Transcript Introduction Overview Role of Audit Firm ASC 820 ASC 805 Lease Accounting Questions −3− Role of Audit Firm Statement on Auditing Standards No.

Introduction
Overview
Role of Audit Firm
ASC 820
ASC 805
Lease Accounting
Questions
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Role of Audit Firm
Statement on Auditing Standards No. 73 - Using the Work of
a Specialist
• Provides guidance to the auditor who uses the work of a
specialist in performing an audit in accordance with
generally accepted auditing standards (GAAS)
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Role of Audit Firm
Specialist. A person (or firm) possessing special skill
or knowledge in a particular field other than
accounting or auditing.
Specialists include, but are not limited to:
• Actuaries
• Appraisers
• Engineers
• Environmental Consultants
• Geologists
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Role of Audit Firm
• Real estate appraisers are valuation specialists in
the area of real property.
• Often referred to as valuers
• Must understand and use the language of potential
clients
• Professional attributes: property valuation (and
valuation-related) skills, knowledge, education,
experience and training
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Role of Audit Firm
Real property valuation specialists – essential team
members.
• Directed by auditor and company that the auditor
represents
• Viewed as subject matter expert (SME) by the audit
and tax users of their services
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Role of Audit Firm
Audit Issues
• Land – quality of land sale data
• Replacement Cost New – source and applicability of data
• Indirect Costs & Entrepreneurial Profit – market support
• External Obsolescence – market support
• Downtime – market support
• Above/Below Market Leases – support for market rents
• Reimbursements – market support
• Discounted Cash Flow – market support for key underlying
assumptions
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Role of Audit Firm
Real property valuation specialists may be required to:
• Estimate fair value at highest and best use
• Allocate a purchase price among land, building and
site improvements and assist others with personal
property and intangible assets
• Evaluate asset impairment
• Perform valuation assignments for other purposes
(i.e., alternate use, etc.)
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ASC 820
Fair Value under ASC 820
• The FASB issued ASC 820 (formally known as FAS
157), which defines fair value as, “the price that
would be received for an asset or paid to transfer a
liability in an orderly transaction between market
participants at the measurement date.”
• Source: SFAS No. 157, Financial Accounting
Standards Board, Sept. 2006
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ASC 820
Fair Value Objectives
• Make financial reports understandable, relevant,
reliable, and comparable
• Provide greater transparency than historical costbased measurements
• Define fair value
• Establish a framework for measuring fair value
• Expand disclosures about fair value measurements
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ASC 820
Fair Value Applications
• ASC 820 applies to all other statements issued by
the FASB where fair value is discussed and it
amends previous statements that provided different
definitions of fair value.
• It does not eliminate the practicability exceptions to
fair value measurements in accounting
pronouncements within the scope of the Statement
• Market participants include buyers and sellers in
the principal or most advantageous market for the
asset
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ASC 820
Fair Value – Standard Expressed in ASC 820
• Intended to provide information to investors about
the price an asset could be sold for at the
measurement date
• Not intended to provide information on anticipated
IRR or future results
• Retains exchange price notion in earlier FASB
definitions of fair value
• Clarifies that the exchange price is the price in an
orderly transaction between market participants
and not a forced transaction
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ASC 820
Fair Value – Standard Expressed in ASC 820
• The Board revised the definition of fair value in this
Statement to refer to an orderly transaction, as do
other definitions used in valuations for purposes
other than financial reporting that are similar to fair
value (for example, fair market value)
• Fair value is generally consistent with similar
definitions of fair market value
• The FASB recognized that fair market value relates
mostly to assets (property)
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ASC 820
Definitions - Some real estate assets affected before others:
• For all financial and nonfinancial assets recognized
at fair value on a recurring basis ….
• For nonfinancial assets measured on a nonrecurring
basis, such as impaired real estate
• For real estate investment companies investing in
office buildings and the like, having a calendar year,
and marking that investment to fair value on a
recurring basis
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ASC 820
Definitions - Some real estate assets affected before others:
• Provides a new definition of fair value
• Creates a framework for developing fair value
estimates (or opinions)
• Requires additional disclosures for fair value
estimates (or opinions)
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ASC 820
Note the distinction between estimates and opinion:
• Preparer of financial statements may estimate an
asset’s fair value
• In other instances, a fair value opinion will be
acquired from a valuation specialist
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IFRS 13
Fair Value under IFRS 13, is effective after January 1, 2013
• Fair value is the estimated price for the transfer of
an asset or liability between identified
knowledgeable and willing parties that reflects the
respective interests of those parties.
• A fair value measurement of a non-financial asset
takes into account a market participant’s ability to
generate economic benefits by using the asset in its
highest and best use or by selling it to another
market participant that would use the asset in its
highest and best use.
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ASC 820
ASC 820 prioritizes valuation inputs
1) Identify exit market
2) Identify market participants
a) Principal or most advantageous market
b) In-use or in-exchange
3) Identify valuation premise (highest and best use)
4) Determine market participant assumptions
5) Apply inputs to valuation techniques
6) Exit price/fair value
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ASC 820
Three Level Hierarchy
Level 1
• Quoted market prices in active markets for identical assets
• An active market for the asset or liability is a market in which
transactions for the asset or liability occur with sufficient
frequency and volume to provide pricing information on an
ongoing basis. A quoted price in an active market provides
the most reliable evidence of fair value and shall be used to
measure fair value whenever available….
Example: Valuation of an investment in the stock of a publicly
traded REIT.
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ASC 820
Three Level Hierarchy
Level 2 - Directly or Indirectly Observable Inputs
• Quoted market prices in active markets for similar assets
• Quoted market prices for identical or similar assets in
inactive markets
• Inputs other than quoted prices that are observable (credit
risks, default rates, prepayment speeds, volatility index,
interest rate and yield curves at quoted intervals)
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ASC 820
Three Level Hierarchy
Level 2 - Directly or Indirectly Observable Inputs (continued)
 There are few transactions for the asset
 The prices are not current
 Price quotations vary substantially, either
over time or among market makers
 Little information is released publicly
 Inputs other than quoted prices that are observable for the
asset
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ASC 820
Three Level Hierarchy
Level 3 - Unobservable Inputs
• Allowed when observable inputs are not available
• For situations when there is little, if any, market activity at
the measurement date
• Reporting entity’s own assumptions about the assumptions
market participants would use
• Most private companies and the equity and debt securities
in them fall into the Level Three category
• Developed from the best information available in the
circumstances, which may include the reporting entity’s own
data.
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ASC 820
Framework for Evaluating Fair Value
Assumptions
• Exposure to the market prior to the measurement date
• Not a forced transaction (e.g., forced liquidation or
distressed sale)
• Sale of the asset occurs from the perspective of a market
participant that holds the asset
• The price is the one that would be received to sell the asset
at the measurement date. The FASB determined that exit
price is appropriate as it presumes current expectations of
future cash flows pertaining to the asset.
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ASC 820
Framework for Evaluating Fair Value (continued)
Reporting entity and valuation specialists need to determine:
• The asset that is the subject of the measurement
• For an asset, the valuation premise appropriate for the
measurement (consistent with its highest & best use)
• The principal (or most advantageous) market for the asset
• The valuation technique(s) appropriate for the measurement
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ASC 820
Framework for Evaluating Fair Value (continued)
Principal (or Most Advantageous) Market
• Fair value assumes the sale of the asset occurs in the
principal market for the asset or, in the absence of a
principal market, the most advantageous market.
 Principal market is the market … with (1) the greatest
volume and (2) the greatest level of activity.
 Most advantageous market … maximizes the amount that
would be received for the asset considering transaction
costs ….
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ASC 820
Framework for Evaluating Fair Value (continued)
Principal (or Most Advantageous) Market
• Fair value is considered from the perspective of the reporting
entity, allowing for differences between, and among,
companies having different activities.
• If there is a principal market for the asset, then the fair value
measurement represents the price in that market, even if
the price in a different market is potentially more
advantageous.
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ASC 820
Framework for Evaluating Fair Value (continued)
Transaction Costs
• The price used to develop an asset’s fair value is not to be
adjusted for transaction costs.
 Represent the incremental direct costs to sell the asset or
transfer the liability in the principal (or most
advantageous) market for the asset or liability … not an
attribute of the asset or liability…[but] specific to the
transaction ….
 Do not include cost to transport the asset to or from its
market (applies to personal property).
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ASC 820
Framework for Evaluating Fair Value (continued)
Transaction Costs
However, when disposition of the asset is typical for developing
the fair value, then the disposition costs are included.
Example
In developing fair value using a DCF model, where the market
participant would anticipate disposition costs in the final year’s
reversion amount, those costs are relevant in estimating what a
buyer would be willing to pay for the asset.
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ASC 820
Framework for Evaluating Fair Value (continued)
Identification of Market Participants
• Buyers and sellers in the principal (or most advantageous)
market for the asset that are:
 Independent
 Knowledgeable
 Able to transact for the asset
 Willing to transact for the asset (not forced or compelled)
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ASC 820
Framework for Evaluating Fair Value (continued)
Identification of Market Participants
• Determination of fair value uses the same assumptions
market participants would use to price the asset. The
reporting entity identifies:
 Characteristics that distinguish market participants
 The principal (or most advantageous) market for the asset
 Market participants with whom the reporting entity would
transact in that market
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ASC 820
Framework for Evaluating Fair Value (continued)
Highest and Best Use: Value In-Exchange
The highest & best use of the asset is in-exchange if the asset
would provide maximum value to market participants
principally on a standalone basis.
If the highest & best use of the asset is in-exchange, the fair
value of the asset shall be measured using an in-exchange
valuation premise. When using an in-exchange valuation
premise, the fair value of the asset is determined based on the
price that would be received in a current transaction to sell the
asset standalone.
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ASC 820
Framework for Evaluating Fair Value (continued)
The highest & best use of the asset establishes the valuation
premise used to measure the fair value of the asset,
specifically in-use or in-exchange.
Fair value of an asset in-use is based on the use of the asset
together with other assets as a group (at its highest & best use
from the perspective of market participants), even if the asset
… is aggregated (or disaggregated) at a different level for …
other accounting pronouncements.
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ASC 820
Framework for Evaluating Fair Value (continued)
Highest and Best Use
• Management’s intention may not be relevant unless by
coincidence it indicates market participants’ assumptions.
• For real estate (and personal property), the highest & best
use principle can have a significant influence on fair value.
• The highest & best use for the asset is based on its use by
market participants, not the subject reporting entity.
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ASC 820
Framework for Evaluating Fair Value (continued)
Initial Recognition
• When an asset is acquired in an exchange transaction for
that asset, the transaction price represents the price paid to
acquire the asset (an entry price). In contrast, the fair value
of the asset represents the price that would be received to
sell the asset (an exit price).
 Valuation specialists need to understand that
conceptually, entry prices and exit prices are different and
entities do not necessarily sell assets at the prices paid to
acquire them.
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ASC 820
Framework for Evaluating Fair Value (continued)
Initial Recognition
 “In many cases, the transaction price will equal the exit
price and, therefore, represent the fair value of the asset
or liability at initial recognition.”
 In determining whether a transaction price represents the
fair value of the asset at initial recognition, the valuation
specialist needs to consider factors specific to the
transaction and the subject asset.
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ASC 820
Framework for Evaluating Fair Value (continued)
Initial Recognition
• The transaction price may not represent the fair value… at
initial recognition if:
 Transaction is between related parties
 Transaction occurs under duress or seller is forced to
accept the price
 Unit of account represented by the transaction price is
different from the unit of account measured at fair value
 Market in which the transaction occurs is different from
the market in which the reporting entity would normally
sell the asset
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ASC 820
Accepted Methods of Valuation
In selecting the appropriate valuation techniques, it is
important to consider the availability of data to develop
valuation inputs that represent the assumptions that market
participants would use in pricing the asset … and the level in
the fair value hierarchy within which the inputs fall.
ASC 820 recognizes the three generally accepted valuation
approaches:
• Market (Sales Comparison) Approach
• Income Approach
• Cost Approach
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ASC 820
Accepted Methods of Valuation
• In some cases, a single valuation technique is appropriate
• If multiple valuation techniques are used, the results
(respective indications of fair value) shall be evaluated and
weighted (i.e., reconciled) as appropriate, considering the
reasonableness of the range by those results
• A fair value measurement is the point within that range that
is most representative of fair value in the circumstances
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ASC 820
Conclusion — Opportunities for Appraisal
• “Typical” valuation assignment
• Client and Audit Firm will review
• Results impact Client’s financial statements
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ASC 805
Business Combinations
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ASC 805
Overview
• ASC 805 requires that intangible assets, aside from goodwill,
be recognized if:
 Contractual or other legal rights, such as patents or
trademarks, give rise to intangible assets, or
 The intangible asset can be separated or divided from the
acquired entity and sold, transferred, licensed, rented or
exchanged individually, or in combination with a related
contract, asset or liability.
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ASC 805
Tangible and Intangible Assets
In accordance with ASC 805, the allocation of purchase price
considers following tangible and intangible asset categories:
Tangible Assets
• Land
• Building and site improvements
• Equipment and/or FF&E
• Tenant improvements
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ASC 805
Tangible and Intangible Assets
Intangible Assets
• Above/below market leases (leasehold value)
• In-place lease value, inclusive of downtime costs, lease
commissions and legal fees
• Mark-to-market value of assumed debt
• Mark-to-market value of assumed ground lease position
• Customer (tenant) relationships
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ASC 805
Land Value
Using the Sales Comparison Approach land is valued by
comparing the subject site to similar, recently sold properties in
the surrounding or competing area. This approach relies on the
principle of substitution, which holds that when a property is
replaceable in the market, its value tends to be set at the cost
of acquiring an equally desirable substitute property.
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ASC 805
Building and Site Improvements
The Cost Approach is based upon the economic principle of
substitution, which states that the price of an asset tends to be
no higher than the cost of producing a substitute property
having equal utility, available without delay. This approach
considers all hard and soft costs and the three potential forms
of depreciation:
• Physical depreciation
• Functional depreciation
• External obsolescence
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ASC 805
Go-Dark Analysis (Land + Building and Site Improvements)
Alternatively, the combined value of the site and building
improvements can be estimated via an estimate of the “as
vacant” value of the property, with consideration given to the
following:
• Lease-up period (to stabilization)
• Carrying costs, including all fixed and variable operating
expenses
• Lease-up costs, including tenant improvements, leasing
commissions and legal fees
Typically accomplished using a discounted cash flow analysis,
considering market conditions
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ASC 805
Tenant Improvements
Tenant improvements for occupied space is a negotiable item
and ranges from “as-is” to “turn-key.” The value of tenant
improvements should be based on the cost of the original fitout of the space, but current market data can be considered
when actual costs are unavailable.
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ASC 805
Equipment and/or Furniture, Fixtures and Equipment
Tangible personal property is defined as: “a right or interest in
things of a temporary or moveable nature.” Typically valued
using Cost or Market Approach methodology.
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ASC 805
Above/Below Market Leases (Leasehold Value)
The value of above and below market leases is estimated by
calculating the difference between present value of the rental
income coupled with the expense reimbursement revenue of
each tenant as set forth in the lease agreements and the rental
revenue that would be generated for that same tenant space at
a market oriented rate as of the acquisition date.
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ASC 805
In-place Lease Value
Collectively, downtime costs, leasing commissions and legal
fees are added together in order to calculate the in-place lease
value.
• Downtime costs represent the value of the revenue that
would be lost during downtime, including all rents and
reimbursements, if the property were purchased 100%
vacant and were then leased to the existing tenants using
market oriented lease-up assumptions.
• Leasing commissions and legal fees reflect the estimated
commissions/fees the landlord would have paid had they
originated the leases in place on the acquisition date.
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ASC 805
Mark-to-Market Value of Assumed Debt
A mark-to-market adjustment (enterprise value component) for
application to the free and clear estimate of property value is
estimated by discounting the remaining loan payments at a
market oriented interest rate and comparing the resulting value
to the current principal balance.
Factors that warrant consideration include loan-to-value (LTV)
ratios, debt service coverage ratios (DSCR) and debt yield.
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ASC 805
Ground Lease
The value of the leasehold position associated with a ground
lease is estimated in the same manner in which the value of
above and below market leases are estimated. An estimated
market rent for the site is compared to the contractual rent
obligation and the difference is discounted to a present value.
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ASC 805
Customer (Tenant) Relationship
Reflects the value associated with establishing an ongoing
relationship with tenants, which are anticipated to generate
income to the landlord through new, future lease agreements.
The value must be measured separately from the value of inplace leases and can be quantified as the value resulting from
the income that the relationship will generate.
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ASC 805
Purchase Price Allocation Steps
1) Estimate the fair value of the real estate interest acquired
2) Fair value of land via sales comparison approach or mark
ground lease to market using income approach
3) Value of building as if vacant using the cost and/or income
approach
4) Estimate fair value of site improvements using the cost
approach
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ASC 805
Purchase Price Allocation Steps
5) Estimate the fair value of tenant improvements (if paid for
by the tenant) based on the cost
6) Estimate the fair value of in-place leases via an income
approach
7) Estimate the above/below market lease fair value using
income approach
8) Estimate customer (tenant) relationship fair value using
income approach
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ASC 805
Purchase Price Allocation Steps
9) Estimate mark-to-market value of assumed debt using
income approach
10)Allocate the fair value based upon the resulting purchase
price allocation component values
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ASC 805
Conclusion — Opportunities for Appraisals
• Niche Business
• Client and Audit firm will review.
• Results impact client’s future financial statements.
• Understand the accounting literature before being
engaged
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Lease Accounting
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Lease Accounting
Current Practices and New Considerations
• The objective of the proposed standard is to ensure that all
assets and liabilities arising from leases are reported in the
financial statements in a consistent manner.
• As a result, the Boards concluded that certain fundamental
changes are required and that the proposed changes
address this issue.
• Any organization that is required to comply with International
Financial Reporting Standards (IFRS) or U.S. Generally
Accepted Accounting Principles (U.S. GAAP) will be affected
by the proposed changes.
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Lease Accounting
The Underlying Asset Approach
• The lessee would amortize the right-of-use asset based on
the estimated consumption of the underlying leased asset
over the lease term. Consequently, the higher the
consumption rate, the more the income statement effects
would resemble those that would arise from purchasing the
underlying asset and financing it separately.
• The lower the rate of consumption, the more the income
statement effects would resemble the rental expense
pattern under current operating lease accounting.
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Lease Accounting
The Underlying Asset Approach
• Where it stands ...
 Although the boards did not make any formal decision, the
IASB indicated an initial leaning toward this approach, if it
is confirmed that it is operational and useful.
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Lease Accounting
The Interest-based Amortization Approach
• The lessee would amortize the right-of-use asset on a
systematic basis that reflects the pattern of consumption of
expected future economic benefits (this is consistent with
the 2010 Leases exposure draft) for those leases for which
substantially all of the risks and rewards of the underlying
leased asset have been transferred to the lessee.
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Lease Accounting
The Interest-based Amortization Approach
• For leases that do not transfer substantially all of the risks
and rewards of the underlying leased asset, the lessee would
use an amortization approach that would result in
recognizing total lease expense in a pattern that would
typically resemble the rental expense pattern under current
operating lease accounting.
• Where it stands ...
 Although the boards did not make any formal decision, the
FASB indicated an initial leaning toward this approach.
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Lease Accounting
Conclusion — Opportunities for Appraisals
• Yet to be determined….
• Large companies will use model-based approach.
Smaller companies may use outside help or
complete analysis internally.
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Questions
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Contact Information
Michael P. Hedden, MAI, CRE, FRICS
Managing Director
(646) 632-3842
[email protected]
Marc R. Shapiro, MAI, MRICS
Managing Director
(973) 852-8154
[email protected]
Brian Johnson, MAI, CRE, FRICS
Partner
(212) 872-5838
[email protected]
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FTI Consulting, Inc.
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