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IFRS in Real Estate

The business of buying, selling and managing portfolios of income-producing real estate has shifted from being domestically focused to being a highly competitive global industry. Today, international real estate investment trusts (REITs) and private equity funds account for the majority of worldwide real estate investment. Investors are attracted to strong dividend yields and opportunities for diversification in new and exciting markets. Notwithstanding these realities, investors to owners and operators should be continuously vigilant in addressing political uncertainty in many countries around the world where real estate is less developed than in the U.S., fluctuating exchange rate risks, and concerns about insufficient liquidity and transparency. For these reasons, among others, opportunities abound but caution is a watchword.

Clarity and transparency in financial reporting is a key ingredient in managing risk of overseas investing. Most overseas-based REITs and private equity funds report periodic financial results following International Financial Reporting Standards (IFRS). IFRS, while followed broadly outside the U.S., not only has different requirements than U.S. Generally Accepted Accounting Principles (GAAP) but also varies in application from country to country. Evaluating financial performance and assessing risk of an entity that follows IFRS may present certain challenges to an investor who is accustomed to reading and analyzing financial statements prepared under GAAP.

Throughout the twenty-first century, the Financial Accounting Standards Board (FASB) and the various international accounting organizations have been working on improving and converging GAAP and IFRS. However, despite all the convergence efforts, the differences between the two accounting frameworks remain significant, with some of the major differences affecting the real estate industry.

At the conceptual level, GAAP is generally considered to be a rules-based financial reporting framework in comparison to IFRS, which is more principles-based. While GAAP offers in-depth guidance covering many variations in circumstance for which accounting principle may be applied, IFRS allows for professional judgement to make decisions based on its principles. IFRS generally permits companies greater flexibility than GAAP as IFRS offers more choices in accounting for similar transactions and, as such, IFRS generally dictates more in-depth disclosures on the financial statements for comparability and transparency purposes.

Some of the more significant differences between U.S. GAAP and IFRS relate to accounting for leases, fixed assets, investment properties, equity method investments and joint ventures. The following table provides a side-by-side analysis of the differences in accounting that exist between the two frameworks in these areas:

 

GAAP

IFRS

Investment Property and Fixed Assets

 

 

  • Investment property

Not separately defined and no specific guidance exists.

Defined as land and/or buildings held to generate rental revenue, capital appreciation, and/or redevelopment; not owner-occupied; and not held for sale in the ordinary course of business.

IFRS permits investment property to be recorded at fair value, with changes in fair value recognized as unrealized gain or loss.

  • Depreciation

Based on the weighted average of the lives of the individual components of an asset. Component depreciation is permitted,

Requires componentization of significant parts of real estate and equipment that have different estimated useful lives. Each significant part of an asset with a different useful life is accounted for and depreciated separately.

  • Assessing for impairment of long-lived assets held and used

Requires a two-step approach to determine whether an impairment loss should be recognized by comparing the carrying value with the undiscounted value of future cash flows of the asset. If the carrying value is higher, then the asset is written down to fair value.

Uses a one-step test comparing carrying value to the recoverable amount.  If the carrying value exceeds the recoverable amount, the asset is written down. This often enables the impairment loss to be recognized sooner and more frequently than under GAAP.

  • Reversing previous impairment losses

Not permitted

Permitted under certain circumstances.

Leases

 

 

  • Effective dates for new lease standards

Effective for annual periods beginning after December 15, 2018, for public business and certain other entities, and after December 15, 2019, for other entities.

Effective for annual periods beginning on or after January 1, 2019. 

  • Lessor accounting

Lessors may elect to combine certain non-lease components into the related lease component.

Lessors may not combine lease and non-lease components.

  • Lessee accounting

 

 

Dual on-balance sheet lease accounting model for lessees, which classifies a lease as either a finance lease or an operating lease.

Under a finance lease, interest and amortization are recorded, while only rent expense is recorded under an operating lease.

Single on-balance sheet lease accounting model for lessees, which is similar to a finance lease accounting for GAAP.

  • Sale and leaseback accounting

Seller-lessee immediately recognizes the full gain or loss from a sale and leaseback transaction that qualifies as a sale.

Recognition of gains from sale and leaseback transactions is limited.

Equity Method Investments

 

 

 

An investment of 20% or more of the voting common stock of an investee leads to a presumption that an investor has the ability to exercise significant influence over an investee, unless this presumption can be overcome based on facts and circumstances.

An investment of 20% or more of the equity of an investee (including potential rights) leads to a presumption that an investor has the ability to exercise significant influence over an investee, unless this presumption can be overcome based on facts and circumstances.

 

When determining significant influence, potential voting rights are generally not considered.

When determining significant influence, potential voting rights are considered if currently exercisable.

 

An investor in a limited partnership, LLC, trust or similar entity normally accounts for its investment using the equity method.

When an investor has an investment in a limited partnership, LLC, trust or similar entity, the determination of significant influence is made using the same general principle of significant influence that is used for all other investments.

 

Conforming accounting policies between investor and investee is generally not permitted.

Uniform accounting policies between investor and investee are required.

Joint Ventures

 

 

 

Joint ventures are generally defined as entities whose operations and activities are jointly controlled by their equity investors. The purpose of the entity should be consistent with the definition of a joint venture.

Joint ventures are separate vehicles in which the parties that have joint control of the separate vehicle have rights to the net assets. These rights could be through equity investors certain parties with decision-making rights through a contract.

 

Joint control is not defined, but it is commonly interpreted to exist when all of the equity investors unanimously consent to each of the significant decisions of the entity.

Joint control is defined as existing when two or more parties must unanimously consent to each of the significant decisions of the entity.

 

An entity can be a joint venture, regardless of the rights and obligations the parties sharing joint control have with respect to the entity’s underlying assets and liabilities.

In a joint venture, the parties cannot have direct rights and obligations with respect to the underlying assets and liabilities of the entity.

 

The investors generally account for their interests in joint ventures using the equity method of accounting. They also can elect to account for their interests at fair value.

The investors generally account for their interests in joint ventures using the equity method of accounting. Investments in associates held by venture capital organizations, mutual funds, unit trusts and similar entities are exempt from using the equity method and the investor may elect to measure its investment at fair value.

 

Proportionate consolidation may be permitted.

Proportionate consolidation is not permitted.


The bottom line is the real estate professionals should always consider consulting with their accountants, consultants and attorneys to better navigate through the complexities and the nuances of both U.S. GAAP and IFRS.

Dmitriy Gelfand is the Real Estate Services Group Senior Manager with experience in public accounting, providing audit, tax and consulting services to clients in real estate and hospitality industries.

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