A Closer Look at FASB’s Latest ASU

BDO’s Julie Valpey and Brandon Landas discuss the key changes and impact of the Financial Accounting Standards Board’s latest update on real estate transactions.
Brandon Landas, Assurance Partner, BDO
Brandon Landas, Assurance Partner, BDO

Chicago and New York—The Financial Accounting Standards Board (FASB) published an Accounting Standards Update (ASU)  on Jan. 5 to clarify the definition of a business. More precisely, the new regulation helps companies and other organization determine more easily whether the purchase (or sale) of an asset or group of assets qualifies as the purchase (or disposal) of a business.

The update requires investors to capitalize acquisition costs for an asset acquisition, whereas for business combinations, these costs are expensed immediately. Julie Valpey and Brandon Landas, assurance partners in BDO’s National Security Exchange Commission (SEC) Department, explain the practical side of this new guidance and its effects on real estate transactions.

CPE: What are the key changes this ASU will bring and how will they impact the commercial real estate industry?

Brandon Landas: ASU 2017-01 clarifies whether transactions should be treated as asset acquisitions or business combinations, and it adds a screening process to help companies determine when an asset is not a business. The guidance impacts transactions across all sectors, but it will have a particular impact on the commercial real estate industry.

Previously, most acquisitions of real estate were treated as business combinations. Under this new guidance, the majority of real estate transactions will likely be treated as asset acquisitions because land, buildings and related intangibles at each property can be considered a single asset. When the purchase price is predominantly related to a single asset or group of similar assets, it will be considered an asset acquisition.

CPE: What benefits do these changes have for the real estate industry? Conversely, do these changes negatively impact the real estate industry in any way?

Julie Valpey: The primary purpose of this ASU is to clarify when transactions should be treated as a business. The new guidance should create a consistent framework for how real estate companies report and account for real estate transactions. One of the benefits for the real estate industry is the requirement to capitalize acquisition costs for an asset acquisition, whereas those costs are expensed immediately for business combinations.

In addition, while the accounting for real estate acquisitions is not expected to change much—companies will still be required to do a purchase price allocation for the assets and lease intangibles acquired—the determination as to which standard to apply (business combinations or asset acquisition accounting) will be easier.

Julie Valpey, Assurance Partner, BDOJulie Valpey, Assurance Partner, BDO
Julie Valpey, Assurance Partner, BDO

CPE: What will be some of the challenges in implementing this new guidance?

Landas: The introduction of a new or updated accounting standard always carries an initial compliance burden. Real estate companies can help minimize those challenges by adopting the guidance and implementing the changes early on in the process. For public companies, the ASU goes into effect for annual periods beginning after Dec. 15, 2017, including interim periods within those annual periods.

For all other companies, the update is effective for annual periods beginning after Dec. 15, 2018, and interim periods within annual periods beginning after Dec. 15, 2019. Real estate companies can choose to apply the guidance to transactions before the issuance date of the ASU, if the transaction has not yet been reported in issued financial statements. We expect many companies will adopt the ASU for transactions occurring in 2017.

CPE: Do you feel the new guidance is clear enough or does it leave room for interpretation,  particularly in regards to what assets should or shouldn’t be considered ‘similar.’

Landas: The new standard indicates that companies should consider the nature of the assets and the risks associated with managing and creating outputs when determining if assets are similar. If the risks are not similar, the assets cannot be combined for the screen. For real estate entities whose sole business is investing in and leasing property, this guidance is fairly straight forward—land, buildings and related lease intangibles are considered to be a single asset.

However, for real estate entities that acquire portfolios of real estate, assessment of the risks of individual properties within the portfolio requires judgment. Additionally, for entities that conduct activities other than property leasing, identifying similar assets based on the nature of the assets and their risk characteristics will require significant judgment. The guidance includes helpful examples to illustrate how to make these evaluations.

Valpey: It’s important to note, however, that even though real estate acquisitions will no longer meet the definition of a business under this new standard, the requirements for SEC reporting purposes have not changed. Under SEC Rule 3-14, the SEC requires public real estate companies to submit financial information for an acquired property. Many real estate executives expected the SEC to change its reporting requirements to more closely align with the FASB’s guidance, but that hasn’t been the case.

CPE: How will these changes influence real estate financing and will they encourage or discourage transactions?

Valpey: We don’t expect this ASU will have a significant impact on real estate financing, since it won’t impact real estate values or how real estate operations are accounted for. However, since acquisition costs will now be capitalized instead of expensed, we expect there will be less volatility from year to year in financials and a simpler ROI calculation.

While the guidance changes the way real estate companies will treat acquisitions on their financial statements, we wouldn’t expect it to serve as a real incentive or disincentive for real estate transactions.

CPE: What will be the effect in the long term?

Landas: The guidance may not have as big of an impact as some real estate executives expected. While the accounting classification will change from a business to an asset acquisition, similar assets and liabilities will be recognized as part of the acquisition. As we touched on earlier, instead of expensing the acquisition costs, companies will capitalize those costs.

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