FASB Readies Investment Property Accounting Project for Public Comment
Yesterday, the FASB made a number of decisions related to the investment property entity (IPE) project. The Board has given the staff permission to draft proposed guidance based on the decisions for a vote by written ballot and expects to issue an exposure draft (ED) by the end of September 2011. The Board believes that because the IPE project is closely related to the investment company entity (ICE) project, the comment period for the IPE project should end on the same date as the comment period for the proposed update on ICE, which is now targeted for early January 2012. The Board also decided to prohibit early adoption of the IPE proposed guidance.
The commentary below is based on our observations at the board meeting and may not reflect the proposals ultimately drafted in the ED.
Scope
At previous meetings, the FASB tentatively decided that an investment property entity is an entity that meets all of the following criteria:1
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1. Nature of the Business Activities. The entity’s primary business activities relate to investing in real estate properties. 2. Express Business Purpose. The express business purpose of the entity is to invest in real estate properties for total return including an objective to realize capital appreciation, for example, through disposal of its real estate properties. The entity does not hold real estate properties for any of the following purposes: a. Use in the production or supply of goods or services or for administrative purposes b. Rental income only c. Sale in the ordinary course of business. 3. Unit Ownership. Ownership in the entity is represented by units of investments, such as shares of stock or partnership interests, to which proportionate shares of net assets can be attributed. 4. Pooling of Funds. The funds of the entity's investors are pooled to avail the investors of professional investment management. The entity has investors who are unrelated to the parent (if any), and in aggregate hold a significant ownership interest in the entity. 5. Reporting Entity. The entity conducts its activities and reports financial information about those activities to its investors. The entity can be, but does not need to be, a legal entity. |
The Board also previously decided that entities with a single investor that currently account for investments at fair value, as required or allowed by U.S. GAAP (e.g., pension plans), would be exempt from the criteria above related to unit of ownership and pooling of funds.
Yesterday, the Board decided to expand the exception for single investor entities to any subsidiary whose parent is required to account for its investments at fair value. This change is intended to accommodate entities with more than one investor and in which the investor who is unrelated to the parent only holds an insignificant interest in the entity.
The Board also decided to remove the restriction that investment property entities cannot own real estate properties for “rental income only.” The Board indicated that when entities primarily invest in real estate for rental income only, they will need to evaluate whether their objective is to realize capital appreciation (i.e., an exit strategy). The Board also asked the staff to provide implementation guidance with examples of an exit strategy.
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Editor’s Note: Although the above criteria do not specifically address exit strategy, such strategy is part of the business purpose criteria. The Board believes that to realize capital appreciation, an entity has to have some type of exit strategy. Exchanges of ownership interests and transactions that will unwind the business are not considered to be an exit strategy. |
Consolidation Versus Fair Value
At previous meetings, the Board tentatively decided that an IPE would be prohibited from consolidating controlling interests in noninvestment property entities unless the controlling interest is in an operating entity that provides services to the investment property entity. Yesterday, the Board decided that to the extent that an IPE has a controlling financial interest in an investment company, the IPE is required to consolidate the investment company.
An IPE should also use fair value to account for all interests over which it has significant influence, including significant influence over another IPE. This reverses the Board’s previous decision that required an IPE to use the equity method to account for significant influence over another IPE.
Measurement
The Board decided that an IPE is required to initially measure its investment properties at transaction price. The initial measurement would therefore include the transaction cost, which is consistent with the requirement under IAS 40.2
In addition, the Board decided to change its previous decision that an IPE would be required to recognize rental revenue from its investment properties on a straight-line basis over the lease term. Accordingly, the Board has tentatively decided that investment property entities should recognize rental income as it is contractually due throughout the lease term. Many investment companies currently use a contractually based measurement to recognize rental revenue from their real estate investments. This differs from IAS 40, which requires rental revenue to be recognized on a straight-line basis for investment properties that are measured at fair value.
The Board also decided to allow investors to use net asset value (NAV) as a practical expedient to measure the fair value of investments in investment property entities when the NAV represents the price at which the investors would transact. The Board plans to carry forward the language from ASU 2009-124 to the ED’s Basis of Conclusions and specify the conditions under which use of NAV is allowed, including the condition that the investor measure substantially all of its investment at fair value.
[1] Criteria are as outlined in the FASB’s Summary of Decisions Reached to Date (as of June 6, 2011).
[2] IAS 40, Investment Properties.
[3] FASB Accounting Standards Codification Topic 805, Business Combinations.
[4] FASB Accounting Standard Update No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).
