(R)-7, Application of FASB Interpretation No.
46(R) to Investment Companies
Paragraph 4(e) of Interpretation 46(R) is amended as follows:
Investments accounted for at fair value in accordance with
the specialized accounting guidance in the AICPA Audit and
Accounting Guide, Investment Companies, are not subject
to consolidation according to the requirements of this
Interpretation
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 14
FSP No. FIN 46(R)-7, Application of FASB Interpretation No.
46(R) to Investment Companies
If initial application of this FSP and SOP 07-01 requires
consolidation of an entity that was not previously consolidated,
or requires an entity that had previously been consolidating an
investment under Interpretation 46(R) to apply the specialized
accounting in the Guide, the entity shall follow the transition
guidance in paragraph 57 of SOP 07-01 applicable to the
related circumstance.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 15
Proposed legislation for SEC registration by RE advisors
On May 15, 2007, new legislation was introduced in the United
States Senate which would require investment advisers of most
hedge funds and other private investment funds to register with
the Securities and Exchange Commission ("SEC") under the
Investment Advisers Act of 1940 (the "Advisers Act") and would
subject such advisers to regulation under the Advisers Act.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 16
Proposed legislation for SEC registration by RE advisors
Under current law, fund advisers may count the fund as a single
client, without "looking through" to count as clients the underlying
fund investors
The proposed legislation, would change this by mandating a
look-through to the fund's investors in most cases.
The current SEC rule had included an exception in the case of
funds that had at least a two-year "lock-up" period preventing
investor withdrawal during such period. Thus, traditional closedend real estate (and private equity) fund managers were spared.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 17
Proposed legislation for SEC registration by RE advisors
The newly proposed legislation, however, includes no such
exception. As a consequence, if the legislation is adopted in its
current form, many real estate fund managers could find
themselves required to register under the Advisers Act and
subject to its terms.
True "dirt" real estate funds may be excluded because the
Advisers Act pertains to advice with regard to securities, however
many funds make investments in real estate-related assets that
would be considered securities for purposes of the Advisers Act.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 18
Joint Lease Project Announcement
On July 19, 2006, the FASB and IASB both agreed to add a joint
project on lease accounting to their accounting project agendas.
The first phase of the project would primarily involve:
• researching the project and developing ideas through discussion of
lease accounting issues with a working group of leasing experts and
financial statements users;
• identifying and analyzing the conceptual and practical issues
involved in further developing the ideas in the 1999/2000 G4+1
Special Report, Leases: Implementation of a New Approach;
• developing a lease accounting model that is consistent with the
current conceptual frameworks of the IASB and FASB.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 19
History
SFAS 13 Accounting For Leases was issued in November 1976.
SFAS 13 provided a form driven approach which classified
leases generally into two categories:
• Finance Leases – situations where “substantially” all the risks
and rewards of ownership have been transferred to the lessee.
Should be accounted for as the acquisition of the asset and
incurrence of a liability by the lessee and a sale or financing by
the lessor .
• Operating Leases – where substantially all the benefits and
risks of ownership have not been transferred.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 20
Joint Lease Project Considerations
While it is not possible to ascertain definitively the direction this project may ultimately
take, the reference to these special reports and other statements by the standard
setters imply that the direction recommended in the special report is considered
preferable to the existing lease accounting model.
The model described for consideration in the Special Report includes the following:
• Advocates a more substance vs form approach
• Eliminates the “arbitrary” bright lines including eliminating the distinction between
capital and operating lease
• Substantially all leases would be capital reflected on books using PV based
methodology
• Potentially will provide some relief for short term leases – i.e., those with original
durations of less than 1 year (acknowledgement that goal is to deal with large dollar
impact)
• General expectation of symmetrical accounting between lessee and lessor
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 21
Tentative Project Time Table
Project Events
Tentative Date
Organization of joint FASB/IASB working group – this group
would report to both FASB and IASB boards
December 2006
Working group activities and Board deliberations
2007
(Initial meeting was
Feb 15)
“Preliminary views” document for public comment
Early 2008
Issue final statement
2008/2009
New statement adoption date
2009/2010
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 22
Focus and Goals
• Need for symmetrical accounting as a requirement (potential
exists to decouple lessee and lessor accounting models and to
phase the project into two parts)
• The goal of the project is to ensure that investors and other
users of the financial statements are provided useful,
transparent and complete information about leasing
transactions in the financial statements.
NCREIF Presentation
PricewaterhouseCoopers
June 2007
Slide 23
Potential Impacts on Real Estate Companies
With respect to real estate companies, such a project would not only have a direct
accounting impact but also could adversely impact their business activities.
This may occur much sooner than the adoption date as lessees anticipate adoption.
Potential impacts:
• Potential tenants may change how they evaluate “lease vs buy” decisions.
• Some tenants may want to renegotiate existing long dated lease terms to reduce
impact (potential lease modification/termination payments may arise).
• Impact on tenant credit mix may be adverse as better credit tenants may be more
likely to purchase property.
• Impact on lease term and roll over risk may be adverse as statement may provide
pressure on lessee to have shorter term leases.
• Impact will vary by property type – some not affected at all and others more so.
Retail property and sale/leaseback or triple net lease property types most affected.
NCREIF Presentation
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June 2007
Slide 24
Questions?
NCREIF Presentation
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June 2007
Slide 25