NCREIF Summer Conference Accounting & …...NCREIF Summer Conference Accounting & Reporting...

NCREIF Summer ConferenceAccounting & Reporting UpdateAccounting & Reporting UpdateJune 2010

This document was presented during the 2010 NCREIF Summer Conference. The author(s) take full responsibility for all content. This posting is for informational purposes only; neither NCREIF nor its Board express any opinion of the content presented herein.

Speaker

David GerstleyDavid GerstleySenior Manager PricewaterhouseCoopers LLPNational Professional Services - SEC Services GroupOffice: 973-236-5101Email: [email protected]

PricewaterhouseCoopers Slide 2June 2010


Agenda

IntroductionIntroductionProfessional and technical updateAccounting hot topicsNew accounting standardsOn the horizonRegulatory environment updateQ & A


Professional and technical update

PricewaterhouseCoopers


Perspectives on FASB leadership

Professional & technical update

FASB board members

Chair, Herz (2012) Smith (2012) Linsmeier (2011) Seidman (2011) Siegel (2013)

Advisory groups to the FASB

Fi i l A ti St d d Ad i C il (FASAC)• Financial Accounting Standards Advisory Council (FASAC)• Financial Crisis Advisory Group (FCAG)• Investor Task Force (ITF)• Investors Technical Advisory Committee (ITAC)


• Valuation Resource Group (VRG)

Slide 5June 2010


FASB & IASB joint projects timeline

Professional & technical update

Statement of comprehensive income

Leases

Financial instruments

IASB - postemployment benefits*

IASB - contingencies*

Fair value measurement

p

Fin instruments with characteristics of equity

Reporting discontinued operations

Financial statement presentation

Consolidation - Investment Companies

Revenue recognition

Leases

Emissions trading schemes**

Fin. instruments with characteristics of equity

Pre-exposure draft deliberations Exposure draft expected Redeliberations Final standard expected

Q2 2010 Q3 2010 Q4 2010 1st half 2011 2nd half 2011

Note – project timelines as of June 24, 2010 revisions announced* These projects are IASB projects that have the potential to impact the views of the FASB as it evaluates existing U.S. GAAP in these areas


GAAP in these areas** IASB official timeline

Slide 6June 2010


IFRS developments



Non-US IFRS usage

IFRS developments

More than 100 countries require, permit or are converting to the use of IFRSMore than 100 countries require, permit or are converting to the use of IFRS

Major global capital marketsAustralia IFRSBrazil Converting to IFRSgCanada Converting to IFRSFrance IFRSGermany IFRSHong Kong IFRSo g o g SIndia Converging with

IFRSJapan IFRS permittedSwitzerland IFRS or US GAAP

Countries seeking convergence with the IASB or pursuing adoption of IFRSsCountries that require or permit IFRSs

Switzerland IFRS or US GAAPUK IFRSUS Analysis ongoing


United StatesThis document was presented during the 2010 NCREIF Summer Conference. The author(s) take full responsibility for all content. This posting is for informational purposes only; neither NCREIF nor its Board express any opinion of the content presented herein.

SEC IFRS roadmap

IFRS developments

• November 2007 – SEC eliminates the US GAAP reconciliation requirement for foreign filersNovember 2007 SEC eliminates the US GAAP reconciliation requirement for foreign filers reporting under IFRS in the US

• November 2008 – SEC proposed a roadmap that:- Establishes a potential mandatory date for US IFRS adoption beginning in 2014 and- Proposes earlier, optional IFRS use by certain domestic issuers- Planned revisit of mandatory adoption timeline in 2011- Three years of IFRS financial statements still required upon adoption

• February 2010 In February 2010 the SEC published a statement of continued support for a• February 2010 - In February 2010, the SEC published a statement of continued support for a single set of high-quality global accounting standards and acknowledged IFRS is best positioned to serve that role.- The statement introduced a work plan to be executed by the SEC Staff. The work plan is

d i d t id i d b d t t th SEC’ i i l ddesigned to consider concerns raised by respondents to the SEC’s original roadmap. - The end goal is to provide analysis to the commissioners to allow them to decide whether,

when and how the US financial reporting system should incorporate IFRS.- The SEC maintained its original timeline of being in a position in 2011 to make a


g g pdetermination regarding incorporating IFRS into the financial reporting system for US domestic issuers.

Slide 9June 2010


SEC IFRS work plan details

IFRS developments

The Work Plan is designed to consider:The Work Plan is designed to consider:• The sufficiency of development and application of IFRS for the U.S. system, including:

- Comprehensiveness- Auditability and enforceability- Consistent and high-quality application

• The independence of standard setting for the benefit of investors• Investor understanding and education regarding IFRS

E i ti f th U S l t i t ff t d b th h• Examination of the U.S. regulatory environment affected by the change• The impact on large and small issuers including the effect on systems, contractual

arrangements, and corporate governance• Human capital readinesspThe first two areas consider whether IFRS should be further incorporated. The remaining fourareas relate to transitional considerations to better evaluate when and how to effectivelyincorporate IFRS.



Possible timeline based on the SEC statement

IFRS developments

Assuming that the SEC determines in 2011 to incorporate IFRS into the U.S. domestic reportingAssuming that the SEC determines in 2011 to incorporate IFRS into the U.S. domestic reportingsystem, a possible timeline may be:

Mid-2011Target date for completion of FASB/IASB convergence agenda

2012 – 2014Possible effective dates of converged standards

2010 2011 2012 2013 2014 2015 2016 2017

January 1, 2015Possible beginning adoption date

2015 – 2018Possible staggered adoption period*

2018

2013-2014Earliest comparative information required

February 24, 2010SEC issues Work Plan

2011Proposed SEC decision on IFRS

2012-2014Possible early adoption

i dperiod



US GAAP convergence agenda

IFRS developments

• The FASB and IASB are currently working on nearly a dozen projects under theThe FASB and IASB are currently working on nearly a dozen projects under the Memorandum of Understanding (MoU). The FASB and IASB are committed to completing convergence projects by 2011 with effective dates after 2012.

• The FASB/IASB convergence agenda may be too ambitious to be completed by June 2011 in a way that ensures high quality standardsin a way that ensures high quality standards.- While the SEC’s Chairman Mary Schapiro and Chief Accountant Jim Kroeker recently

stated publically that convergence need not be fully completed before the SEC makes a final decision on IFRS, it is still unclear how the full Commission will measure the success of the convergence agenda when making the 2011 decisionsuccess of the convergence agenda when making the 2011 decision.

- Legitimate concerns exist that quality standards cannot be conceptualized, developed, vetted and finalized at the current pace.

- The decibel level of those calling for the two boards to slow down convergence is g gincreasing.



US GAAP convergence agenda (continued)

IFRS developments

• However, even if the convergence agenda is not completed by 2011, the IASB and FASBHowever, even if the convergence agenda is not completed by 2011, the IASB and FASB should continue completion of the projects in due course.

• No matter the outcome of the SEC’s decision in the US, the ongoing convergence and development of standards will result in significant changes. This, together with regulatory changes caused by the financial crisis and continual global adoption of IFRS will result in anchanges caused by the financial crisis and continual global adoption of IFRS, will result in an extended period of substantial change for which companies should prepare.



What should companies do now

IFRS developments

Awareness and preparedness are essential. Given the timeline, companies should be thoughtfulAwareness and preparedness are essential. Given the timeline, companies should be thoughtfuland measured in their approach as they consider this complex challenge. Below are oursuggestions on what companies should be doing now:• Focus on the challenge. The next several years will bring major changes to US financial

reporting. Whether changes arrive through convergence, an SEC-mandated move to IFRS, regulation, or continued IFRS adoption by subsidiaries and counterparties, the effect on US businesses will be considerable.

• Perform an assessment. Consider the effects various alternative paths could have. Identify p yand consider the implications of business, accounting, tax structure, financing, long-term contractual commitment, investor, control systems and work-force related issues. Consider how changes will influence the behavior of your non-US counterparties (customers and vendors).)

• Use scenario planning to incorporate likely convergence and IFRS adoption expectations into your strategic thinking and business planning. Closely follow SEC actions, new FASB and IASB standards, and the increasing international acceptance of IFRS and IFRS for SMEs for statutory purposes.


statutory purposes.

Slide 14June 2010


What should companies do now (continued)

IFRS developments

• Maintain corporate oversight. IFRS adoption for statutory reporting continues in manyMaintain corporate oversight. IFRS adoption for statutory reporting continues in many territories. Influence transition timing, strategies, and policy decisions of non-US subsidiaries who are increasingly likely to be on IFRS or IFRS for SMEs in the foreseeable future.

• Identify what you can do now. Be mindful of aspects of convergence and conversion that will take the longest If highly probable changes can be made efficiently and without waste gettake the longest. If highly probable changes can be made efficiently and without waste, get started addressing those challenges. Consider smaller controlled one-off projects and “easy wins” where desirable.

By following these recommendations companies will be better prepared for what comes nextBy following these recommendations, companies will be better prepared for what comes next.



Accounting hot topics



EITF - Issue No. 09-D

• Meeting on December 14, 2009 amongst accounting firms, preparers, industry associationsMeeting on December 14, 2009 amongst accounting firms, preparers, industry associations (SEC participated as an observer). Most of the Working Group members were also members of the AICPA Real Estate Funds Task Force

• Two different presentation methods for Real Estate FundsI t t C M th d N t- Investment Company Method – Net

- Consolidation Method – Gross• Measurement of Liabilities• DepreciationDepreciation• Fee Simple Properties• Public REIT registrants and the Investment Company Guide



Valuation trends


Source - Korpacz survey

National average cap Q2 2010 cap rate Change since Q1 Q2 2009 cap rate Change from Q2 2009National average cap rates

Q2 2010 cap rate Change since Q1 2010 (bps)

Q2 2009 cap rate Change from Q2 2009 to Q2 2010

Apartment 7.68% -17 7.49% +19Regional Mall 7.93% -41 7.79% +14CBD Office 8 15% -20 7 94% +21CBD Office 8.15% -20 7.94% +21Strip Shopping Center 8.38% -11 7.91% +47Power Center 8.70% +15 8.04% +66Warehouse 8.60% -13 7.93% +67Medical Office 8 53% 25 8 58% 5Medical Office Buildings

8.53% -25 8.58% -5

Suburban Office 8.60% -19 8.24% +36Net Lease 8.98% +12 8.83% +15Flex/ R&D 9 38% +2 8 36% +102Flex/ R&D 9.38% +2 8.36% +102



Valuation issues

• Replacement ReservesReplacement Reserves• Initial-Year market rent change rates• Management Fees• Lease Commissions• Concessions



Evaluating single-lessee entities under the new Variable Interest


Significant assets (e.g. airplanes, ships, real estate) are often leased from single-asset special

Entity (VIE) model

Significant assets (e.g. airplanes, ships, real estate) are often leased from single asset specialpurpose entitiesOperating leases that contain any of the following features may result in the lessee consolidatingthe entity: • Purchase options • Residual value guarantees • Fixed price renewal optionsC lid ti l i ill ft t i hi th th t th l h ld iConsolidation conclusion will often rest on weighing the powers that the lessee holds incomparison to others in the entity



Tax update


• IRS proposal on tax return disclosure of uncertain tax positions (UTP):IRS proposal on tax return disclosure of uncertain tax positions (UTP):- IRS Announcement 2010-09 proposes that companies with more than $10 million of

assets disclose UTPs as part of their federal tax return- Affected companies will be required to provide a concise description of each UTP,

i l di th ti l f th iti d h it i t i d th i tincluding the rationale for the position and why it is uncertain, and the maximum amount of tax liability that would result if the position is not sustained

- IRS Announcement 2010-17• 2010-09 does not apply to calendar year 2009 tax returnspp y y• Comment period open until June 1, 2010

- IRS Announcement 2010-30• Announces the release of the draft schedule UTP, which companies will use to

di l UTP d th i d ft i t tidisclose UTPs, and the accompanying draft instructions• Clarifies the companies that will be required to file a schedule UTP; pass-through

entities and tax-exempt organizations will not be required to file a schedule UTP under the current proposal



New accounting standards



ASU 2010-6, fair value measurements and disclosures (Topic


• Gross presentation of activities within the Level 3 roll forward

820) - Improving disclosures about fair value measurement

Gross presentation of activities within the Level 3 roll forward• New requirement to disclose transfers in and out of Level 1 and 2 and the reasons for the

transfer• Does not require the sensitivity for Level 3 measurements that was originally proposed• Clarifies two existing disclosure requirements by requiring:

- Fair value disclosures by class of assets and liabilities rather than by major category;- Disclosure of valuation technique and the inputs used in determining fair value of each

class of assets and liabilities for Level 2 and Level 3 measurements.class of assets and liabilities for Level 2 and Level 3 measurements. • Required for all entities that are required to provide disclosures about recurring and

nonrecurring fair value measurements. • Effective date – January 1, 2010 for calendar year-end Companies• January 2011 for the gross presentation of the Level 3 roll forward information



Subsequent events


Subsequent Events as issued on May 28, 2009Subsequent Events as issued on May 28, 2009• Incorporates accounting guidance that existed in auditing standards into U.S. GAAP• Familiar “Type 1” and “Type 2” subsequent event terms are replaced with “recognized”

subsequent events and “nonrecognized” subsequent events, respectively • Effective for interim and annual periods ending after June 15, 2009

Boards issued ASU 2010-09: Subsequent Events, Amendments to Certain Recognition andDisclosure Requirements, on February 24, 2010q , y ,• SEC filers are not required to disclose the date through which subsequent events have been

evaluated and do not need to disclose that a review of subsequent events has occurred• Conduit bond obligors that have debt securities traded in a public market must evaluate

subsequent events through issuance and must disclose that date in their financial statementssubsequent events through issuance and must disclose that date in their financial statements • All other entities must evaluate subsequent events through date available to be issued and

must disclose that date in their financial statements• Effective upon issuance, except for conduit bond obligors who are required to apply the


amended requirements in fiscal periods ending after June 15, 2010

Slide 24June 2010


Accounting and reporting for decreases in ownership of a


• Clarifies that the scope of the decrease in ownership provisions applies to the following:

subsidiary - A scope clarification

Clarifies that the scope of the decrease in ownership provisions applies to the following: - A subsidiary or group of assets that is a business or nonprofit activity - A subsidiary that is a business or nonprofit activity that is transferred to an equity method

investee or joint venture - An exchange of a group of assets that constitutes a business or nonprofit activity for a

noncontrolling interest in an entity• Clarifies that the decrease in ownership guidance does not apply to the following transactions

even if they involve businesses:y- Sales of in-substance real estate. Entities should apply the sale of real estate guidance- Conveyances of oil and gas mineral rights. Entities should apply the mineral property

conveyance guidance



Accounting and reporting for decreases in ownership of a


• Expands existing disclosures relating to:

subsidiary - A scope clarification (continued)

Expands existing disclosures relating to:- Nature of continuing involvement with the subsidiary after deconsolidating- Valuation techniques- Involvement of related parties in the transaction

• Effective beginning in the first interim or annual reporting period ending on or after December 15, 2009. The amendments should be applied retrospectively to the first period that an entity adopted Statement 160



Consolidation of variable interest entities


• Amends ASC 810 (FIN 46(R)) for consolidation of variable interest entitiesAmends ASC 810 (FIN 46(R)) for consolidation of variable interest entities• Eliminates scope exception for QSPEs resulting in more consolidations• Methodology for determining the Primary Beneficiary shifts towards a qualitative analysis• Continuous reassessment of Primary Beneficiary• Enhanced disclosures• May change who consolidates• Effective Q1 2010 for calendar year companies



Consolidation of variable interest entities (continued)


ASU 2010-10 deferred FAS 167 for certain investment companies and added clarification for

Deferral

ASU 2010 10 deferred FAS 167 for certain investment companies and added clarification for service provider/decision maker considerations• Issued on February 25, 2010 and effective for Q1 2010• Clarification of paragraph B22 quantitative

- Quantitative analysis should not be sole basis for assessing criteria- Related parties need to be considered for every test in B22





• No longer a quantitative expected loss model based upon “risks” and “rewards”

Primary beneficiary determination

No longer a quantitative expected loss model based upon risks and rewards• New qualitative PB analysis• Requires 2 criterion to be met: Power and Losses or Benefits

Power + = Primary BeneficiaryLossesorbenefits





These rights are no longer considered relevant under FAS 167, unless held by a single party.

Kick-out and participating rights

These rights are no longer considered relevant under FAS 167, unless held by a single party.

• Rights are ignored when evaluating the Power Criterion, unless they are b t ti i h ld b i l t d it l t d ti d dsubstantive – i.e. held by a single party and its related parties and de

facto agents

• The same approach to kick-out rights applies when determining whether or not an entity is a VIE

Inconsistent with EITF 04 5 and 96 16 where kick out and participating

Kick-out rights

+ • Inconsistent with EITF 04-5 and 96-16, where kick-out and participating rights may be held by numerous parties

• Will result in more entities being considered VIEs and will likely bias the PB determination toward the party subject to such rights

• Protective rights should not be considered

Participating rights

• Protective rights should not be considered





2 significant changes – both of which may have significant effects on the determination of the PB

Related parties

2 significant changes both of which may have significant effects on the determination of the PB of an entity.

• Mutual transfer restrictions based on mutually agreed upon terms by willing, independent i l d f l i hiparties no longer creates a de facto agency relationship

• Joint ventures previously consolidated under the related party tiebreaker may be deconsolidated under the new model

Transfer restrictions

• When one party within a related party group meets both the criteria for being the primary beneficiary, that party would consolidate the VIE

• If no party within the related party group meets both criteria, then the primary beneficiary is

Related party tiebreaker

the party most closely associated with the VIE



On the horizon



Accounting for leases - A “Joint” project

On the horizon

History and perceived problems with current modelsHistory and perceived problems with current models• SEC Staff specifically asserted that lease standards should be rewritten in its 2005 report on

off-balance sheet transactions.• In July 2006, the FASB and IASB both agreed to add a joint project on lease accounting to

th i ti j t d

• Existing lease model considered to be “Broken” – most significantly for Lessees. Common example: A commercial airline with no airplanes on its balance sheet

their accounting project agendas. • Discussion Paper issued March 19, 2009, almost 300 comment letters received.

• Common example: A commercial airline with no airplanes on its balance sheet.• Similar transactions can be accounted for in different ways, reducing

comparability.• Current standards provide structuring opportunities.• Current model is complex and the dividing line between operating and finance

Problems with current d l • Current model is complex and the dividing line between operating and finance

lease is ‘bright-line’ rather than principles based. • Conceptually flawed as a lease meets the definitions of both an asset and a

liability in the conceptual framework.• Users believe operating leases should be recognized in the financial statements of

model


g gthe lessee.

Slide 33June 2010


The future of lease accounting

On the horizon

• Proposed rules will eliminate operating lease accounting by lesseesProposed rules will eliminate operating lease accounting by lessees - Balance sheet will be grossed up with an obligation and an asset - P&L geography changes (EBITDA increases)- Expense recognition pattern will change and become front-ended

• Lease term, contingent rents, residual value guarantees will need to be estimated and included in the lease obligation at lease commencement and subsequently re-measured

• More volatility will be introduced in the income statement • Broad impacts on debt covenants credit ratings real estate and equipment financing strategy• Broad impacts on debt covenants, credit ratings, real estate and equipment financing strategy

(lease vs. own), models for forecasting, impacts on incentive compensation plan metrics, etc.• Additional accounting processes and/or applications to prepare/maintain records to support

estimates on lease commencement date and for the life of the lease; impacts on internal t l t dd i iti l ti t d i di tcontrols to address initial estimates and periodic re-measurements

• Exposure draft expected in second quarter 2010 and final standard expected in 2011; Boards have yet to discuss proposed effective date

• Existing leases are generally not expected to be “grandfathered”


g g y p g

Slide 34June 2010


Potential lessor accounting model

On the horizon

The boards are still discussing the basic lessor accounting model. Two different models areThe boards are still discussing the basic lessor accounting model. Two different models are being developed.Approach 1 – “Performance Obligation”• The lease contract is viewed as creating a new right, leaving the lessor’s rights relating to the

l d t h dleased asset unchanged.• Asset remains on lessor’s balance sheet.• A separate receivable and a performance obligation are also recognized. Approach 2 – “Derecognition”Approach 2 Derecognition• Lessor is viewed as having transferred a portion of the leased item to the lessee.• Derecognize leased item and recognize a receivable and a residual value asset. • Similar to current IFRS for finance leases.



Lessee accounting model

On the horizon

• Lessee will recognize “right-of-use” asset and a liability for obligation to pay lease rentalsLessee will recognize right of use asset and a liability for obligation to pay lease rentals• Initial measurement

- Asset is the present value of lease payments plus initial direct costs incurred by lessee- Obligation is present value of lease payments discounted at lessee’s incremental

borrowing rate; implicit rate may be used if readily determinable- Determined at inception of lease

• Subsequent accountingRight of use asset- Right-of-use asset• Amortized cost based approach (typically straight line method)• Will be subject to impairment under existing rules• IFRS preparers permitted to revalue; US preparers not permitted to revaluep p p p p p

- Obligation• Amortized cost using effective interest method • Adjust estimate if facts and circumstances change


• Re-measurements

Slide 36June 2010


Lessee accounting model (continued)

On the horizon

• At transition dateAt transition date- Obligation and asset will be measured at present value of lease payments for both

operating and capital leases- Only simple capital leases with no renewal options, contingent rentals, residual value

t ill i ff t dguarantees will remain unaffected



Impact of the proposed model on annual expense

On the horizon

2,700

2,300

2,400

2,500

2,600

1,900

2,000

2,100

2,200

Proposed Model

Current Model

Pre-

Tax

Exp

ense

1,500

1,600

1,700

1,800

Annu

al P

The chart above depicts the impact on earnings for a basic 10 year lease with an initial annual rent of $2,000, a 2% annual escalation rate and an assumed incremental borrowing rate of 7%.

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019



Simple lease example (Lessee)

On the horizon

Lease Terms and assumptions PwC ObservationsLease Terms and assumptions

Lease commenced on 1/1/xx00

Square ft 100,000

Annual initial rent per square ft $ 20.00 (Paid Monthly)

Initial annual rent $ 2,000,000 (000’s omitted)

Annual escalation 2.0%

• Right to use asset amortizes over the term of the lease.

• Lease obligation acts like a mortgage, each payment is applied to “Principal” and interest. Interest is higher in earlier years.

• Total expense is same over term of the lease.

• Combined expenses for new model are higher in the earlier years than both the current model and cash terms.

Assumed incremental borrowing rate 7.00% (10 year rate)

Triple net lease – executory costs paid separately

No extension options

No purchase options

No residual value guarantees

No contingent rent of any kind

• Lease obligation exceeds net unamortized asset after day 1 until the end of the lease.

• Longer lease terms or lease terms with contingent rents (usually back ended from cash perspective) would have even more distortion to both current accounting model and cash terms.

• Example is for net lease and cash payments exclude executory costs. If base year or gross leases, executory costs would need to be removed from payments for lease accounting.

Balance Sheet Implications recognition XX01 XX02 XX03 XX04 XX05 XX06 XX07 XX08 XX09 XX10Right to use asset $15,540 $13,986 $12,432 $10,878 $9,324 $7,770 $6,216 $4,662 $3,108 $1,554 $0 Lease obligation ($15,540) ($14,598) ($13,547) ($12,377) ($11,080) ($9,646) ($8,062) ($6,319) ($4,404) ($2,302) $0 Income Statement Implications

For the year ended December 31, Proposed model: Method XX01 XX02 XX03 XX04 XX05 XX06 XX07 XX08 XX09 XX10 Total

g y

pAmortization/depreciation of right to use asset Straight Line Amort. $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 1,554 $ 15,540 Interest expense on lease obligation Effective interest 1,058 989 911 825 730 625 509 382 242 87 6,358

Combined expenses related to lease A $ 2,612 $ 2,543 $ 2,465 $ 2,379 $ 2,284 $ 2,179 $ 2,063 $ 1,936 $ 1,796 $ 1,641 $ 21,898 Current accounting model (straight line) B $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 2,190 $ 21,899 Difference - current period A- B $ 422 $ 353 $ 275 $ 189 $ 94 $ (11) $ (127) $ (254) $ (394) $ (548)Difference cumulative 422 775 1,050 1,240 1,334 1,323 1,196 942 548 (0)

$ $ $ $ $ $ $ $ $ $

PricewaterhouseCoopersJune 2010

Slide 39

Cash (Paid in monthly installments) $ 2,000 $ 2,040 $ 2,081 $ 2,122 $ 2,165 $ 2,208 $ 2,252 $ 2,297 $ 2,343 $ 2,390 Cummulative Cash 2,000 4,040 6,121 8,243 10,408 12,616 14,869 17,166 19,509 21,899 This document was presented during the 2010 NCREIF Summer Conference.

The author(s) take full responsibility for all content. This posting is for informational purposes only; neither NCREIF nor its Board express any opinion of the content presented herein.

Financial statement presentation and disclosure

On the horizon

• The Boards tentatively decided that the right-of-use asset should be presented in theThe Boards tentatively decided that the right of use asset should be presented in the statement of financial position on the basis of the nature of the leased item, but should be presented separately from owned assets.

• The Boards preliminarily decided that the obligation to pay rentals should be presented separately from other financial liabilities on the face of the statement of financial positionseparately from other financial liabilities on the face of the statement of financial position.

• Both amortization and interest expense arising in lease contracts would be separated from other amortization expense and other interest expense either on the face of the statement of comprehensive income or in the notes of financial statements.

• Cash flow presentation will likely be impacted (i.e. operating vs. financing).• Consistent with the Boards’ general thinking on disclosure, and because of the increased

emphasis on estimates in the proposed model, it was no surprise that they have proposed disclosure requirements that go well beyond those required under current leasing standards.g y g

• In doing so, they articulated the following principle:- An entity should disclose the quantitative and qualitative financial information that

identifies and explains the amounts recognized in its financial statements arising from lease contracts


lease contracts

Slide 40June 2010


Business implications (General)

On the horizon

• Financial ratios and metrics will changeFinancial ratios and metrics will change- Balance sheets would expand; leverage and capital ratios may suffer- Rent expense recast as interest and amortization expense will change performance

measures such as EBITDA and, in the statement of cash flows, cash flows from operating ti itiactivities

- Loan covenants, credit ratings, internal budgeting, compensation plans and other agreements may be affected

• Inventorying all leases and gathering data about the key provisions of each lease may be y g g g y p ytime-consuming

• Systems and controls evaluation - Record-keeping and accounting under the new model will likely need to be systems-

basedbased- New processes and controls will need to be developed – especially around changes in

estimates



Accounting for financial instruments

On the horizon

• Objective to improve the decision usefulness of financial instrument reporting for users of

A “Joint” project

Objective to improve the decision usefulness of financial instrument reporting for users of financial statements and to increase convergence in accounting for financial instruments

• Intended to be a joint project but political pressure has caused different project plans. Overall environment is fluid and complex.O M 26 2010 th FASB i d d A ti St d d U d t A ti f• On May 26, 2010, the FASB issued a proposed Accounting Standards Update, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities



FASB/IASB joint project: Fair value measurement and disclosure

On the horizon

• Objectives of project include:Objectives of project include: - Ensure fair value (FV) has the same meaning in U.S. GAAP and IFRS- Promote convergence with IFRS FV exposure draft, even if it results in amendments to

current U.S. GAAP FV guidance• Many aspects of the converged standard, including the definition of fair value and the market

participant concepts, appear to be similar to existing U.S. guidance• The FASB is expected to expose proposed changes to ASC 820 in the second quarter 2010;

the IASB plans to issue a limited re-exposure on sensitivity disclosures also in the second p p yquarter 2010

• The two boards will re-deliberate the comments received on the exposure drafts together, with the intent of issuing substantially converged guidance in the fourth quarter 2010

• Deliberations have resulted in some changes to U S GAAP that will be proposed• Deliberations have resulted in some changes to U.S. GAAP that will be proposed• Two main areas may not be converged through this project



Loss contingency disclosures

On the horizon

• Redeliberations continued in April 2010 / moving away from the ED issued June 2008Redeliberations continued in April 2010 / moving away from the ED issued June 2008- Board decided to focus on the following broad principles for disclosures

• Disclose publicly-available information on the nature, timing and magnitude of loss• More extensive disclosures as the life cycle of a case progresses• Disclosures can be aggregated

- Disclosures should not impact the outcome of the contingency (no prejudicial exemption is expected in the ED)Maintain existing disclosure thresholds except for certain remote contingencies that may- Maintain existing disclosure thresholds, except for certain remote contingencies that may have a “severe impact”

- Ignore possibilities of recoveries when assessing whether a contingency meets the threshold for disclosure

- Extensive quantitative and qualitative disclosures based on nonprivileged information - Tabular reconciliation of all recognized contingency accruals



Loss contingency disclosures

On the horizon

• Next StepsNext Steps - ED expected in May 2010 for a 30-day comment period- Final standard expected in Q3 2010- Effective date 12/31/10 for calendar year-end public companies



Regulatory environment update



Perspectives on the PCAOB leadership


PCAOB board members

OpenOpen

Open 1 Chairman Goezler 2 Niemeier 3 Gradison 4 Harris

Office of the chief auditor Division of registration and InspectionsMartin Baumann, Chief Auditor & Director of Professional Standards

George Diacont, DirectorStandardsJennifer Rand, Deputy Chief AuditorGreg Scates, Deputy Chief Auditor

1 Chairman Olson resigned at the end of July 2009.2 Goezler named Acting Chairman of the PCAOB by the SEC effective August 1 2009


Slide 47

2 Goezler named Acting Chairman of the PCAOB by the SEC, effective August 1, 2009.3 Niemeier’s term expired in 2008 and announced in September that he will be leaving in the near future.4 Gradison’s term expired in 2009.


Key PCAOB developments


• Open board positionsOpen board positions• Auditing standards

- Standard on engagement quality review - Suite of seven proposed auditing standards regarding assessment and response to risk in

an audit- Concept release on requiring the engagement partner to sign the audit report - Other major projects in process

• Inspection matters• Inspection matters- Fair value and estimates- International

• Supreme Court rules that limitations on power to remove PCAOB board members by the SEC p p yis unconstitutional



Perspectives on SEC leadership


PCAOB board members

Chair, Schapiro (I) Casey (R) Walter (D) Aguilar (D) Paredes (R)

Office of the chief accountant Division of corporation finance Division of enforcementJim Kroeker, Chief Accountant Meredith Cross, Director Robert Khuzami, DirectorPaul Beswick, Deputy Chief Accountant – AccountingJulie Erhardt, Deputy Chief Accountant – InternationalOPEN Dep t Chief Acco ntant

Wayne Carnall, Chief Accountant Howard Scheck, Chief Accountant


Slide 49

OPEN, Deputy Chief Accountant –Professional Practice


Key SEC agenda items


• Active regulatory agendaActive regulatory agenda- Closing regulatory gaps exposed by economic downturn/high profile cases- Emphasis on corporate governance

• Implementation of Financial Regulatory Reform once it is signed into law• IFRS adoption by US registrants• Vigorous enforcement program

- Streamline procedures H dli ti (Offi f M k t I t lli )- Handling tips (Office of Market Intelligence)

- Flatter organizational structure



Enforcement trends

SEC Hot topics

• New director of enforcement Robert Khuzami.New director of enforcement Robert Khuzami. • Creation of 5 highly specialized investigative units• Streamlined management and internal processes• Granted more authority to division and investigators• Key 2009 statistics demonstrate the commitment to aggressive enforcement in the wake of

the Madoff and other scandals• Continued focus on hedge funds, short sellers and insider trading• Use of “claw back” provision in section 304 of Sarbanes Oxley• Use of claw-back provision in section 304 of Sarbanes Oxley• Whistleblower tips



Sarbox 404 for smaller companies

• Current waiver was set to expire in June 2010Current waiver was set to expire in June 2010• SEC had no intention of granting additional waiver• In mid-June the financial regulatory reform conference committee approved a permanent

exemption from the 404 audit requirements for public companies with public floats of less th $75 illithan $75 million

• Next step would be for both houses of Congress to vote on the final reconciliation report (when it is ready)

• As passed, legislation also requires the SEC to study ways to reduce the burdens of p g q y ycompliance with Section 404(b) on companies with public floats of $75 million to $250 million



New wave of REIT IPOs

• Why now?Why now?• Roll Ups vs. Blind Pools• The REIT IPO ‘window’• Pros and Cons



SEC comment letter trends

SEC Hot topics

• Common recurring areas of focusCommon recurring areas of focus- Impairments- Segment reporting- Non-GAAP measures- Income taxes- Disclosure of changes in internal control- Proxy Disclosures

MD&A i l di li idit d h fl di l- MD&A, including liquidity and cash flow disclosures- Revenue recognition- Litigation contingencies and restructurings



Comment letter trends - Impairments

SEC Hot topics

• Disclose methodology and key assumptions used to test for impairmentDisclose methodology and key assumptions used to test for impairment• Disclose the specific facts and circumstances that gave rise to impairments • Disclose any assets or reporting units for which impairment charges are reasonably likely to

occur in the next 12 to 24 months• Provide sensitivity analyses



Sample SEC comments - Impairments

Appendix B

Describe the nature of the valuation techniques and the significant estimates and assumptionsDescribe the nature of the valuation techniques and the significant estimates and assumptions you employed to determine the fair value of your reporting units in your impairment analysis. Forexample, if you utilize the discounted cash flow approach, you should disclose the discount ratesfor each reporting unit and how those discount rates were determined, including yourconsideration of any market risk premiums. In addition, we believe your disclosure shouldaddress your estimates of future cash flows, as follows:• Provide a discussion of your historical cash flow growth rates and explain how your historical

growth rates were considered when determining the growth rate to be utilized in your cashgrowth rates were considered when determining the growth rate to be utilized in your cash flow projections.

• Disclose the growth rate you need to achieve in your cash flow projections in order to avoid having a goodwill impairment charge.I i f th t i i t di h id d th t i ti• In view of the current economic environment, discuss how you considered the uncertainties inherent in your estimated future growth rates. For example, you should explain if and when you anticipated a recovery of the economy in your growth rates used in your cash flows analysis.



Sample SEC comments - Impairments (continued)

Appendix B

Describe changes to the assumptions and methodologies, if any, since your last annualDescribe changes to the assumptions and methodologies, if any, since your last annualimpairment test.For further guidance, refer to Release No. 33-8350 “Interpretation: Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of O ti ”Operations.”“There is a concern that investors may have been surprised by the …impairment charge. In this regard, we note the significant impact on share price when the charge was announced… Item 303 of Regulation S-K requires M,D&A disclosure of material uncertainties unless management has concluded that the uncertainty is not reasonably likely to materially impact future operating results…Section 216 of the Financial Reporting Codification states that ‘registrants have an obligation to forewarn investors of deteriorating conditions which, unless reversed, may result in a subsequent g ywrite-off. This includes an obligation to provide information regarding the magnitude of exposure to loss’…Please clarify for us why there was apparently no specific, prior disclosure regarding a material uncertainty over the recoverability of the goodwill.”




Appendix B

“For each methodology, provide a qualitative and quantitative description of the materialFor each methodology, provide a qualitative and quantitative description of the material assumptions used and a sensitivity analysis of those assumptions. For example, such assumptions should include for a discounted cash flow method the discount rate used, the revenue growth rates, the operating profit margins, and the terminal rate, at a minimum; and for a comparable business method the sales and/or EBITDA multiple used.”comparable business method the sales and/or EBITDA multiple used.“Disclose those reporting units whose carrying value is close to the estimated fair value, including the amount of goodwill for the reporting unit, the carrying value of the reporting unit and the fair value of the reporting unit.”“It appears that your current market capitalization is significantly below the book value of your“It appears that your current market capitalization is significantly below the book value of your equity. Please advise us whether you have performed a recent impairment test. If not, please explain how you analyzed the difference to conclude that an impairment test is not necessary. Please explain any qualitative and quantitative factors you considered (e.g. reconciliation). If you have performed a recent impairment test please provide us with a summary of your results inhave performed a recent impairment test, please provide us with a summary of your results in Step 1 and Step 2, if applicable.”




Appendix B

“Disclose how you weight each of the methods used, including how you determined the weightsDisclose how you weight each of the methods used, including how you determined the weights for each method. Given that the weight assigned to each method is a subjective estimate, please include a sensitivity analysis to address the amount the fair value would have changed by had you weighted the fair value methods differently.”“Please provide us with a more specific and comprehensive discussion of your impairment policyPlease provide us with a more specific and comprehensive discussion of your impairment policy. In this regard, please address the following items:• Discuss how you establish cash flows and allocate expenses by asset group.• Discuss how you determine the fair value of your asset group.• Include a qualitative and quantitative description of the critical assumptions used in your

impairment analysis and a sensitivity analysis of those assumptions based upon reasonably likely changes.

• Discuss quantitative information regarding any significant known trends;Discuss quantitative information regarding any significant known trends;• Discuss any material and useful information that you gather and analyze regarding the risks

of recoverability of your assets.”




Appendix B

“We note that your stock price declined significantly. Considering this decline in your stock priceWe note that your stock price declined significantly. Considering this decline in your stock price and market capitalization over the past three months and the impact of economic events on your current critical accounting policy for goodwill and long lived assets, your disclosure appears to be too general in nature to provide an investor with sufficient information about management's insights and assumptions with regard to the recoverability of these asset balances. In this regard,insights and assumptions with regard to the recoverability of these asset balances. In this regard, your policy only describes the steps that you perform to review your goodwill and long-lived assets for recoverability. Please expand your disclosure to describe the assumptions used, include a sensitivity analysis of significant assumptions, and provide information as to known trends, uncertainties or other factors that will result in, or that are reasonably likely to result in,trends, uncertainties or other factors that will result in, or that are reasonably likely to result in, any material impairment charges in future periods.”




Appendix B

“Further tell us and clarify in future filings, whether or not an impairment test was performed onFurther tell us and clarify in future filings, whether or not an impairment test was performed on your long lived assets under SFAS 144. Please disclose the results of those tests, to the extent they were performed and if no test was performed how you considered that one was not necessary under paragraph 8 of SFAS 144. To the extent no test was performed, given the adverse stock price trends, disclosing whether or not a SFAS 144 analysis was actuallyadverse stock price trends, disclosing whether or not a SFAS 144 analysis was actually performed would clearly inform investors whether the absence of impairment charges is due to management's determination that the SFAS 144 test were not required as a result of no triggering events or because there were triggering events present and managements estimate of cash flow projections exceeded asset carrying values resulting in no impairment charges. Please reviseprojections exceeded asset carrying values resulting in no impairment charges. Please revise future filings to clarify these points.”



Comment letter trends - MD&A

SEC Hot topics

Increased transparency, better (not necessarily more) in-depth analysis, and plain English:Increased transparency, better (not necessarily more) in depth analysis, and plain English:• Provide an executive overview• Quantify significant reasons underlying variances,• Discuss trends, which may have a material impact on future operating results and liquidity • Foreign currency matters (e.g., Venezuela)• Critical accounting estimates

- Discuss how changes in judgments, estimates, and other variables impacts operating resultsresults

- Fair value estimates (impact of credit risk)• Focus on liquidity

- Disclose items that impact the availability of creditp y- Compliance with covenants, including likelihood of covenant defaults- Tabular presentation of financial covenants versus actual ratios



Comment letter trends - MD&A (continued)

SEC Hot topics

• Cash flowsCash flows- Discuss drivers of changes in cash flows from operations- Discuss trends in cash flow, particularly when cash flow does not correlate to income

from operations (i.e., positive cash flow, but operating losses, or vice versa)



Questions



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