The debate over whether real estate
acquisition transactions should be valued as business combinations should have ended after the implementation of
Financial Accounting Standards No. 141
(FAS 141). Now a new change in the accounting standards will modify accounting for
investment property acquisitions.
Although FAS 141 was enacted in 2001,
some accountants were continuing to value
acquired real estate as land and buildings and
not recognizing intangible assets acquired
during real estate acquisition transactions. In
December 2007, the Financial Accounting
Standards Board issued Financial Accounting Standard No. 141 (revised), FAS 141R,
which replaced FAS 141, but retains the fundamental basis of the original standard. Its
adoption is also significant because it represents progress toward two additional initiatives: the gradual migration toward a single
set of international accounting standards and
the need for greater accuracy and a standard
presentation of financial reporting.
“Executives who invest in rental real estate
properties should become familiar with the
new accounting standard now,” says Paul
Louis, CPA, audit manager for the Audit and
Business Advisory Services Group at Haskell
& White LLP. “FAS 141R changes accounting
and reporting requirements for real estate
acquisitions in fiscal years beginning on or
after Dec. 15, 2008. It will require measuring
and recognizing the acquired business at its
full fair value as of the acquisition date.”
Smart Business spoke with Louis regarding what CEOs should know about the
change in standards under FAS 141R.
Are real estate acquisitions considered business combinations?
Yes, but the definition applies, with some
exceptions, to acquisitions of rental commercial or office property with tenants in place,
not vacant land or owner-occupied property.
Companies are not only purchasing the land
and building, but they are purchasing the
entire business. As part of the transaction,
the buyer obtains control over the real estate
and becomes responsible for all of its activities. In that respect, the acquirer’s balance
sheet will more accurately capture the fair
value of the assets acquired and assumed liabilities as of the acquisition date than it would
using a traditional approach.
How does FAS 141R impact the treatment of
acquisition costs?
This is one of the biggest changes under
FAS 141R. Direct professional fees related to
the acquisition, such as consulting fees or
due diligence costs, can no longer be capitalized or used as part of the real estate acquisition cost. Now, those fees must be completely expensed in the period in which they
occur. This change gives a real-time presentation for the fair value of the acquired assets
and assumed liabilities as well as the expenses. This will impact the profitability of the
acquiring company in the acquisition year as
well as the years immediately preceding and
following the acquisition.
How does FAS 141R change the allocation of
tangible and intangible assets?
Tangible assets include land, building, site
improvements and tenant improvements.
Intangible assets include the value of existing
leases (including the value of those leases
that are above or below existing market
rates), customer relationships, leasing commissions and legal and marketing costs. FAS
141R retains the guidance of FAS 141 for
identifying and recognizing intangible assets.
The value of all acquired assets and assumed
liabilities should be based on fair value. The
value of the existing leases and the materiality of those leases are some of the major components for the determination of intangible
assets value. The acquired tangible and intangible assets and any assumed liabilities can
be valued using one of these approaches or a
combination: sales comparison, income
approach or cost approach valuation.
What other changes should CEOs expect from
FAS 141R?
Expect to provide greater transparency and
disclosure to the financial statements’ user.
The users will often be lenders or investors,
who will benefit from greater standardization
so they can compare expenses and values
across similar transactions. The auditor will
test the reasonableness of the assumptions
used by valuation and appraisal specialists in
setting the property’s fair value.
How can CEOs prepare for the change?
Begin addressing the changes with team
members who are involved with real estate
acquisitions and the members of the accounting department who prepare your company’s
financial statements. Run financial models as
part of the due diligence process to understand how the new standards will impact
your company’s profitability as you consider
new deals. Be sure to identify all the costs,
including all the depreciation and amortization of tangible and intangible assets, respectively. Watch for updates and check with
your accountant for more information.
Lastly, remember FAS 141R applies to
acquisitions made on or after the beginning
of the first annual reporting period beginning
on or after Dec. 15, 2008. So for companies
that have a fiscal year-end of Dec. 31, this
new FAS statement is applicable for acquisitions made on or after Jan. 1, 2009; and early
adoption of the standard is prohibited.
PAUL LOUIS, CPA, is an audit manager for the Audit and Business Advisory Services Group at Haskell & White LLP. Reach him at
(949) 450-6237 or [email protected].
