NAREIT Submission to FASB on Asset Impairment and Disposal
October 13, 2000
Mr. Timothy S. Lucas
Director of Research and Technical Activities
Financial Accounting Standards Board
File Reference No. 210-D
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116
Re: Proposed Statement of Financial Accounting Standards - Accounting for the Impairment or Disposal of Long-Lived Assets and for Obligations Associated with Disposal Activities
Dear Mr. Lucas:
The National Association of Real Estate Investment Trusts (NAREIT) is pleased to have the opportunity to respond to the Financial Accounting Standards Board's (the Board) Exposure Draft (ED) of the proposed policy on asset impairment and disposal. NAREIT is the national trade association for real estate investment trusts (REITs) and other publicly traded real estate companies. Members include REITs and other businesses that develop, own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service these businesses.
The business of developing, owning and operating income-producing property involves long-lived assets and their disposal. In this context, the accounting standards for asset impairment and disposal are of vital importance to producing useful and relevant financial reports for publicly traded real estate companies.
NAREIT supports the Board's efforts to enhance the usefulness and relevance of financial reporting by developing standards that would supersede FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, as well as the accounting and reporting provisions of APB No. 30 that address the disposal of a segment of a business. However, as discussed below, we believe there are certain aspects of the proposal that should be amended to facilitate its implementation.
Exchanging an asset (group) for a similar productive asset (group):
Paragraph 29 of the ED requires that when an asset (group) is exchanged, a loss shall be recognized if the carrying amount of the asset (group) exceeds its fair value. That loss, if any, is in addition to, rather than a substitution for, any impairment losses required to be recognized while the asset (group) was held and used. NAREIT supports the use of fair value in this situation, as well as more broadly as it relates to accounting for investment property. We believe that the foregoing recognition and measurement guidance also should apply where the fair value of the asset (group) exchanged/surrendered is greater than its carrying amount. Further, if the fair value of the asset (group) received is "more evident" (see comment below) than the carrying amount of the asset (group) surrendered, the asset (group) received should be recorded at its fair value and the related gain recognized. At a minimum, such gain should be recognized to the extent of any previous impairment write-down recognized while an exchanged asset (group) was held and used. This position is supported by paragraph 18 of APB 29, which states that, "the fair value of the asset received should be used to measure cost if it is more clearly evident than the fair value of the asset surrendered."
In the event the final standard retains the use of fair value to measure only losses on asset (group) exchanges as proposed in the ED, we believe that such loss should be limited to the difference between the fair value of the asset (group) received and the carrying amount of the asset (group) exchanged when the fair value of the asset (group) received is "more evident" than the fair value of the asset (group) exchanged. Again, this position is supported by paragraph 18 of APB 29.
Asset sold or liability settled separately from a group:
Pursuant to paragraph 40 of the ED, if an entity sells an individual asset previously classified as held for sale as part of a group or settles before its maturity an individual liability previously included as part of the group, the remaining assets and liabilities of the group shall not continue to be measured as a group. The remaining assets will continue to be held for sale and measured individually at the lower of their carrying amounts or fair values less cost to sell. The remaining liabilities will be measured individually at their carrying amounts.
NAREIT believes that the final standard should permit one-off asset sales and liability settlements that do not otherwise change management's initial plan to sell the group of assets and liabilities. The one-off asset sales or settlements should not disqualify the continued grouping of the remaining assets and liabilities so long as all other criteria continue to be met.
When to test an asset (group) for impairment:
Paragraph 13 of the ED provides examples for when an asset (group) shall be tested for impairment. Specifically, paragraph 13(f) suggests that an asset (group) shall be tested for impairment when there is "[a] more-likely-than-not expectation that it will be sold or otherwise disposed of significantly before the end of its previously estimated useful life."
NAREIT is concerned that this indicator of when to test for impairment is much too subjective for long-lived assets (i.e., assets with useful lives beyond 10 years). For an investment property with a useful life of 40 years, it would be impossible for management to represent in the early years of the property's life whether or not the property might be sold within the first 20 years. We suggest removing this indicator or changing the language as follows:
"A more-likely-than-not expectation that it will be sold or otherwise disposed of at the earlier of (a) significantly before the end of its previously estimated useful life or (b) within five years from the reporting date."
The term "useful life" does not appear in boldface type the first time it appears in the document (see paragraph 11).
Issues on which the Board has requested comments
Issue 1: Using the expected cash flow approach in developing estimates of future cash flows to test an asset (group) for recoverability.
Although NAREIT believes the expected cash flow approach is appropriate on a theoretical basis, we think the existing standard that allows for either a "best estimate" or an "expected cash flow method" remains appropriate. We believe that a company should be permitted to use an approach that is based on how it evaluates its business.
In the case of the real estate industry, the utilization of cash flow modeling is well established and currently an integral part of managing the business through budgets, as well as evaluating development, acquisition and disposition opportunities. In addition, long standing real estate appraisal/valuation methodology utilizes best estimates of future cash flows. Underlying independent appraisal methodology is the concept of "highest and best use," which requires that the estimate of value reflect the asset's highest and best use and a "best estimate" of value. When developing cash flow estimates, real estate companies and appraisers calculate a "best estimate" that involves numerous assumptions such as lease renewal expectations, market conditions (changes in market rental rates), the economic environment (inflation rates), and operating expenses. Probabilities regarding these assumptions are reflected in the best estimate of cash flow.
NAREIT does not believe that requiring multiple cash flows, weighted by their likelihood of occurrence, would improve the quality of the ultimate cash flow used to calculate recoverability. To the contrary, assigning probabilities to various cash flow scenarios would create complexity by increasing variables, be extremely subject to manipulation, and very difficult, if not impossible, to audit.
Further, requiring companies that use "best estimate" cash flow models for budgeting and forecasting purposes to use a probability-weighted expected cash flow method would be burdensome and may not yield the most appropriate cash flow estimates. Again, auditing the accuracy of a probability percentage would be virtually impossible. Conversely, a "best estimate" cash flow model used for budgeting and forecasting purposes could be reviewed based on historical results and the reasonableness of future assumptions.
It seems more logical to use management assumptions incorporated into actual business decisions regarding an asset that can be more readily evaluated during the audit process to determine recoverability of an asset, than to impose another method which would increase complexity, provide the ability to manipulate the outcome, and reduce the auditability of the cash flow stream. Existing rules that allow for either a "best estimate" or the use of an "expected cash flow method" remain appropriate.
NAREIT also believes that the approach used to test for recoverability should be consistent with the approach used to measure impairment. Under the proposal, a company that uses a traditional cash flow estimate to measure impairment must use the expected cash flow approach to test for recoverability. We believe that this results in an effort that is duplicative and not necessary.
Issue 2: Definition of "primary asset" of an asset group.
NAREIT has no comment on this issue.
Issue 3: "Held for sale" criteria.
The criteria in paragraph 30(e) related to assets to be sold as a group states:
Assets to be sold as a group are expected to be sold to a single buyer. The estimated net proceeds expected to result from that sale are higher than those that would result if the assets were sold individually.
There are many reasons a company may want to sell a group of assets for less than the amount that could be obtained if they were sold individually. Reasons may include the ability to include in the group assets with a lower return-on-capital potential, the exiting out of a geographic area or product type, and the sale of strategically aligned assets as a group. NAREIT believes that FASB should eliminate the last sentence of paragraph 30(e).
Issue 4: Discontinued Operations
NAREIT has no comment on this issue.
Issue 5: Obligations Associated with Disposal Activities
NAREIT has no comment on this issue.
Issue 6: Public Hearing
The ED contains accounting policies that have not previously been required. NAREIT believes that the Board would benefit by hearing how the proposed accounting could impact companies.
Although we consider all of the foregoing issues to be important, we urge the Board to especially consider the recognition of gain/loss upon exchange of an asset (group) for a similar productive asset (group). We applaud the Board's continued use of fair value to measure the impairment of long-lived assets, and encourage the Board to consider broadening its use of fair value for investment property, possibly in a manner similar to the International Accounting Standards Committee's adoption of International Accounting Standard No. 40, Investment Property.
NAREIT appreciates the opportunity to participate in the Board's considerations with respect to accounting for asset impairment and disposal. If you should have any questions regarding this response, please contact George Yungmann, NAREIT's Vice President, Financial Standards, at (202) 739-9432, David Taube, NAREIT's Director, Financial Standards at (202) 739-9442, or me at (908) 497-2015.
Executive Vice President, Chief Financial Officer
Mack-Cali Realty Corporation
Co-Chair, NAREIT Accounting Committee