NAREIT Submission to FASB on Business Combinations and Intangible Assets


December 7, 1999

Mr. Timothy S. Lucas
Director of Research and Technical Activities
Financial Accounting Standards Board
File Reference 201-A
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116

RE: Proposed Statement of Financial Accounting Standards - Business Combinations and Intangible Assets

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 business combinations and intangible assets. NAREIT is the national trade association for REITs and publicly traded real estate companies. Members include real estate investment trusts (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 regularly involves the acquisition of businesses and/or assets. Retrospectively, the impact on real estate companies of the prohibition of the pooling-of-interests method of accounting for business combinations would be minor, as nearly all transactions have been accounted for using the purchase method. However, as real estate companies increase their involvement with businesses and services that do not hold tangible assets, the proposal's provisions would become more applicable. In this context, the accounting standards for business combinations and intangible assets are important to producing useful financial reports for publicly traded real estate companies.


NAREIT generally supports the Board's conclusions included in the ED. We support the Board's conclusion that "pooling-of-interests" accounting should be eliminated and that the amortization of goodwill should be included as a charge to income - not to equity or to other comprehensive income. Further, it is our understanding that the elimination of "pooling-of interests" accounting for business combinations would achieve harmonization with international standards. We agree with this direction toward establishing uniform international accounting standards.


Although NAREIT generally supports the Board's proposal, we offer our observations on three issues raised in the ED: income statement presentation, transition and earnings representation.


Income Statement Presentation
The unique treatment afforded unidentifiable goodwill through disclosure in the income statement presents an opportunity for earnings management. Because of the unique nature of unidentifiable goodwill, we support the separate disclosure of its amortization and impairment charges in the income statement. However, this disclosure may serve as a disincentive to objectively recognizing identifiable intangible assets that are not afforded the same treatment. Perhaps additional/better guidance on assigning and measuring goodwill may prevent earnings disclosure abuses and help sustain the comparability intended by the standard.


Transition Application
We recommend the retroactive application of the ED's amortization provisions to previously recognized goodwill and other intangible assets for all periods presented, unless not practical to do so. We believe that this transition accounting would prospectively enhance comparability between companies. Earnings Representation and the Similarity Between Goodwill and Depreciation
For years, real estate companies have presented net income under generally accepted accounting principles (GAAP) which has limited relevance to financial statement users. This limitation is driven only by the current GAAP depreciation model applied to income-producing real estate. Upon review of paragraphs 327 through 343, we are encouraged that the Board's conclusion to segregate unidentifiable goodwill amortization in the income statement is based on virtually the same fact pattern present in depreciation accounting and the characteristics of income-producing property. The Board based their conclusion on the following observations:


  • The asset's uniqueness;
  • Comparability issues between companies which "purchase" goodwill and those which internally develop goodwill;
  • Differing views about whether - and the degree to which - any pattern of amortization can be representationally faithful of the consumption or diminution of the asset;
  • Users, in some cases, eliminate goodwill amortization entirely from their analysis to better facilitate an understanding of the cash consequences of these charges; and
  • Analysts' primary focus on summary measures of earnings to set stock price multiples.


    Nearly identical observations would lead the Board to the same conclusion regarding cost basis depreciation on income-producing property. In practice, cost basis depreciation is excluded from users' analyses of the operating results of investment property:


  • Investment property is unique in terms of its "investment characteristics" - identifiable, long-term cash flows, as well as changing market values and regularity of asset exchanges;
  • Lack of earnings comparability between acquiring companies which must depreciate purchased value in excess of the cost to develop, and developing companies which have no similar depreciation because of value internally created through development;
  • Wide range of views regarding the pattern of the assets' consumption in its operation - and, therefore, the appropriateness of current methods of depreciating investment property;
  • The elimination of investment property depreciation in calculating the supplemental performance measure ( Funds From Operations ) used by the entire industry; and
  • Users' primary focus on the supplemental measure (excluding depreciation) in setting stock price multiples.


    Based on the Board's conclusion to segregate unidentifiable goodwill amortization in the income statement and the foregoing direct similarities between goodwill and its amortization, and investment property and its depreciation, we urge the Board to develop a GAAP disclosure practice for real estate companies. The disclosure would similarly isolate investment property depreciation from other operating expenses and allow an earnings subtotal, absolute and per share, before this depreciation. Although this practice would not provide for carrying investment property at fair value, by reporting earnings exclusive of cost basis depreciation it would represent a degree of harmonization with the International Accounting Standards Committee's exposure draft on accounting for investment property.


    NAREIT appreciates the opportunity to participate in the Board's considerations with respect to accounting for business combinations and intangible assets. If you should have any questions regarding this response, please contact George Yungmann at (202) 739-9432, David Taube at (202) 739-9442, or me at (484) 530-1888.


    Timothy A. Peterson
    Executive Vice President and Chief Financial Officer, Keystone Property Trust
    Co-Chair, NAREIT Accounting Committee