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Moore Together: Implementing Revenue Recognition for Real Estate, Part I

Moore-Together-Graphic.jpgMoore Stephens North America is comprised of over 42 member firms that provide key services across a wide variety of industries and niches. This month’s “Moore Together” is a collaboration between Nancy Cox with The Bonadio Group and Jessica Saugstad with HCVT.
As you may have heard, ASU 2014-09, Revenue from Contracts with Customers (Topic 606) is coming! It is effective for years beginning after December 15, 2018 for private companies. If you work with public companies, the standard is already effective. Although ASU 2016-02, Leases, is not effective until years beginning after December 15, 2019, the two standards will likely go hand in hand for real estate companies and should be considered together. In this article we will focus on steps to help your clients proactively consider the standards as it relates to their business. We will go into more depth as it relates to the technical application in a subsequent article.
The role we play could be critical and potentially ease the burden in the year of adoption to our clients.  It is often difficult to get our clients to understand the significance that these new accounting standards could have on their organizations.  Some of our clients may have a misconception that the adoption will be quick and simple.  Getting their attention and encouraging them to start thinking about these standards early is imperative to a successful adoption. 
Below is suggested guide to help accountants and companies prepare for implementation.
  • Schedule a meeting with your clients as soon as possible. Some questions to consider:
    • Have you considered the effect the new revenue recognition guidance will have on your business?
    • Have your key accounting personnel received related training?
    • What approach have you used to determine the effect? Is it documented?
    • Do you plan to use the full or modified retrospective application?
    • Do you have controls in place over the process to determine how revenue will be recognized?
    • Have you considered the changes you will need related to your accounting systems?
    • Have you considered the disclosures that will be required?
    • Do your current systems have the capabilities to produce the information you will need for additional disclosures?
    • Have you received any consulting advice regarding implementation?
    • Have you considered the tax impacts as a result of implementation?
A majority of private companies will be unable to answer the questions above. Even if a company has performed an evaluation and determined that there will be minimal changes to revenue recognition as a result of the standard, accountants should remind them that 1) the evaluation should still be completed and documented, and 2) there will still likely be additional disclosure requirements, which will require additional consideration.
There may be opportunity to help our clients with the implementation process.  Depending on the level of service provided to these clients, accounting firms need to be mindful of maintaining independence. Provided that management accepts responsibility and has the skills, knowledge and experience necessary to apply the guidance, accountants may be able to assist with the transition.
The first step to determine the effect Topic 606 will have, is to determine the company's revenue streams and review its contracts. In general, real estate companies may have standard contracts, which will make it easier to implement Topic 606. Companies with customized contracts may want to consider standardization if possible. Some considerations are documented below.
Company Considerations:
  Lease / Rental Agreements:
  • Review lease agreements:
    • Are there typically "non-lease" components?**
      • Items the tenant would have been otherwise required to contract for (e.g., maintenance, utilities)
      • Lease components (rent) = follow lease standard, non-lease components = follow revenue recognition standards
  Sale Transactions:
  • Review a typical contract:
    • Isolate any separate performance obligations outside of the sale itself. For example:
      • Property management services
      • Development of amenities (e.g., pool, tennis court)
      • Design services
  • When does the buyers ability to direct the use of the performance obligation typically occur?
    • This will effect when the revenue is recognized
  • Review capitalized costs to incur the contracts and separate into:
    • Direct costs that would not have occurred if the contract had not been executed (e.g., commissions)
    • Expenses that would have been incurred regardless of whether the contract was obtained (e.g., travel and professional advisor fees)
    • Direct costs will continue to be capitalized, other items will now be expensed
  Other Considerations:
  • Does the company have related party leases? Are the leases formalized? 
  • Does the company engage in sale/leaseback transactions?
  • Should contract language be modified or standardized?
Accountant considerations:
  • Send articles and other relative information related to the new standards to clients.
  • Schedule a meeting with management to discuss the items detailed above.
  • Invite clients to attend relevant seminars/webcasts.
  • Document conversations related to implementing the new standard.
  • Consider independence as it relates to implementation.
  • It is determined that the accounting firm will help management with implementation:
    • Draft an engagement letter in a manner consistent with maintaining independence.
    • Document independence considerations.
    • Obtain a list of contracts and leases.
  • For December 31, 2018 engagements:
    • Ensure management has included proper disclosure regarding the effect that the standard will have on the 2019 statements.
    • Consider representation letter inclusion regarding managements analysis of the effects and processes in place.
    • Document the new standards and their anticipated effect in the letter to those charged with governance.
    • Consider management letter comments as it relates to 1) managements understanding of the new ASU, 2) internal controls surrounding the implementation of the new ASU, 3) related party leases that are not formalized or up to date.
    • While performing risk assessment, include analysis of accounting systems and processes as it relates to capabilities needed to implement.
 Keep in mind that public companies have already began implementing the new standard and interim financial statements will have likely been already filed. Review public real estate entity 10-Q's and closely monitor articles and related commentary regarding implementation efforts. The Center for Plain English Accounting (CPEA) can also be a good resource for staying up to date with the new standards.

We will end with a quote directly from the CPEA's Report dated May 16, 2018 related to the early results and lessons from implementation of FASB ASU 606. "Preparation should include monitoring applicable significant judgments and challenges faced by others. Some entities may be tempted to find the expedient path with quick judgments designed to minimize current costs. Given the importance of revenue, judgments are likely to face additional scrutiny beyond auditors and bankers from peer reviewers, regulators, purchasers, passive shareholders, and employees. Proper research and preparation will form the basis for a lasting foundation."

To learn more about implementing revenue recognition for real estate, please contact Nancy Cox with The Bonadio Group or Jessica Saugstad with HCVT. NOTE: Keep an eye out for part two of this piece for a more technical overview of this topic!

We’re great alone, but we’re “Moore Together!” If you would like to collaborate with other members, or if you have a topic you would like to address, please contact Laura Ponath.
** Note that in January, the FASB issued a proposal to make the lease accounting standard easier to apply. The proposed ASU, would add a practical expedient that would permit lessors to not separate non-lease components from the associated lease components if certain conditions are met. This practical expedient could be elected by class of underlying assets; if elected, certain disclosures would be required.