Revenue Recognition for Real Estate Sales and Purchases
We talked about this before in our article that relates to this topic regarding revenue recognition for property managers. This topic is also important for real estate companies as well, in order for them to be in compliance with the new accounting standards adopted by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
These new standards require changes in revenue recognition for real estate companies when they are involved in the sale and/or the purchase of properties.
This is not something that is happening far out in the future. This is something that is happening now. It is important for real estate companies to be prepared for the changes in order to make the proper procedural shifts that are necessary to remain in compliance with the new regulations.
Here is a summary of the changes to the new revenue recognition rules and how they apply to real estate companies that are involved in the sale or the purchase of real estate.
New Accounting Rules for Real Estate Sales/Purchase Agreements
The general guidance includes recognizing revenue in such a way that accounts for how the revenue is calculated and this is especially important regarding sale/leaseback transactions.
As we noted before, these general guidance rules require taking the five following steps:
Step 1 – Identify the contract(s) with each customer.
Step 2 – Identify the performance obligations in the contract(s)
Step 3 – Determine the transaction(s) value.
Step 4 – Allocate the transaction(s) according to the performance obligation(s) under the contract.
Step 5 – Recognize revenue at the time when the performance obligation(s) are satisfied.
These steps are the same for all revenue recognition calculations under the new regulations.
The effects for real estate companies that buy and sell properties are complex and how the accounting needs to be done properly is something that needs careful scrutiny. The things that need to be considered are collectability concerns and collaborative arrangements.
The property needs to be organized in three categories:
- Property intended for sale in the ordinary course of business is accounted for as inventory and then when it is sold the revenue is recognized as a payment from a contract with a customer.
- An owner-occupied property is considered as an asset under property, plant, and equipment.
- Property held for rental income is categorized as an investment property.
Here are a few issues where we can help with any questions you may have. These issues are very complicated. Our simple summary is only an idea of why and how you need to seek more professional help that can give the in-depth answers regarding any specific transaction.
Real Estate companies now need to use good judgment for the following situations:
- Contributions of Real Estate in Transactions – The contribution of real estate to a joint venture is made at the investor’s cost, less any related depreciation and/or valuation allowances. This is the same if the transaction involves other investors who contribute cash, property, or services, with certain exceptions. If the transaction has the characteristics of a sale of the real estate, for example, if the investor gets some cash from the transaction for the contribution of the real estate, such a contribution is subjected to the new rules. If the investor is not required to re-invest the cash received, then the cash that the investor gets from the transaction is now considered revenues. No matter what form the contribution of real estate to a transaction takes, if the investor receives cash from the transaction, those funds are now considered revenues.
- Sale/Leaseback Transactions – These transactions are considered as a complete transfer of the property to the new owner for revenue recognition purposes with certain exceptions. The key to understanding this issue is to determine if the transfer is considered “secure” and if the ownership of the property is transferred by the transaction. A “secure” transaction is one where there is a high probability that the entity making the leaseback payments will continue to make all timely payments due under the leaseback agreement. For additional security, they may have pledged other collateral besides just the leaseback property involved in the transaction. A more secure leaseback transaction is based on a stronger creditworthiness of the entity obligated to make the leaseback payments.
- Financing Arrangements – Transactions that do not meet the following criteria are now considered “financing transactions”: 1) When a transaction is not a “normal” leaseback transaction.; 2) Payment terms and provisions do not adequately demonstrate the real estate property buyer’s interest in and continuing ownership of the subject property, and; 3) There is not a transfer of all of the risk and rewards of the ownership of the property to the new owner under the sale/leaseback transaction. Revenues are recognized in a different way when the transaction is a “financing transaction” because there is less absolute certainty that the payments will be made to complete the transfer of the ownership of the property. For example, if the only collateral in the transaction is the subject real estate and the entity making the payments for the real estate does not have a strong creditworthiness, the revenues from the payments are not recognized until received. The level of certainty of receiving future payments in a transaction is a judgment call that is made by a professional analysis of each specific transaction.
There are a variety of situations commonly experienced by real estate companies that fall under the new rules, which now require new accounting methodologies. Revenue recognition allocation procedures need to be put in place to handle these situations consistently and in accordance with the new rules. It is best to contact the professional consultants at Revenuerec.com for a complete assessment of your current situation and for recommendations about accounting procedures before you experience any difficulty for failing to be in compliance with these new rules.
Here are resources that we recommend reviewing in order to learn more about this subject:
Accounting for Real Estate Sales Under the New Revenue Standard
A Look At Current Financial Reporting Issues
Lessor Accounting – How The New Lease And Revenue Standards Interact
Recognizing Revenue In The Real Estate And Construction Industries
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Contact us to find out if you qualify for a valuable, no-obligation Discovery Consultation to further explore implementing these new standards and to validate the new accounting procedures are being applied correctly at your company.