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Babush, Neiman, Kornman & Johnson, LLP
Certified Public Accountants & Consultants
Celebrating 40 Years of Serving You
1st QUARTER
REAL ESTATE ROUNDTABLE
WELCOME
Babush, Neiman, Kornman & Johnson, LLP
Certified Public Accountants & Consultants
Real Estate Fair Value Accounting
Jeff Olson, CPA
Babush, Neiman, Kornman & Johnson, LLPwww.bnkj.com
Real Estate Fair Value Accounting
“Historic cost numbers are reliable and relevant only on the day they are recorded”
Rebecca McEnally, VP Advocacy AMR
Fair Value Accounting
Why Fair Value?
It is GAAP for tax-exempt (pension/benefit plan) investors (FAS 35)
Useful supplemental reporting to GAAP historical cost
It’s allowed Likely more relevant than historical cost
Fair Value Accounting
Other GAAP & internationalaccounting standards indicatemovement to FV
See article “Question of Value” CFO Magazine, February 2003
As Bob Dylan said, “The times they are a changin”
GAAP FV Accounting
GAAP FV Based Pronouncements
Loan impairment (FAS 114) Impairment of long-lived assets (FAS 121/144)Marketable securities (FAS 115)Stock based compensation (FAS 123)Hedging derivatives (FAS 133)Business combinations (FAS 141)Purchased intangibles (FAS 142)Guarantee liabilities (FAS FIN 45)
International Accounting
International Accounting Standard40 (“IAS 40”) January 2001
FV for investment property
Use as accounting basis If retaining historical cost, must
disclose FV in notes
Should we be concerned with IAS Standards?
International AccountingStandards
Who cares, not U.S.
10/29/02 FASB & IAS announce project to begin “convergence” of global standards
12/15/03 FASB issues initial exposure drafts under convergence project
FASB chairman Herz is former IAS member & originally from UK not America
May Full FV Be Better?
GAAP patch work Some measurements at HC, others at FV Some changes in measurements go to P&L,
others go through “OCI” which is often presented in the equity statement
Greater earnings volatility
Only FV’s assets and liabilities; does not Value “going concern” business, ability to
capitalize on future opportunities Establish share prices of public companies
U.S. RE FV Accounting
Currently driven by pension
professionals - Real Estate
Information Standards (REIS)
National Council of Real Estate Investment Fiduciaries (NCREIF)
National Association of Real Estate Investment Managers ( NAREIM)
Pension Real Estate Association (PREA)
REIS
Updated annually and coversValuationAccounting & related disclosures Investment performance measurement & reporting
Draws fromAICPAFASBAIMRAppraisal Standards Board
REIS
Adds established “industry practice” to increase comparability/reliability
Includes investments in Wholly owned real estate JV real estate Debt investments in real estate
REIS Continued Addresses issues unique to investment real estate not covered by AICPA Investment Company Guide
REIS Appendix 1- NCREIF Market Value Accounting Policy Manual
Available at ncreif.org REIS, including MV manual NCREIF Debt Accounting Workbook
FV Accounting
FV minus cost = unrealized gain or
loss at a point in time
Balance sheet is fair value at a
point in time
FV Accounting
Change in unrealized gain loss (or
differences in net changes in FV and
cost) over a period of time runs
through the P&L
Realized g/l is factored out of the
gross change in unrealized
FV Accounting Basic Model
Balance SheetCost FV Unreal. G/L Realized G/L
Balance 1/1/xx 10,000 15,500 5,500
Plus additions 3,000 3,000 0
Less disposals (at last FV) (4,000) (4,700) (700) 700
Change in FV, assets held during the period 0 4,000 4,000
Balance 12/31/xx 9,000 17,800 8,800 700
FV Accounting Cost Concepts No depreciation or amortization No rent normalization (stepped or free
rent receivable) No impairment adjustments Certain deferred costs that have no
value are expensed, formerly
organizational cost Capital additions
Those that increase valueThose that do not
FV Accounting -FV Concepts
Real Estate is most often valued using a discounted cash flow method (DCF) particularly if an income producing property
Projected rent and expenses Projected capital expenditures Projected disposition proceeds and
expenses
FV Accounting -FV Concepts
Debt adjustments depend on
Likelihood of entity-level interests trading
If interests likely to trade, then debt valued at PV of expected future CF’s
If interests not likely to trade, valued at current settlement value excluding transaction costs
FV Accounting -FV Concepts Debt adjustments depend on
If debt is transferable/assumable
Even if interests not likely to trade value at PV of future CF’s
Fixed rate or variable rate
Variable rate usually has no FV adjustment for I-rate
FV Accounting - FV Concepts NCRIEF Debt Accounting Workbook- Examples A-J with DCF calculations
Each has trading and non-trading of equity interests value Transferable & non-transferable debt Favorable & unfavorable interest rates Debt to be prepaid & pending foreclosure Interest buy-down Financing costs, predetermined prepayment & yield maintenance
FV Accounting - FV Concepts
Non real estate assets/liabilities
Short term held at un-discounted values
Long term must be valued at time value discount not to exceed value in a current transaction
Changes go through P&L like real estate
FV Accounting - FV Concepts
Real estate JV investments
If subject to consolidation, treat as wholly owned real estate with minority interests
Otherwise Use equity method of historical
accounting (cost method would seldom be used)
Value JV assets/liabilitiesApply hypothetical liquidation
FV Accounting -FV ConceptsReal estate debt investments
Nonparticipating loansAt market value, considering future CF’s,
risks, collateral value, guarantees
Participating loans If considered ADC arrangements, value
as a JV interestNon-ADC, value as a nonparticipating
loan
FV Accounting Examples
REIS has illustrated statements & disclosures example
Fannie Mae 10-K financials FV balance sheet in supplemental note PWC addresses FV disclosure in audit opinion FMNA Website “Answers from the CEO” NYT article on FV balance sheet & reporting “core earnings” vs. GAAP net income
FNMA ReportingPick a Measure - in millions
GAAP net income 4,619Purchased options adjustment:
Add back FAS 133 FV adjustment 4,545Deduct S/L amortization (1,814)Income tax effect (956)
Net adjustment 1,775
"Core Earnings" 6,394
FV equity 12/31/01 22,675FV equity 12/31/02 22,130
Net decrease in FV (545)
Add back:Dividends-common 1,409Dividends-preferred 99Repurchase common 1,167Net treasury and preferred issued/redeemed (854)
Change in FV, excluding capital transactions 1,276
FAS FIN No. 46 Update
FASB Staff Positions & Revised FIN No. 46 , December 2003
Babush, Neiman, Kornman & Johnson, LLPwww.bnkj.com
FAS FIN No. 46Consolidation of variable interest entities (VIEs) originally issued January 2003
Who has majority risks and rewards?
Equity owner (s) - expected losses & residual returns Contractual parties
Primary beneficiary - must consolidate
May be a non equity owner & voting control is no longer the consolidation basis
FIN 46 - FASB Staff Positions
FSP FIN 46-1 to 46-8
See hand out summary & copies of each
No’s 3, 4, 6 & 7 were also incorporated in newly issued revision to FIN 46 or “FIN 46 (R)”
FIN 46 - FASB Proposed Staff Positions
FSP FIN 46-a to 46-f See hand out summary & copies
All but “d” have either been issued or were encompassed in FIN 46 (R)
FAS FIN No. 46 (R)
December 2003 revision Available on fasb.org
Handout - 41 paragraph “redline” version Full text FIN 46 (R) w/appendices
Effective dates & transition covered in 15 paragraphs (para. 27-41)
Disclosure only by 12-31-03 Full application is staggered by type entity
FAS FIN No. 46 (R) Effective dates & transition for public companies
“Large” public Co’s - generally, 3/15/04
“Small business issuer” - generally, 12/15/04
Exceptions to each
“Special purpose entities” by 12/15/03 Continue to apply to entities to which “original” FIN 46 was previously applied
FAS FIN No. 46 (R)
Effective dates & transition for private companies
New entities formed after 12/31/03 - immediately
All others - by 12/15/04
FAS FIN No. 46 (R)
Investment company effective dates Registered investment companies specifically excluded para 4(e)
Non registered investment companies following AICPA Audit Guide
Effective date deferred while AICPA finalizes a proposed SOP on scope of the guide to parent companies & other equity investors in investment companies
FAS FIN No. 46 (R)
Disclosure requirements
Remember that enterprises with “significant” interests in VIEs have certain disclosure requirements even if a non-consolidating Primary Beneficiary