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Financial statements are a tool that investors, creditors and management use as a financial dashboard of the business or fund. It is important that financial statements are designed in a manner that is easy to understand by these users. In financial reporting, it is strongly advised that the financial statements be prepared in accordance with the standards, and present information in a clear and simple manner without omitting useful information.

In order to provide the most transparent financial information to the users, a real estate fund’s management, administration firm, and audit firm should foster a collaborative environment. Identifying proper financial reporting requirements, as well as useful financial statement information in a timely manner, will be critical to the overall presentation of a fund’s audited financial statements.

During the planning phase of your audit, discuss the draft financial statements with your auditors in order to avoid unexpected surprises, such as new or required disclosures as a result of new accounting standards updates (ASUs) that may affect your fund. Being proactive could alleviate delays when you are trying to finalize your audited financial statements.

Let’s review some “Dos and Don’ts” that go into the preparation of the financial statements of real estate funds.

Choose the right basis of accounting for your fund

Cash, Accrual or Tax Basis – which basis of accounting is best for your fund? Users rely on the financial statements to gain an understanding of your fund’s financial position and the results of its operations. Regulatory requirements surrounding your fund, following an established framework (generally accepted accounting principles or GAAP), or provisions in your organizational documents are just some of the factors to consider when making a choice.

• Do: seek out the advice of your attorney, administration, or audit advisor regarding the proper basis. Make sure this is done prior to finalizing your fund documents. These advisors will be able to guide you through the advantages and disadvantages of each option and provide valuable insights on what could be the right fit for your fund.
• Don’t: choose a methodology solely because of what you have seen the most, is the most popular, or is the least costly to maintain.
• Don’t: deviate from the basis of reporting outlined in your fund documents as this can be problematic.  Unless necessary and beneficial, don’t contemplate changing your basis at a later date as the process could be costly and time consuming.

Be consistent in applying valuation methodologies

When it comes to the financial statements of a real estate fund, one of the most critical disclosures relates to the valuation of the fund’s underlying investments. There must be adequate disclosures which should include the valuation techniques, methods and inputs used by the fund to measure fair value of the real estate, including any judgments and assumptions.

• Do: make sure your financial statement disclosures align with the policies and procedures the fund has written in the fund agreements.
• Do: make sure you are following those procedures in practice and not just in documentation alone. The accounting policy on valuation methodologies should be included and discussed in depth in the fund agreement and consistently applied to all of the real estate investments made by the fund.
• Don’t: choose a policy that is too vague or too complex as this will make it difficult to follow in practice. Your valuation policies should be based on industry practices and should follow Generally Acceptable Accounting Principles.

Writing the financial statements

Once you have determined the basis of accounting for your fund and you have created and implemented your valuation policy, you can now begin preparing the actual financial statements and disclosures.

• Do: make sure to have a knowledgeable person in-house who can prepare the statements and the disclosures that comprise the financial report. Alternatively, if you have engaged an administration firm to prepare your books and records, make sure they will be able to prepare the financial statement and related support to compliment your accounting and administrative needs. It is also important that you have someone in-house who can review and approve those financial statements.
• Do: look to your advisors for industry guidance and standard financial statement reporting. Most audit firms have a financial statement guide and disclosure checklists where you can find valuable information and samples for both the overall presentation as well as disclosures.
• Don’t: expect your audit firm to prepare your financial statements.

Getting the basics right

When preparing your annual financial statements, there is significant information that must be included, both from a financial perspective as well as a disclosure perspective. Often, it is the basics that are overlooked.

• Do: make sure that significant financial accounts that are being presented in the financial statements have corresponding required disclosures. In addition, make sure the disclosures agree to the financial statement line items they relate to.
• Don’t: assume everything is correct, even if you have engaged an outside service provider to prepare your financial statements. Take your time and thoroughly review the financial statements, making certain they present the fund’s records fairly and accurately.

As the fund manager, you have the responsibility of reviewing and ultimately approving the financial statements that will be issued. Take the time to understand the required disclosures and how these disclosures best fit your fund. Make sure that all disclosures accurately and fairly represent the fund’s performance. To conclude, work with your advisors, ask questions, and seek out guidance.

For more information on best practices for preparing your financial statements, please contact Anchin’s Emerging Manager Platform team or your Anchin Relationship Partner.