Introduction

2. Introduction Overview Role of Audit Firm ASC 820 ASC 805 Lease Accounting Questions

3. Role of Audit Firm Statement on Auditing Standards No. 73 - Using the Work of a Specialist • Provides guidance to the auditor who uses the work of a specialist in performing an audit in accordance with generally accepted auditing standards (GAAS)

4. Role of Audit Firm Specialist. A person (or firm) possessing special skill or knowledge in a particular field other than accounting or auditing. Specialists include, but are not limited to: • Actuaries • Appraisers • Engineers • Environmental Consultants • Geologists

5. Role of Audit Firm • Real estate appraisers are valuation specialists in the area of real property. • Often referred to as valuers • Must understand and use the language of potential clients • Professional attributes: property valuation (and valuation-related) skills, knowledge, education, experience and training

6. Role of Audit Firm Real property valuation specialists – essential team members. • Directed by auditor and company that the auditor represents • Viewed as subject matter expert (SME) by the audit and tax users of their services

7. Role of Audit Firm Audit Issues Land – quality of land sale data Replacement Cost New – source and applicability of data Indirect Costs & Entrepreneurial Profit – market support External Obsolescence– market support Downtime – market support Above/Below Market Leases – support for market rents Reimbursements – market support Discounted Cash Flow – market support for key underlying assumptions

8. Role of Audit Firm Real property valuation specialists may be required to: • Estimate fair value at highest and best use • Allocate a purchase price among land, building and site improvements and assist others with personal property and intangible assets • Evaluate asset impairment • Perform valuation assignments for other purposes (i.e., alternate use, etc.)

9. ASC 820 Fair Value under ASC 820 The FASB issued ASC 820 (formally known as FAS 157), which defines fair value as, “the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Source: SFAS No. 157, Financial Accounting Standards Board, Sept. 2006

10. ASC 820 Fair Value Objectives Make financial reports understandable, relevant, reliable, and comparable Provide greater transparency than historical cost-based measurements Define fair value Establish a framework for measuring fair value Expand disclosures about fair value measurements

11. ASC 820 Fair Value Applications ASC 820 applies to all other statements issued by the FASB where fair value is discussed and it amends previous statements that provided different definitions of fair value. It does not eliminate the practicability exceptions to fair value measurements in accounting pronouncements within the scope of the Statement Market participants include buyers and sellers in the principal or most advantageous market for the asset

12. ASC 820 Fair Value – Standard Expressed in ASC 820 Intended to provide information to investors about the price an asset could be sold for at the measurement date Not intended to provide information on anticipated IRR or future results Retains exchange price notion in earlier FASB definitions of fair value Clarifies that the exchange price is the price in an orderly transaction between market participants and not a forced transaction

13. ASC 820 Fair Value – Standard Expressed in ASC 820 The Board revised the definition of fair value in this Statement to refer to an orderly transaction, as do other definitions used in valuations for purposes other than financial reporting that are similar to fair value (for example, fair market value) Fair value is generally consistent with similar definitions of fair market value The FASB recognized that fair market value relates mostly to assets (property)

14. ASC 820 Definitions - Some real estate assets affected before others: For all financial and nonfinancial assets recognized at fair value on a recurring basis …. For nonfinancial assets measured on a nonrecurring basis, such as impaired real estate For real estate investment companies investing in office buildings and the like, having a calendar year, and marking that investment to fair value on a recurring basis

15. ASC 820 Definitions - Some real estate assets affected before others: Provides a new definition of fair value Creates a framework for developing fair value estimates (or opinions) Requires additional disclosures for fair value estimates (or opinions)

16. ASC 820 Note the distinction between estimates and opinion: Preparer of financial statements may estimate an asset’s fair value In other instances, a fair value opinion will be acquired from a valuation specialist

17. IFRS 13 Fair Value under IFRS 13, is effective after January 1, 2013 Fair value is the estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties. A fair value measurement of a non-financial asset takes into account a market participant’s ability to generate economic benefits by using the asset in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use.

18. ASC 820 ASC 820 prioritizes valuation inputs Identify exit market Identify market participants • Principal or most advantageous market • In-use or in-exchange Identify valuation premise (highest and best use) Determine market participant assumptions Apply inputs to valuation techniques Exit price/fair value

19. ASC 820 Three Level Hierarchy Level 1 Quoted market prices in active markets for identical assets An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available…. Example: Valuation of an investment in the stock of a publicly traded REIT.

20. ASC 820 Three Level Hierarchy Level 2 - Directly or Indirectly Observable Inputs Quoted market prices in active markets for similar assets Quoted market prices for identical or similar assets in inactive markets Inputs other than quoted prices that are observable (credit risks, default rates, prepayment speeds, volatility index, interest rate and yield curves at quoted intervals)

21. ASC 820 Three Level Hierarchy Level 2 - Directly or Indirectly Observable Inputs (continued) • There are few transactions for the asset • The prices are not current • Price quotations vary substantially, either over time or among market makers • Little information is released publicly • Inputs other than quoted prices that are observable for the asset

22. ASC 820 Three Level Hierarchy Level 3 - Unobservable Inputs Allowed when observable inputs are not available For situations when there is little, if any, market activity at the measurement date Reporting entity’s own assumptions about the assumptions market participants would use Most private companies and the equity and debt securities in them fall into the Level Three category Developed from the best information available in the circumstances, which may include the reporting entity’s own data.

23. ASC 820 Framework for Evaluating Fair Value Assumptions Exposure to the market prior to the measurement date Not a forced transaction (e.g., forced liquidation or distressed sale) Sale of the asset occurs from the perspective of a market participant that holds the asset The price is the one that would be received to sell the asset at the measurement date. The FASB determined that exit price is appropriate as it presumes current expectations of future cash flows pertaining to the asset.

24. ASC 820 Framework for Evaluating Fair Value (continued) Reporting entity and valuation specialists need to determine: The asset that is the subject of the measurement For an asset, the valuation premise appropriate for the measurement (consistent with its highest & best use) The principal (or most advantageous) market for the asset The valuation technique(s) appropriate for the measurement

25. ASC 820 Framework for Evaluating Fair Value (continued) Principal (or Most Advantageous) Market Fair value assumes the sale of the asset occurs in the principal market for the asset or, in the absence of a principal market, the most advantageous market. • Principal market is the market … with (1) the greatest volume and (2) the greatest level of activity. • Most advantageous market … maximizes the amount that would be received for the asset considering transaction costs ….

26. ASC 820 Framework for Evaluating Fair Value (continued) Principal (or Most Advantageous) Market Fair value is considered from the perspective of the reporting entity, allowing for differences between, and among, companies having different activities. If there is a principal market for the asset, then the fair value measurement represents the price in that market, even if the price in a different market is potentially more advantageous.

27. ASC 820 Framework for Evaluating Fair Value (continued) Transaction Costs The price used to develop an asset’s fair value is not to be adjusted for transaction costs. • Represent the incremental direct costs to sell the asset or transfer the liability in the principal (or most advantageous) market for the asset or liability … not an attribute of the asset or liability…[but] specific to the transaction …. • Do not include cost to transport the asset to or from its market (applies to personal property).

28. ASC 820 Framework for Evaluating Fair Value (continued) Transaction Costs However, when disposition of the asset is typical for developing the fair value, then the disposition costs are included. Example In developing fair value using a DCF model, where the market participant would anticipate disposition costs in the final year’s reversion amount, those costs are relevant in estimating what a buyer would be willing to pay for the asset.

29. ASC 820 Framework for Evaluating Fair Value (continued) Identification of Market Participants Buyers and sellers in the principal (or most advantageous) market for the asset that are: • Independent • Knowledgeable • Able to transact for the asset • Willing to transact for the asset (not forced or compelled)

30. ASC 820 Framework for Evaluating Fair Value (continued) Identification of Market Participants Determination of fair value uses the same assumptions market participants would use to price the asset. The reporting entity identifies: • Characteristics that distinguish market participants • The principal (or most advantageous) market for the asset • Market participants with whom the reporting entity would transact in that market

31. ASC 820 Framework for Evaluating Fair Value (continued) Highest and Best Use: Value In-Exchange The highest & best use of the asset is in-exchange if the asset would provide maximum value to market participants principally on a standalone basis. If the highest & best use of the asset is in-exchange, the fair value of the asset shall be measured using an in-exchange valuation premise. When using an in-exchange valuation premise, the fair value of the asset is determined based on the price that would be received in a current transaction to sell the asset standalone.

32. ASC 820 Framework for Evaluating Fair Value (continued) The highest & best use of the asset establishes the valuation premise used to measure the fair value of the asset, specifically in-use or in-exchange. Fair value of an asset in-use is based on the use of the asset together with other assets as a group (at its highest & best use from the perspective of market participants), even if the asset … is aggregated (or disaggregated) at a different level for … other accounting pronouncements.

33. ASC 820 Framework for Evaluating Fair Value (continued) Highest and Best Use Management’s intention may not be relevant unless by coincidence it indicates market participants’ assumptions. For real estate (and personal property), the highest & best use principle can have a significant influence on fair value. The highest & best use for the asset is based on its use by market participants, not the subject reporting entity.

34. ASC 820 Framework for Evaluating Fair Value (continued) Initial Recognition When an asset is acquired in an exchange transaction for that asset, the transaction price represents the price paid to acquire the asset (an entry price). In contrast, the fair value of the asset represents the price that would be received to sell the asset (an exit price). • Valuation specialists need to understand that conceptually, entry prices and exit prices are different and entities do not necessarily sell assets at the prices paid to acquire them.

35. ASC 820 Framework for Evaluating Fair Value (continued) Initial Recognition • “In many cases, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition.” • In determining whether a transaction price represents the fair value of the asset at initial recognition, the valuation specialist needs to consider factors specific to the transaction and the subject asset.

36. ASC 820 Framework for Evaluating Fair Value (continued) Initial Recognition The transaction price may not represent the fair value… at initial recognition if: • Transaction is between related parties • Transaction occurs under duress or seller is forced to accept the price • Unit of account represented by the transaction price is different from the unit of account measured at fair value • Market in which the transaction occurs is different from the market in which the reporting entity would normally sell the asset

37. ASC 820 Accepted Methods of Valuation In selecting the appropriate valuation techniques, it is important to consider the availability of data to develop valuation inputs that represent the assumptions that market participants would use in pricing the asset … and the level in the fair value hierarchy within which the inputs fall. ASC 820 recognizes the three generally accepted valuation approaches: Market (Sales Comparison) Approach Income Approach Cost Approach

38. ASC 820 Accepted Methods of Valuation In some cases, a single valuation technique is appropriate If multiple valuation techniques are used, the results (respective indications of fair value) shall be evaluated and weighted (i.e., reconciled) as appropriate, considering the reasonableness of the range by those results A fair value measurement is the point within that range that is most representative of fair value in the circumstances

39. ASC 820 Conclusion — Opportunities for Appraisal “Typical” valuation assignment Client and Audit Firm will review Results impact Client’s financial statements

40. ASC 805 Business Combinations

41. ASC 805 Overview ASC 805 requires that intangible assets, aside from goodwill, be recognized if: • Contractual or other legal rights, such as patents or trademarks, give rise to intangible assets, or • The intangible asset can be separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged individually, or in combination with a related contract, asset or liability.

42. ASC 805 Tangible and Intangible Assets In accordance with ASC 805, the allocation of purchase price considers following tangible and intangible asset categories: Tangible Assets Land Building and site improvements Equipment and/or FF&E Tenant improvements

43. ASC 805 Tangible and Intangible Assets Intangible Assets Above/below market leases (leasehold value) In-place lease value, inclusive of downtime costs, lease commissions and legal fees Mark-to-market value of assumed debt Mark-to-market value of assumed ground lease position Customer (tenant) relationships

44. ASC 805 Land Value Using the Sales Comparison Approach land is valued by comparing the subject site to similar, recently sold properties in the surrounding or competing area. This approach relies on the principle of substitution, which holds that when a property is replaceable in the market, its value tends to be set at the cost of acquiring an equally desirable substitute property.

45. ASC 805 Building and Site Improvements The Cost Approach is based upon the economic principle of substitution, which states that the price of an asset tends to be no higher than the cost of producing a substitute property having equal utility, available without delay. This approach considers all hard and soft costs and the three potential forms of depreciation: Physical depreciation Functional depreciation External obsolescence

46. ASC 805 Go-Dark Analysis (Land + Building and Site Improvements) Alternatively, the combined value of the site and building improvements can be estimated via an estimate of the “as vacant” value of the property, with consideration given to the following: Lease-up period (to stabilization) Carrying costs, including all fixed and variable operating expenses Lease-up costs, including tenant improvements, leasing commissions and legal fees Typically accomplished using a discounted cash flow analysis, considering market conditions

47. ASC 805 Tenant Improvements Tenant improvements for occupied space is a negotiable item and ranges from “as-is” to “turn-key.” The value of tenant improvements should be based on the cost of the original fit-out of the space, but current market data can be considered when actual costs are unavailable.

48. ASC 805 Equipment and/or Furniture, Fixtures and Equipment Tangible personal property is defined as: “a right or interest in things of a temporary or moveable nature.” Typically valued using Cost or Market Approach methodology.

49. ASC 805 Above/Below Market Leases (Leasehold Value) The value of above and below market leases is estimated by calculating the difference between present value of the rental income coupled with the expense reimbursement revenue of each tenant as set forth in the lease agreements and the rental revenue that would be generated for that same tenant space at a market oriented rate as of the acquisition date.

50. ASC 805 In-place Lease Value Collectively, downtime costs, leasing commissions and legal fees are added together in order to calculate the in-place lease value. Downtime costs represent the value of the revenue that would be lost during downtime, including all rents and reimbursements, if the property were purchased 100% vacant and were then leased to the existing tenants using market oriented lease-up assumptions. Leasing commissions and legal fees reflect the estimated commissions/fees the landlord would have paid had they originated the leases in place on the acquisition date.