May 11, Business Activities. The entity s substantive activities relate to investing in real estate.

Transcription

1 Board Meeting Handout Investment Properties Presentation and Consolidation of Investment Property Entities, and Scope Overlap between Investment Property Entities and Investment Companies Purpose of This Meeting May 11, The purpose of this meeting is to discuss presentation and consolidation methods for an investment property entity, as well as how to address the overlap between investment property entities and investment companies. Background 2. The Board tentatively decided that the investment properties guidance would apply to an entity that meets all of the following criteria: (a) (b) Business Activities. The entity s substantive activities relate to investing in real estate. Business Purpose. The express business purpose of the entity is to invest in real estate for total return including an objective to realize capital appreciation. The entity has potential strategies for realizing capital appreciation, including selling a property to maximize its total return. The entity s business purpose is not to hold real estate properties for the following: (1) Use in the production or supply of goods or services or for administrative purposes (2) Rental income only (3) Sale in the ordinary course of business. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations

2 (c) (d) (e) Unit Ownership. Ownership in the entity is represented by units of investments, such as shares or partnership interests, to which proportionate shares of net assets can be attributed. Pooling of Funds. The entity has one or more unrelated investors that hold significant ownership interests in the entity. Reporting Entity. The entity can be, but does not need to be, a legal entity. Notwithstanding the conditions noted above, entities that have only one investor that accounts for its investments at fair value pursuant to a requirement or an option under U.S. generally accepted accounting principles (GAAP) are not subject to the unit ownership and pooling of funds requirements. Issue 1: Investment Property Entity Presentation 3. For entities currently reporting real estate investments at fair value, various presentation methods have been developed in practice. The staff notes that the presentation methods being used in practice are variations of (a) the net method (similar to the investment company presentation) or (b) the gross method (similar to the noninvestment company presentation). Net Presentation Method 4. Under the net presentation method, an entity whose portfolio includes real estate properties carried at fair value would net gross rental income with related property expenses and then present the net income from investment properties in one line on its income statement. 5. In the statement of financial position, entities using the net presentation method would generally offset the debt with the property s value to present the net investment in properties. 2

3 Gross presentation method 6. Under the gross presentation method, an entity whose portfolio includes real estate properties carried at fair value would present gross rental income separately from related property expenses on its income statement. 7. In the statement of financial position, entities using the gross presentation method would generally present debt relating to an investment property separately from the investment property. Staff Recommendation 8. The staff recommends that the Board require separate presentation of rental income from investment properties and investment property-related expenses in an investment property entity s income statement. The staff also recommends that the Board require separate presentation of the value of investment properties and related debt instead of netting them on the balance sheet. The staff notes that the presentation of these four line items reflects the risks, benefits, and profitability associated with investment property entities. Question 1 Presentation Does the Board want to require separate presentation on the face of the financial statements of the following: 1) Rental income from investment properties? 2) Investment property-related expenses? 3) Investment properties? 4) Debt related to the investment properties? 3

4 Issue 2: Investment Property Entity Consolidation 9. There are three scenarios that the Board needs to address related to whether an investment property entity should consolidate an entity in which it holds a controlling financial interest: (a) (b) (c) Scenario 1: An investment property entity has a 100 percent ownership interest in another investment property entity. Scenario 2: An investment property entity has a 70 percent ownership interest in another investment property entity. Scenario 3: An investment property entity has a controlling interest in a noninvestment property entity. 10. Due to the similarities between investment property entities and investment companies, the discussion below compares the alternatives to the consolidation requirements for investment companies under Topic 946 as well as the general consolidation guidance under Topic 810. Scenario 1: An investment property entity has 100 percent ownership interest in another investment property entity 11. Consistent with industry practice for investment companies and the general consolidation guidance for noninvestment company entities, the staff thinks that an investment property entity (the parent) should be required to consolidate a 100 percent-owned subsidiary if that subsidiary is also an investment property entity. Question 2 Consolidation for investment property subsidiaries Does the Board support consolidation by an investment property entity of 100 percent-owned investment property subsidiaries? 4

5 Scenario 2: An investment property entity has 70 percent ownership interest in another investment property entity 12. Topic 946 is silent on whether an investment company should consolidate majorityowned investment companies. However, in practice, most investment companies do not consolidate nonwholly-owned subsidiaries. The staff notes that the Board has three alternatives for consolidation under this scenario. Alternative 1. Require consolidation 13. Under this alternative, the parent entity would apply the consolidation requirements in Topic 810 and consolidate its nonwholly-owned investment property entities. Alternative 2. Require investments in nonwholly-owned investment property subsidiaries to be presented at fair value (no consolidation) 14. Under this alternative, the parent company would present its investment in a nonwholly-owned investment property entity at fair value on one line item. Alternative 3. Remain silent on consolidation 15. Alternative 3 is the most consistent with current guidance for investment companies. Staff Recommendation 16. Some staff members recommend Alternative 1, to require investment property entities to consolidate nonwholly-owned investment property subsidiaries, and other staff members recommend Alternative 3, to remain silent on the issue. Question 3 Consolidation for nonwholly-owned investment property subsidiaries Which alternative does the Board support for nonwholly-owned investment property subsidiaries? 5

6 Scenario 3: An investment property entity has a controlling financial interest in a noninvestment property entity 17. Under this scenario, the issue is whether an investment property entity should apply the general consolidation guidance under Topic 810, which is to consolidate the subsidiary, or follow a method similar to investment companies, whereby majority-owned investments in noninvestment property subsidiaries would be presented at fair value on one line. 18. The staff has identified two alternatives for the Board to consider for this scenario: Alternative 1. Require fair value for investments in noninvestment property subsidiaries (no consolidation) 19. Under this alternative, investment property entities would account for controlling investments in other noninvestment property entities at fair value on one line, which is similar to the approach used by investment companies. Alternative 2. Require consolidation of the noninvestment property subsidiary 20. This alternative is consistent with consolidation guidance under Topic 810. It is also consistent with the treatment by investment property entity parents of investment property entity subsidiaries. No exceptions would need to be made to Topic 810 or to the tentative investment property guidance under Alternative 2. Staff Recommendation 21. The staff recommends Alternative 1. Under Alternative 2, when a controlled investment is not an investment property entity, requiring the investment property entity to consolidate the investee may provide less useful information to users of the consolidated financial statements because operating details of the noninvestment property entity would be combined with rental revenue, expenses, and property-related debt. Therefore, the staff thinks that accounting for the investment at fair value under Alternative 1 (similar to the accounting by an investment company of noninvestment companies) is more appropriate. 6

7 Question 4 Consolidation for noninvestment property subsidiaries Which alternative does the Board support for noninvestment property subsidiaries? Issue 3: Scope Overlap between Investment Companies and Investment Property Entities 22. This issue discusses which set of guidance (investment companies or investment property entities) an entity that invests in real estate should follow. Since the investment property entity definition is designed to allow entities that invest in real estate properties along with real estate securities to qualify as an investpment property entity, there is overlap between the definitions of an investment company and an investment property entity. 23. The main difference between an investment company and an investment property entity is the criterion requiring the entity to manage its investments on a fair value basis. The investment company guidance includes a criterion in which substantially all of the entity s investments are managed, and their performance evaluated, on a fair value basis; however, investment property entity guidance does not include that criterion. 24. Another difference between an investment company and an investment property entity is related to disclosure requirements. For an investment property entity, the Board has decided that the disclosures should include (1) the methods and assumptions used in calculating the fair value of investment properties, (2) rental income and expense recognized in profit and loss for investment properties, (3) a reconciliation between the carrying amounts of investment property at the beginning and end of the period, and (4) a reconciliation for significant adjustments. Topic 946 does not specify disclosures for properties but, instead, requires disclosure of financial highlights, which include per share information, financial ratios, and total return. Thus, if an entity meets the criteria of both investment companies and investment property entities, it is not clear whether that entity would be required to provide disclosures under both sets of guidance. 7

8 If so, some entities would be required to provide additional disclosures compared to what those entities (for example, real estate investment trusts) disclose under current U.S. GAAP. 25. Additionally, depending on the Board s decisions on presentation and consolidation for Issue 1 and 2, there could be additional differences between an investment company and an investment property entity. Approaches 26. The staff is presenting the following approaches for those entities that meet the definitions of an investment property entity and an investment company: Approach 1 Require the entity to follow investment property entity guidance 27. Under this approach, entities that meet both definitions would apply investment property entity guidance. This approach is based on the belief that the investment property guidance is more comprehensive in addressing investments in real estate than investment company guidance, which focuses more on investments in securities. 28. This approach also would require real estate investment entities that register under the SEC s 1940 Investment Company Act to follow the SEC requirements in addition to the investment property entity guidance. Approach 2 Require the entity to follow investment company guidance 29. Under this approach, entities that meet both definitions would apply investment company guidance. This approach would allow entities that are applying investment company guidance today to continue with current practice. Current investment company disclosures include a schedule of investments and financial highlights, which include per share information, financial ratios, and total return. Entities that invest in a significant amount of securities would be able to keep those valuable disclosures. 30. However, choosing this approach could significantly reduce the application of the investment property guidance for entities that do not fall within investment property guidance alone. In effect, entities that would most appropriately fit into 8

9 investment property entity guidance (such as those that hold significant properties) would lack the gross presentation that investors need to properly assess the property performance. Approach 3 Remain silent on which set of guidance an entity should apply 31. This approach is based on the notion that real estate investments can take different forms, making it nearly impossible to prescribe one method of presentation or consolidation. 32. The industry has developed into different sectors based on similarities and differences of entities investment and operating strategies. Therefore, entities tend to compare their performances to their peers in the same sector. Approach 3 would allow the industry and market to drive the method of presentation and disclosure that would best serve the financial statement users of a real estate investment entity. 33. Those opposed to this alterative are concerned that allowing an option would result in a lack of consistency. Those in favor of this approach note that the industry, market, and users would drive comparability among similar entities. Entities would need to evaluate the needs of their users and use judgment to determine the industry guidance in which they are best suited. Staff Recommendation 34. The staff recommends Approach 3 because it would provide flexibility based on substance. Question 5 How to Address the Scope Overlap Which approach does the Board support relating to the overlap between investment companies and investment property entities? 9