The debate over whether real estate acquisition transactions should be valued as business combinations should have ended after the implementation of Financial Accounting Standards No. 141 (FAS 141). Now a new change in the accounting standards will modify accounting for investment property acquisitions.
Although FAS 141 was enacted in 2001, some accountants were continuing to value acquired real estate as land and buildings and not recognizing intangible assets acquired during real estate acquisition transactions. In December 2007, the Financial Accounting Standards Board issued Financial Accounting Standard No. 141 (revised), FAS 141R, which replaced FAS 141, but retains the fundamental basis of the original standard. Its adoption is also significant because it represents progress toward two additional initiatives: the gradual migration toward a single set of international accounting standards and the need for greater accuracy and a standard presentation of financial reporting.
“Executives who invest in rental real estate properties should become familiar with the new accounting standard now,” says Paul Louis, CPA, audit manager for the Audit and Business Advisory Services Group at Haskell & White LLP. “FAS 141R changes accounting and reporting requirements for real estate acquisitions in fiscal years beginning on or after Dec. 15, 2008. It will require measuring and recognizing the acquired business at its full fair value as of the acquisition date.”
Smart Business spoke with Louis regarding what CEOs should know about the change in standards under FAS 141R.
Are real estate acquisitions considered business combinations?
Yes, but the definition applies, with some exceptions, to acquisitions of rental commercial or office property with tenants in place, not vacant land or owner-occupied property. Companies are not only purchasing the land and building, but they are purchasing the entire business. As part of the transaction, the buyer obtains control over the real estate and becomes responsible for all of its activities. In that respect, the acquirer’s balance sheet will more accurately capture the fair value of the assets acquired and assumed liabilities as of the acquisition date than it would using a traditional approach.
How does FAS 141R impact the treatment of acquisition costs?
This is one of the biggest changes under FAS 141R. Direct professional fees related to the acquisition, such as consulting fees or due diligence costs, can no longer be capitalized or used as part of the real estate acquisition cost. Now, those fees must be completely expensed in the period in which they occur. This change gives a real-time presentation for the fair value of the acquired assets and assumed liabilities as well as the expenses. This will impact the profitability of the acquiring company in the acquisition year as well as the years immediately preceding and following the acquisition.
How does FAS 141R change the allocation of tangible and intangible assets?
Tangible assets include land, building, site improvements and tenant improvements. Intangible assets include the value of existing leases (including the value of those leases that are above or below existing market rates), customer relationships, leasing commissions and legal and marketing costs. FAS 141R retains the guidance of FAS 141 for identifying and recognizing intangible assets. The value of all acquired assets and assumed liabilities should be based on fair value. The value of the existing leases and the materiality of those leases are some of the major components for the determination of intangible assets value. The acquired tangible and intangible assets and any assumed liabilities can be valued using one of these approaches or a combination: sales comparison, income approach or cost approach valuation.
What other changes should CEOs expect from FAS 141R?
Expect to provide greater transparency and disclosure to the financial statements’ user. The users will often be lenders or investors, who will benefit from greater standardization so they can compare expenses and values across similar transactions. The auditor will test the reasonableness of the assumptions used by valuation and appraisal specialists in setting the property’s fair value.
How can CEOs prepare for the change?
Begin addressing the changes with team members who are involved with real estate acquisitions and the members of the accounting department who prepare your company’s financial statements. Run financial models as part of the due diligence process to understand how the new standards will impact your company’s profitability as you consider new deals. Be sure to identify all the costs, including all the depreciation and amortization of tangible and intangible assets, respectively. Watch for updates and check with your accountant for more information.
Lastly, remember FAS 141R applies to acquisitions made on or after the beginning of the first annual reporting period beginning on or after Dec. 15, 2008. So for companies that have a fiscal year-end of Dec. 31, this new FAS statement is applicable for acquisitions made on or after Jan. 1, 2009; and early adoption of the standard is prohibited.
PAUL LOUIS, CPA, is an audit manager for the Audit and Business Advisory Services Group at Haskell & White LLP. Reach him at (949) 450-6237 or email@example.com.