April 24, 2014
Highlights of this Issue:
FASB Refocuses Future Standard Setting Agenda
On Jan. 29, the Financial Accounting Standards Board (FASB or Board) held a meeting to discuss the future priorities of its standard setting agenda. Among the Projects discussed that are of interest to NAREIT members were:
Investment Companies: Real Estate Property Investments
Investment Property Entities
Financial Statement Presentation
The FASB decided to remove both the Investment Companies: Real Estate Property Investments and Investment Property Entities Projects from its agenda. Thus, the existing accounting framework for both mortgage and equity REITs in these areas looks to remain in place for some time. Additionally, the Board voted to add a research project to explore whether the Board should pursue the Financial Statement Presentation Project. For more information, refer to SFO Alert dated Feb. 4, 2014.
FASB/IASB Leases Project – Boards Diverge on Lessee and Lessor Accounting Models
On March 18-19, NAREIT observed the joint meetings of the FASB and the International Accounting Standards Board (IASB, collectively Boards). In a highly anticipated joint meeting, the Boards had hoped to reach decisions on both lessee and lessor accounting, among other items. While certain decisions were reached by both Boards on lessee and lessor accounting, the Boards were unable to reach final converged decisions on either aspect of the Leases project.
Equity REITs will welcome the Boards’ decision to abandon the approach to lessor accounting contained in the 2013 Leases exposure draft. The Boards appear to have accepted the feedback received that current lessor accounting is not broken and, therefore, does not need to be modified. Nevertheless, the Boards could not reach a converged decision for exactly how to maintain current lessor accounting. The IASB preferred to make no changes to existing IFRS lessor accounting. While the FASB appeared to agree, they preferred to make certain consequential amendments to align lessor accounting with the Revenue from Contracts with Customers project.
The Boards appear to agree that lessees should recognize lease liabilities on their balance sheets. However, the Boards disagree on the subsequent accounting for the lease expense pattern. The IASB prefers a single lease model for all lessees, where the lease liability is treated in a similar fashion as a financing and the right-of-use asset is depreciated on a straight-line basis. This accounting would result in front end charges to net income and replace rental expense with interest and amortization expense. In an effort to reduce cost and complexity, the IASB agreed to carve out “small ticket items” (i.e., high volume, low dollar value leases). FASB prefers a dual model that is similar to existing IFRS guidance that allows for both operating and capital leases. Given the FASB preference for a dual model, it did not believe that a carve-out for “small ticket items” was necessary. This FASB view would maintain the current reporting of rental expense on a straight-line basis for most property lessees.
Given the impasse, FASB Chairman Russ Golden instructed the FASB staff to conduct more research on issues that divide the Boards. The Boards plan to reconvene over the next several months to discuss whether the Boards can come to common ground.
While no effective date has been established, NAREIT anticipates that the effective date will be no earlier than Jan. 1, 2017.
FASB/IASB Joint Revenue from Contracts with Customers Project Nears Final Issuance
The Boards have finalized their re-deliberations of the proposed Revenue from Contracts with Customers Proposal (the Proposal or the Revenue Recognition Proposal). In the fourth quarter, the Boards revisited a few remaining issues and instructed its staff to proceed with writing a final standard.
The Boards reached decisions on the following issues:
Constraint on variable consideration
One of the steps of applying the Proposal will be determining the transaction price. This assessment can become complicated when the transaction price includes things like incentives, rebates, performance bonuses or royalties. The Boards agreed that the amount of revenue to be recognized should be limited to amounts that are probable of not resulting in a significant revenue reversal in the future.
The Boards also introduced a collectability threshold for determining whether a contract is valid and represents a legitimate transaction. In order to recognize revenue, a company would need to conclude that collection of the transaction price is probable.
The Boards agreed to provide criteria to differentiate a license that provides access to a company’s intellectual property and those that provide a right to use an entity’s intellectual property. The consequence of this assessment would drive the manner in which revenue is recognized. Licenses that provide access to intellectual property would represent performance obligations that are settled over time. As a result, revenue would be recognized over the same time horizon. Licenses that provide a right to use intellectual property at a point in time would satisfy the performance obligation at a point in time. Therefore, revenue would be recognized at the point when control of the license transfers to the counterparty.
The Boards expect to issue a final standard in the second quarter of 2014. The FASB decided that the standard will be effective for annual reporting periods beginning after Dec. 15, 2016, and interim periods therein. Non-public entities were provided an optional one year deferral. While the IASB will permit early adoption, the FASB will preclude early adoption of the standard.
FASB Reporting Discontinued Operations - Final Standard Issued
On Jan. 15, the FASB finalized its re-deliberations on the Reporting Discontinued Operations Project. During the meeting, the Board adopted NAREIT’s recommendations regarding disclosure requirements and early adoption when it finalized its re-deliberations on the Proposal and instructed the staff to draft the final standard. For more information, refer to SFO Alert dated Nov. 19, 2013.
The FASB issued the final standard on April 10. Generally, the final standard would be applied prospectively to all disposals that occur for annual periods beginning on or after Dec. 15, 2014 and interim periods within that year. Early adoption, as requested by NAREIT, would be permitted. We understand that a number of NAREIT member companies will apply the standard in the first quarter of 2014.
FASB Narrows Applicability of new Credit Losses Model
On March 12, the FASB held a meeting to discuss whether the current expected credit loss (CECL) model would be applicable to all financial assets. The conclusions reached at this meeting should be of interest to both mortgage REITs and equity REITs, as the Financial Instruments – Credit Losses Proposal (the Proposal) would not only apply to mortgage loans and securities, but also lease receivables. At the meeting, the Board decided that the CECL model would apply to financial assets that are measured at amortized cost. Additionally, the Board provided prescriptive guidance for how the CECL model would apply to financial assets measured at fair value with changes in value recognized in other comprehensive income. For more information, refer to SFO Alert dated March 20, 2014.
FASB Retains Fair Value Option for Measuring Financial Instruments
On April 4, the FASB met to discuss whether it should retain the unconditional option in current U.S. GAAP to measure financial instruments at fair value. At the meeting, the Board tentatively agreed to retain the fair value option. The Proposed Accounting Standards Update Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities issued in Feb. 2013 would have eliminated a company’s unconditional option to measure financial instruments at fair value.
Additionally, on March 12, the FASB discussed whether targeted improvements should be made to existing U.S. Generally Accepted Accounting Principles (GAAP) for the classification and measurement of loans and debt securities. Mortgage REITs will be interested in the Board's decision, given the nature of the mortgage REIT business model to invest in loans and/or debt securities. The Board decided to retain current U.S. GAAP with respect to loans and debt securities and incorporate a requirement that equity investments be measured at fair value with changes in value recognized in net income. The decision overturns years of the work to converge U.S. GAAP with International Financial Reporting Standards on the classification and measurement of financial instruments. For more information, refer to SFO Alert dated March 20, 2014.
FASB Narrows Scope of the Insurance Contracts Project
On Feb. 19, the FASB held a meeting to determine the future direction of the Insurance Contracts Project, including whether the scope should continue to include all insurance and insurance-like contracts or to limit the scope to include insurance entities only. Consistent with the recommendation made by NAREIT in its Oct. 25, 2013 submission, the Board decided to limit the scope of the project to insurance entities only. For more information, refer to Feb. 21, 2014 SFO Alert.
FASB Issues Proposed Statement of Financial Accounting Concept: Conceptual Framework for Financial Reporting: Chapter 8. Notes to the Financial Statements
On March 4, the FASB issued Proposed Statement of Financial Accounting Concept: Conceptual Framework for Financial Reporting: Chapter 8. Notes to the Financial Statements (the Proposal). The purpose of the Proposal is to improve the Board’s process for evaluating existing and future disclosure requirements in notes to financial statements. If you are interested in participating on a NAREIT Task Force that will evaluate the Proposal and consider whether NAREIT should develop a response, please contact Christopher Drula by April 30. Comments are due to the FASB by July 14.
The Proposal suggests that once the Board has identified what should be broadly considered based on the concepts, the FASB would:
Identify information to be disclosed in the notes that is likely to be helpful to those making decisions about providing resources and that would be relevant to a significant number of the organizations to which it applies;
Eliminate disclosures of certain types of future-oriented information that may have negative effects on the cash flow prospects of the reporting organization and its investors and creditors; and,
Consider the costs and potential consequences of providing a disclosure in the notes.
The Proposal also contains a discussion of what the Board should consider when determining which disclosures should be required at interim periods for those companies who produce such statements.
For further information, please contact George Yungmann, NAREIT's SVP, Financial Standards, at firstname.lastname@example.org or Christopher Drula, NAREIT's Vice President, Financial Standards, at email@example.com.
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