Key Accounting and Financial Reporting Disclosure Considerations for 2020Anchin Real Estate UpdateNovember 4, 2020
This was an arduous year for many, as the pandemic abruptly disrupted business operations and brought on a multitude of challenges for businesses as well as their professional service providers. The Real Estate industry has been no exception, as many would agree it has taken the largest hit and suffered unparalleled losses.
In a recent announcement, New York State Governor Andrew Cuomo has extended the state’s moratorium on commercial evictions and foreclosures in place through January 1, 2021. There have been reports that more than 15% of all landlords could default on their property taxes next year and even more may not be able to meet debt payments. As a result, many are estimating a recovery in some real estate industry sectors to be in 2024-2025, at the earliest.
The Pandemic has created an unprecedented level of uncertainties about the economy and unique challenges as it relates to accounting considerations as well as financial statement reporting and disclosure requirements. There will be many implications to be considered by preparers of financial statements and auditors, both in the near future and long term, that did not have to be addressed in the past.
With so many changes and challenges, now is the time to start assessing the impact on your financial reporting. Addressing these issues early will save time later and give you adequate time to prepare.
The following are key accounting and reporting disclosure considerations, to keep in mind as we all are gearing up to begin planning for 2020 year-end reporting:
The Pandemic has caused many landlords to renegotiate their existing leases with tenants and provide for various concessions, and in some cases, termination of leases. These concessions can vary in nature, but primarily have been in the form of forgiveness of rent or deferral of payments. Determining whether or not a concession is a change in accordance with lease modification guidance is complex and requires significant judgment. Lease terminations, as well, have their own considerations and need to be dealt with carefully.
Many companies have suffered from lost revenues and increased operating costs resulting in landlords facing significant cash flow challenges. In addition, many development companies have construction loans that need to be converted to permanent financing. As a result, landlords are looking to obtain additional financing, modify their existing mortgages and/or renegotiate terms. For accounting purposes, borrowers will need to determine whether such changes represent a troubled debt restructuring (TDR). If not a TDR, then a borrower will need to decide if such changes result in debt modification or an extinguishment of debt, each of which have different accounting treatments.
Long lived assets and other finite intangible assets
As there has been a significant decrease in the market value for real estate assets, and development has been either delayed or curtailed, landlords/developers need to determine whether or not changes in circumstance indicate that the carrying amount of the assets on the financial statements may not be recoverable. In addition, many landlords may be operating at a loss due to the significant decrease in revenues, another indication that an impairment may exist. Long-lived assets include not only land and building, but also any other property, plant equipment held for use as well as other finite-lived intangible and right of use assets. If a landlord has decided to dispose of an asset that is no longer being “held for use,” but “held for sale” and has met certain criteria, a loss may need to be recognized, as well as cease to take depreciation.
Equity Method Investments
Investments that a company has made in underlying joint ventures will need to be analyzed for impairment as the underlying investee may not be able to sustain its operations due to the effects of the Pandemic. Consequently, an investor may not be able to recover its amount invested or not be able to continue to provide committed capital to the underlying investment, indicating that the amount of investment is impaired.
Fair Value Measurements
Fair value measurements are required in many areas of accounting, especially when indicators of impairment exist and fair value needs to be determined to adjust to carrying value. Fair value, for accounting purposes, is the price that would be received between market participants at the measurement date (as opposed to potential value at a future date) in an orderly transaction, in contrast to a value one would receive under a distressed or forced sale. Determining fair value relies on future projections of cash flows that, during this time, may be very difficult to predict.
Many tenants are experiencing financial difficulty and have been working out payment arrangements with their landlords, either through renegotiating their lease terms or being offered concessions, in order to continue to pay their rent. However, there still remains a great deal of uncertainty as to whether or not landlords will be able to collect all amounts due under such arrangements. Receivables need to be measured for collectability and to the extent there is doubt as to its recoverability, an allowance for doubtful account needs to be recorded. Allowances are based on historical collections and current conditions and need to be supported by reasonable assumptions. COVID-19 has created a need to challenge those estimates and in most cases will require some adjustments.
Loss Contingencies Accruals
When uncertainty as to possible losses exists (legal matters or other contingencies, i.e. pending or anticipated litigation, loss or disposal/exiting of business, etc.) and they are both probable to occur and costs are reasonably estimable, they should be accrued for and charged to income. Because COVID-19 has caused growing uncertainties, economic volatility and instability, many companies have obtained legal counsel as they monitor developments and implications to their business. Loss contingencies can arise from many circumstances and need to be considered and evaluated.
Real Estate Held for Sale
Many landlords during this time may decide to sell their real estate assets. This has special accounting considerations. A long-lived asset that meets the criteria for an asset to be classified as held for sale cannot be depreciated and is measured at the lower of its carrying costs or fair value less cost to sell.
Financial Statement Disclosures
Financial statement users will be looking for additional disclosures around COVID -19. Companies must take into account their unique circumstances and risk exposure when considering how the pandemic has effected them, and make sure that the financial statements address all material circumstances. As discussed above, many financial statements could change as a result of the current situation by having to address many accounting areas that in the past were not relevant. This will require a heightened level of disclosures that companies will need to consider. The following are some of the key financial reporting matters and key disclosure areas that should be considered while companies address their specific and unique circumstances.
- Risk and Uncertainties that could potentially, within one year from the financial statement date, have a material effect on the amounts reported in the financial statements and require disclosure as to what those are and their potential impact.
- Use of estimates are required to be disclosed each reporting period and will need to be revisited in light of COVID-19. Due to a higher level of uncertainty, reliance on accounting estimates will be greater than ever.
- Loss Contingencies are required to be disclosed when there is a reasonable possibility that a loss has been incurred. Where possible, an estimated amount of such loss should be disclosed or, at a minimum, indicate that such an estimate is not determinable.
- Going Concern must be evaluated by management to determine the company’s ability to continue as a going concern for at least one year after the financial statements are issued.
- Subsequent Events fall into two categories. The first type reflects conditions that existed as of the balance sheet date and therefore would be recognized in the financial statements. The second type reflects conditions that arose subsequently to the balance sheet date for which disclosure only is required. Consequences of both types need to be carefully considered.
- Impairment losses recognized in the financial statements will require a description of the impaired asset and the facts and circumstances that lead to the impairment as well as the methods for determining fair value.
- Related Party Disclosures should be disclosed for all transactions that would make a difference in the decision making of users of the financial statements. It is important to note that transactions between related parties are required to be disclosed even though they may not be given accounting recognition. For example, this includes services from a related party without charge.
- Debt Covenant Compliance disclosures will be especially scrutinized given the results of business slowdown and lost revenues due to the Pandemic that may have caused entities to be in violation of key financial ratios or other non-financial covenants.
Planning a year-end strategy early will enable your company’s management to make better informed decisions. We encourage you to review the above key accounting and reporting disclosure considerations as the end of 2020 is nearing.
For more information on any of the above key accounting and reporting disclosure considerations and/ or any other related topics, please contact your Anchin Relationship Partner, Robert Gilman at Robert.Gilman@anchin.com or Marc Wieder at Marc.Wieder@anchin.com.