NAREIT Submission to the AcSEC Cost Capitalization Task Force - Comments on July 2000 Draft SOP
August 15, 2000
Mr. Mark Simon
AICPA - Accounting Standards
1211 Avenue of the Americas, 6th Floor
New York, New York 10036
Re: Proposed Statement of Position; Capitalization of Certain Costs Related to Property, Plant and Equipment
The National Association of Real Estate Investment Trusts (NAREIT) has followed and directly supported the Accounting Standards Executive Committee's (AcSEC) process and deliberations with respect to its proposed Statement of Position (SOP), Capitalization of Certain Costs Related to Property, Plant and Equipment. NAREIT representatives have attended public AcSEC meetings at which this project has been discussed and provided the Project Task Force with NAREIT's views and concerns based on the materials discussed at these meetings. This letter raises certain questions about this project, especially its scope, and certain positions reflected in the July 24, 2000 draft of the SOP.
NAREIT is the national trade association for real estate investment trusts (REITs) and other publicly traded real estate companies. NAREIT members include over 200 REITs and other companies that develop, own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service these businesses. Providing useful and relevant financial information related to investment property (property held for rental and/or capital appreciation), is of vital importance to the capital formation and investor relations activities of companies involved in these businesses. NAREIT has and will continue to actively support the development of accounting and reporting standards. Our goal is to responsibly advocate those standards that reflect the economic reality of acquiring, developing, owning and operating investment property. In this context, the accounting standards for capitalizing the cost of these assets are fundamental to producing useful financial reports for publicly traded real estate companies. These standards may have a more significant impact on the financial statements of NAREIT members than on the financial statements of companies that simply use property, plant and equipment in the production of products or delivery of services - property assets account for the great majority of member company assets and maintenance of these properties represents a significant annual cost. NAREIT representatives have reviewed all public documents related to this project and have attended all AcSEC meetings at which this project has been discussed. We are providing you with our views on the draft SOP at this stage for two reasons. First, we want to ensure that conclusions embedded in any public exposure draft are based on a full understanding of the related underlying business transactions and are practical from a cost/benefit perspective. Second, we would like to raise certain issues with tentative conclusions reached thus far.
We have reviewed the following materials related to this project:
- October 22, 1988 letter from Lynn Turner to David Kaplan
- February 3, 1999 prospectus of proposed SOP, Capitalization of Costs in Real Estate Assets not Within the Scope of FASB Statement No. 67
- March 10, 2000 letter from Lynn Turner to David Kaplan regarding the expansion of the project beyond real estate assets
- March 14, 2000 response from David Kaplan to Lynn Turner
May 21, 2000 Revised Prospectus of Proposed SOP, Capitalization of Certain Costs Related to Property, Plant and Equipment
- May 24, 2000 AcSEC staff's cover letter forwarding the June 8 draft to AcSEC
- June 8, 2000 draft SOP
- July 14, 2000 AcSEC staff cover letter forwarding July 24 draft to AcSEC
July 24, 2000 draft SOP
- diversity in accounting for capital maintenance costs,
- the appropriateness of capitalizing certain kinds of these costs,
- accounting for the net book value of components replaced, and
the practice of reserving for overhaul/turnaround costs. All of these concerns/issues relate to costs expended to maintain or enhance property, plant and equipment already in operation. We understand and appreciate these concerns and support the SEC Staff's and AcSEC's efforts to improve the accounting related to them.
We understand that there may be issues with specific practices associated with accounting for capital maintenance expenditures - and these need to be resolved. At the same time, the depth and detail to which certain of the AcSEC discussions have gone appear very inconsistent with more profound directions being taken with respect to accounting for investment property.
Our remaining comments are in order of and referenced to specific paragraphs in the July 24, 2000 draft SOP.
This proposed accounting implicitly eliminates the use of the composite depreciation method - currently an acceptable accounting method widely used in practice. Under the composite method of depreciation, groups of assets or components of assets with different service lives are depreciated over the weighted useful lives of the individual assets of the group or components. If a component is retired before or after the average useful life, any resulting gain or loss is charged/credited to accumulated depreciation. This practice is justified because individual components will be retired both before and after the average useful life. The composite method of depreciation results in appropriate financial reporting at reasonable cost.
- AICPA Industry Audit Guide; Audits of Airlines;
- SFAS No. 19, Appendix B; and
AICPA Industry Audit Guide; Audits of Agriculture Producers and Agricultural Cooperatives.
As stated above, we strongly believe that SFAS 67 has provided appropriate accounting guidance for acquisition and development costs of investment property and that there is minimal observed diversity in practice. Investment property should therefore be exempted from the application of these paragraphs.
The accounting proposed in these paragraphs, combined with the Task Force's elimination of the criteria for capitalization included in Paragraph 23 of the June 8, 2000 draft SOP, represents a dramatic change in GAAP. Paragraph 27 of the current draft SOP states: "costs incurred during the in-service stage, including costs of normal, recurring or periodic repairs and maintenance activities, should be charged to expense as incurred unless the costs are incurred for a replacement of PP&E or component of PP&E"(emphasis added). If taken literally, this standard eliminates the concept of deferred costs in accounting for betterments, improvements, refurbishments, rearrangements and other forms of major, long-term maintenance activities. At the June AcSEC meeting there was a discussion about accounting for "treatments" that may extend the original useful life of an asset. By a vote of 9-4, AcSEC concluded that, "costs incurred to extend the expected useful life of PP&E should be capitalized provided the costs extend the life beyond that originally expected assuming the entity performs normal, ongoing maintenance on that PP&E." Our understanding was that these were costs that may not represent tangible PP&E (new or replacement components) but costs that met the criteria for capitalization as set forth in paragraph 23 of the June draft SOP.
The guidance in these sections of the draft is simply not logical. If a composite depreciable life of a PP&E asset is 40 years and a component having a 15 year life (reflected in the weighted average life used) is replaced at the end of 10 years, the applicable accumulated depreciation is 10/15 times the original cost - not 15/40 times the original cost. While the weighted average life of the PP&E asset is 40 years, the short-lived component has been depreciated over its 15-year useful life. This is especially appropriate where the composite depreciation rate assumed multiple generations of short-lived assets in calculating the weighted average life. To measure the accumulated depreciation related to a replaced, short-lived component using the full weighted average life does not result in an accurate measure of the book value of the component. Paragraph 39, line 16 of the July 24 draft SOP should read: "expected useful life being used to depreciate the PP&E component."
AcSEC discussed the accounting for capital costs recoverable under the terms of tenant leases. We believe the discussion provided an incomplete understanding of many lease agreements requiring these reimbursements. The discussion focused on the accounting where there is a direct relation between a capital expenditure and a tenant. To illustrate, a question was asked as to whether a tenant with 2 years to run on its lease in year X is required to reimburse the landlord for its full share of a capital expenditure made in year X having a useful life of 5 years.
George L. Yungmann
Vice President, Financial Standards
- David B. Kaplan, AcSEC Chair
- Mark V. Sever, AcSEC Incoming Chair
- R. Scott Blackley, SEC, Officer of Chief Accountant
Timothy S. Lucas, FASB, Director of Research and Technical Activities