ACCOUNTING FOR REAL ESTATE - Wiley

COPYRIGHTED MATERIAL

1 PART

ACCOUNTING FOR REAL ESTATE TRANSACTIONS--GENERAL

1

1 CHAPTER

ACQUISITION, DEVELOPMENT, AND CONSTRUCTION OF REAL ESTATE

1.1 OVERVIEW

4

1.2 ACQUISITION, DEVELOPMENT, AND

CONSTRUCTION COSTS

5

1.2.1 Preacquisition Costs

6

1.2.1.1 Principles for the

Capitalization of

Preacquisition Costs

6

1.2.1.2 Capitalization of Internal

Preacquisition Costs

8

1.2.2 Project Costs

9

1.2.2.1 Direct Costs

9

1.2.2.2 Indirect Costs

10

1.2.2.3 General and Administrative

Expenses

12

1.2.2.4 Property Taxes and

Insurance

12

1.2.2.5 Interest

13

1.2.3 Cost Allocation

16

1.2.4 Change in Estimates or Project Plans

and Abandonments of Projects 19

1.3 COSTS INCURRED TO SELL OR

RENT A REAL ESTATE PROJECT

21

1.3.1 Costs Incurred to Sell a

Real Estate Project

21

1.3.2 Costs Incurred to Rent a

Real Estate Project

24

1.4 INCIDENTAL OPERATIONS

24

1.5 ACCOUNTING FOR COSTS

INCURRED SUBSEQUENT TO

PROJECT COMPLETION

25

1.5.1 Determining the Date of Project

Completion

25

1.5.2 Costs Incurred Subsequent

to Project Completion

26

1.6 PURCHASE OF INCOME

PRODUCING PROPERTY

27

1.6.1 1.6.2 1.6.3

1.6.4

1.6.5 1.6.6

Purchase of a Business

27

Purchase of an Asset /Asset Group 29

Recognition of Intangible Assets

Acquired

29

Valuation of Land, Buildings, and

Intangibles

31

Allocation of Acquisition Cost 33

Accounting Subsequent to

Acquisition

36

1.7 SPECIAL ACCOUNTING ISSUES

36

1.7.1 1.7.2 1.7.3 1.7.4 1.7.5

1.7.6

Costs of Amenities

36

Start-Up Costs

38

Land Options

39

Financing as Part of a

Purchase Transaction

43

Environmental Costs and

Liabilities

44

1.7.5.1 Asset Retirement

Obligations

45

1.7.5.2 Environmental Remediation

Liabilities

47

1.7.5.3 Capitalizing versus

Expensing of Environmental

Remediation Costs

51

Transactions with Related Parties 52

1.7.6.1 Financing Provided by

Related Parties

52

1.7.6.2 Interest Capitalization on

Investments Accounted for

by the Equity Method 53

1.7.6.3 Purchase of Real Estate

from Party under Common

Control

53

3

4 Chapter 1 Acquisition, Development, and Construction of Real Estate

1.8 FINANCIAL STATEMENT

1.9 INTERNATIONAL FINANCIAL

PRESENTATION AND DISCLOSURE 54

REPORTING STANDARDS

57

1.8.1 Cash Flow Statement

1.9.1 IAS 16

57

Presentation

54

1.9.2 IAS 40

61

1.8.2 Segment Disclosures for Public

Companies

55 1.10 SYNOPSIS OF AUTHORITATIVE

1.8.3 Other Presentation and Disclosure

LITERATURE

65

Requirements

55

1.1 OVERVIEW Investments in real estate projects require significant amounts of capital. For real estate properties that are developed and constructed, rather than purchased, project costs include the costs of tangible assets, such as land and other hard costs (sometimes referred to as "bricks and mortar"); intangible assets and other soft costs, such as architectural planning and design; and interest and taxes. Costs are often incurred before the actual acquisition of the project, which raises certain questions--for example, from what point in time should costs be capitalized? What types of costs are capitalizable?

Determining what types of costs to capitalize in the preacquisition, acquisition, development, and construction stages of a real estate project has been an issue for many years. Several decades ago, the American Institute of Certified Public Accountants (AICPA) issued the following accounting guidance relating to cost capitalization, reacting to significant diversity in practice:

? Industry Accounting Guide, Accounting for Retail Land Sales, issued in 1973

? Statement of Position (SOP) 78-3, Accounting for Costs to Sell and Rent, and Initial Rental Operations of, Real Estate Projects, issued in 1978

? SOP 80-3, Accounting for Real Estate Acquisition, Development, and Construction Costs, issued in 1980

In 1982, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 67, Accounting for Costs and Initial Operations of Real Estate Projects, extracting the accounting principles provided by these AICPA pronouncements. Nevertheless, diversity in practice has continued to exist in some areas, including the capitalization of indirect costs during the development and construction period and the treatment of repair and major maintenance costs incurred subsequent to the completion of real estate projects.

The AICPA undertook another project to develop a comprehensive framework for cost capitalization and, in 2003, issued for public comment the proposed Statement of Position, Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment. That proposed SOP was approved

1.2 Acquisition, Development, and Construction Costs 5

by the AICPA Accounting Standards Executive Committee (AcSEC), in September 2003; however, a final SOP was never issued. In April 2004, the FASB decided not to clear that proposed SOP, mainly for the following stated reasons:

? Lack of convergence with International Accounting Standards ? The concept of componentization, particularly the amount of judgment

allowed, which could potentially result in lack of comparability ? Implications for the capitalization of major overhaul expenses

1.2 ACQUISITION, DEVELOPMENT, AND CONSTRUCTION COSTS FASB Statement No. 67 provides the primary authoritative guidance for the cost capitalization of real estate project costs. That Statement divides the costs incurred to acquire, develop, and construct a real estate project into preacquisition and project costs. Preacquisition costs encompass costs incurred in connection with, but prior to the acquisition of, real estate. Project costs include costs incurred at the time of the real estate acquisition, as well as costs incurred during the subsequent development and construction phase (see Exhibit 1.1).

Preacquisition Costs

Project Costs (Acquisition, Development, and Construction

Costs)

Time of Acquisition

EXHIBIT 1.1 ILLUSTRATION OF COST CLASSIFICATION

Real estate developed by a company for use in its own operations other than for sale or rental is not within the scope of Statement 67.1 Because--aside from the proposed SOP, Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment--there is no authoritative literature relating to the capitalization of costs for properties used by an enterprise in its own operations, the guidelines in Statement 67 are generally also applied to properties used by an enterprise in its own operations.

1 FAS 67, paragraph 2(a)

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