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Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants

WELCOME. Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants Celebrating 40 Years of Serving You    1st QUARTER REAL ESTATE ROUNDTABLE. Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants.

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Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants

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  1. WELCOME Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants Celebrating 40 Years of Serving You    1st QUARTER REAL ESTATE ROUNDTABLE Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants

  2. Real Estate Fair Value Accounting Jeff Olson, CPA Babush, Neiman, Kornman & Johnson, LLP www.bnkj.com

  3. Real Estate Fair Value Accounting “Historic cost numbers are reliable and relevant only on the day they are recorded” Rebecca McEnally, VP Advocacy AMR

  4. Fair Value Accounting Why Fair Value? • It is GAAP for tax-exempt (pension/benefit plan) investors (FAS 35) • Useful supplemental reporting to GAAP historical cost • It’s allowed • Likely more relevant than historical cost

  5. Fair Value Accounting Other GAAP & international accounting standards indicate movement to FV • See article “Question of Value” CFO Magazine, February 2003 • As Bob Dylan said, “The times they are a changin”

  6. GAAP FV Accounting GAAP FV Based Pronouncements • Loan impairment (FAS 114) • Impairment of long-lived assets (FAS 121/144) • Marketable securities (FAS 115) • Stock based compensation (FAS 123) • Hedging derivatives (FAS 133) • Business combinations (FAS 141) • Purchased intangibles (FAS 142) • Guarantee liabilities (FAS FIN 45)

  7. International Accounting International Accounting Standard 40 (“IAS 40”) January 2001 • FV for investment property • Use as accounting basis • If retaining historical cost, must disclose FV in notes • Should we be concerned with IAS Standards?

  8. International AccountingStandards Who cares, not U.S. • 10/29/02 FASB & IAS announce project to begin “convergence” of global standards • 12/15/03 FASB issues initial exposure drafts under convergence project • FASB chairman Herz is former IAS member & originally from UK not America

  9. May Full FV Be Better? • GAAP patch work • Some measurements at HC, others at FV • Some changes in measurements go to P&L, others go through “OCI” which is often presented in the equity statement • Greater earnings volatility • Only FV’s assets and liabilities; does not • Value “going concern” business, ability to capitalize on future opportunities • Establish share prices of public companies

  10. U.S. RE FV Accounting Currently driven by pension professionals - Real Estate Information Standards (REIS) • National Council of Real Estate Investment Fiduciaries (NCREIF) • National Association of Real Estate Investment Managers ( NAREIM) • Pension Real Estate Association (PREA)

  11. REIS • Updated annually and covers • Valuation • Accounting & related disclosures • Investment performance measurement & reporting • Draws from • AICPA • FASB • AIMR • Appraisal Standards Board

  12. REIS • Adds established “industry practice” to increase comparability/reliability • Includes investments in • Wholly owned real estate • JV real estate • Debt investments in real estate

  13. REIS Continued • Addresses issues unique to investment real estate not covered by AICPA Investment Company Guide • REIS Appendix 1- NCREIF Market Value Accounting Policy Manual • Available at ncreif.org • REIS, including MV manual • NCREIF Debt Accounting Workbook

  14. FV Accounting • FV minus cost = unrealized gain or loss at a point in time • Balance sheet is fair value at a point in time

  15. FV Accounting • Change in unrealized gain loss (or differences in net changes in FV and cost) over a period of time runs through the P&L • Realized g/l is factored out of the gross change in unrealized

  16. FV Accounting Basic Model

  17. FV Accounting Cost Concepts • No depreciation or amortization • No rent normalization (stepped or free rent receivable) • No impairment adjustments • Certain deferred costs that have no value are expensed, formerly organizational cost • Capital additions • Those that increase value • Those that do not

  18. FV Accounting -FV Concepts Real Estate is most often valued using a discounted cash flow method (DCF) particularly if an income producing property • Projected rent and expenses • Projected capital expenditures • Projected disposition proceeds and expenses

  19. FV Accounting -FV Concepts Debt adjustments depend on • Likelihood of entity-level interests trading • If interests likely to trade, then debt valued at PV of expected future CF’s • If interests not likely to trade, valued at current settlement value excluding transaction costs

  20. FV Accounting -FV Concepts Debt adjustments depend on • If debt is transferable/assumable • Even if interests not likely to trade value at PV of future CF’s • Fixed rate or variable rate • Variable rate usually has no FV adjustment for I-rate

  21. FV Accounting - FV Concepts NCRIEF Debt Accounting Workbook- Examples A-J with DCF calculations • Each has trading and non-trading of equity interests value • Transferable & non-transferable debt • Favorable & unfavorable interest rates • Debt to be prepaid & pending foreclosure • Interest buy-down • Financing costs, predetermined prepayment & yield maintenance

  22. FV Accounting - FV Concepts Non real estate assets/liabilities • Short term held at un-discounted values • Long term must be valued at time value discount not to exceed value in a current transaction • Changes go through P&L like real estate

  23. FV Accounting - FV Concepts Real estate JV investments • If subject to consolidation, treat as wholly owned real estate with minority interests • Otherwise • Use equity method of historical accounting (cost method would seldom be used) • Value JV assets/liabilities • Apply hypothetical liquidation

  24. FV Accounting -FV Concepts Real estate debt investments • Nonparticipating loans • At market value, considering future CF’s, risks, collateral value, guarantees • Participating loans • If considered ADC arrangements, value as a JV interest • Non-ADC, value as a nonparticipating loan

  25. FV Accounting Examples • REIS has illustrated statements & disclosures example • Fannie Mae 10-K financials • FV balance sheet in supplemental note • PWC addresses FV disclosure in audit opinion • FMNA Website “Answers from the CEO” • NYT article on FV balance sheet & reporting “core earnings” vs. GAAP net income

  26. FNMA ReportingPick a Measure - in millions

  27. FAS FIN No. 46 Update FASB Staff Positions & Revised FIN No. 46 , December 2003 Babush, Neiman, Kornman & Johnson, LLP www.bnkj.com

  28. FAS FIN No. 46 Consolidation of variable interest entities (VIEs) originally issued January 2003 • Who has majority risks and rewards? • Equity owner (s) - expected losses & residual returns • Contractual parties • Primary beneficiary - must consolidate • May be a non equity owner & voting control is no longer the consolidation basis

  29. FIN 46 - FASB Staff Positions FSP FIN 46-1 to 46-8 • See hand out summary & copies of each • No’s 3, 4, 6 & 7 were also incorporated in newly issued revision to FIN 46 or “FIN 46 (R)”

  30. FIN 46 - FASB Proposed Staff Positions FSP FIN 46-a to 46-f • See hand out summary & copies • All but “d” have either been issued or were encompassed in FIN 46 (R)

  31. FAS FIN No. 46 (R) December 2003 revision • Available on fasb.org • Handout - 41 paragraph “redline” version • Full text FIN 46 (R) w/appendices • Effective dates & transition covered in 15 paragraphs (para. 27-41) • Disclosure only by 12-31-03 • Full application is staggered by type entity

  32. FAS FIN No. 46 (R) Effective dates & transition for public companies • “Large” public Co’s - generally, 3/15/04 • “Small business issuer” - generally, 12/15/04 • Exceptions to each • “Special purpose entities” by 12/15/03 • Continue to apply to entities to which “original” FIN 46 was previously applied

  33. FAS FIN No. 46 (R) Effective dates & transition for private companies • New entities formed after 12/31/03 - immediately • All others - by 12/15/04

  34. FAS FIN No. 46 (R) Investment company effective dates • Registered investment companies specifically excluded para 4(e) • Non registered investment companies following AICPA Audit Guide • Effective date deferred while AICPA finalizes a proposed SOP on scope of the guide to parent companies & other equity investors in investment companies

  35. FAS FIN No. 46 (R) Disclosure requirements Remember that enterprises with “significant” interests in VIEs have certain disclosure requirements even if a non-consolidating Primary Beneficiary

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