Preparation Tips for Real Estate Entities for the 2020 Audit Season
December 01, 2020
By Alyssa Dolinshek
As the 2020 audit season quickly approaches, real estate companies should begin their planning now to ensure a smooth process. The pandemic has impacted the entire real estate industry and, as such, the audit season may look and feel different this year. There will likely be more discussions and new requests that arise from auditors’ efforts to ensure that they are meeting generally accepted auditing standards given the widespread effects of COVID-19. There are some steps management and owners can take now to help make those audit kick-off discussions as productive as possible.
1. Plan ahead for discussions with auditors regarding:
- The current status and forecast of operations.
- Status of ongoing negotiations with tenants or lenders (e.g., loss of tenants, lease modifications, COVID-19-related relief received or provided, debt modifications or refinances).
- Audit timing. Consider and anticipate any delays or inefficiencies due to the current work-from-home environment.
- Status of any legal or regulatory issues, including communications with an attorney regarding potential or pending legal matters.
- Subsequent events, such as tenant vacancies, which may require adjustments to financial statements or related disclosures.
- Delays in adopting applicable accounting standard updates (e.g., Topic 606 Revenue Recognition and Topic 842 Leases).
- Changes to deadlines, including SEC filings, and the impact of the amended definition of accelerated filers.
2. Review major transactions and changes to internal controls and processes:
- Update internal control narratives for any changes during the current year, such as any changes as a result of working from home or key staff turnover.
- Provide detailed explanations, along with all supporting executed legal documents, for transactions that have occurred during the year, such as executed lease amendments or a loan-closing binder.
3. Prepare for changes in audit requests:
- Anticipate new requests, such as virtual meetings with property managers, or cash flow projections.
- Use the auditor’s secure site, such as EisnerAmper’s client portal, to view and upload documents. Management should verify that all necessary personnel can access the site during planning discussions with the auditors.
- Discuss and walkthrough processes and procedures remotely.
- Determine if remote access to general ledger systems exists within the system.
Going Concern Considerations
While going concern is always an audit consideration, consider the pandemic and, at a minimum, discuss with the audit team. An entity’s ability to continue as a going concern may be impacted by a variety of adverse conditions, such as loss of a major tenant, negative operating cash flows, or non-compliance with loan terms and covenants. Anticipate these auditor questions and requests:
1. Management should prepare an analysis reflecting the financial impact of any adverse conditions, including management’s plan to mitigate such effects. These plans may include capital calls from ownership; cost reductions like maintenance deferrals, furloughs or layoffs; modification of debt terms, including waiver of loan covenants; and disposal of assets to increase cash.
2. Prepare a 2021 budget and cash flow projections through 2022, including an explanation of all projection assumptions.
Technical Accounting Considerations
There are considerations for entities reporting on either the income tax basis (“ITB”) of accounting or generally accepted accounting principles (“GAAP”).
1. Rent Concessions:
- ITB – If tenants received rent concessions, they would directly offset revenue and the corresponding account receivable.
- GAAP – The Financial Accounting Standards Board (“FASB”) has allowed for certain instances of rent relief to tenants due to COVID-19 as if such relief was already included in the original lease agreement. Thus, the entity may recognize the rent concession in the current period as opposed to accounting for it as a lease modification.
2. Rent Deferrals:
- ITB – If tenants received rent deferrals, this would merely impact the timing of cash collection from the tenant and not impact when revenue is recognized by the entity.
- GAAP – There are generally two options regarding COVID-19-related rent deferrals. Account for the deferral as if there are no changes to the lease contract, but merely a delay in cash receipts; account for such deferral as an offset to revenue during the deferral months. Click here for an in-depth article discussing such options.
3. Tenant-Related Assets:
- Accounts Receivable – Perform a thorough evaluation of the collectability of accounts receivable. Under ITB, once all collection efforts are exhausted, write off any uncollectible accounts receivable directly to operations. An allowance for doubtful accounts is not permitted. For GAAP, record an allowance for doubtful accounts against any receivable that may not be collectible.
- Tenant Improvements – For ITB and GAAP, identify tenant improvements relating to tenants who have vacated and terminated their lease agreement during the year. Can these assets provide any future economic benefit? Is the carrying amount of these assets recoverable over their remaining useful life? Are these assets tenant specific? Should the carrying amount of these assets be written off?
- Deferred Leasing Costs – For ITB and GAAP, identify deferred leasing costs related to tenants who have vacated and terminated their lease agreement during the year. Write off the remaining unamortized costs.
4. Deferred Financing Costs: If the entity entered into a transaction to extinguish or modify its debt, management should perform an analysis to determine the treatment of both any existing and/or new financing costs. The basis of accounting for which the entity is reporting on may contain nuances that dictate the treatment of financing costs.
- Extinguishment – Generally, write off the carrying amount of existing deferred financing costs as of the date of extinguishment. New costs incurred are capitalized and amortized over the term of the new loan.
- Modification – Generally, amortize over the term of the modified loan the carrying amount of existing deferred financing costs as of the date of modification. Expense any new cost in the period of the modification. However, under GAAP, capitalize new costs incurred and paid directly to the lender.
5. Asset Impairment: For entities reporting under GAAP, perform an impairment analysis of assets if management determines a “triggering event” has occurred. A triggering event may include, for example, the loss of a major tenant or the occurrence of negative operating cash flows. Management should determine if any such triggering events have occurred and, if one has, determine if the carrying amounts of any assets are not recoverable over their remaining useful lives. This is not a consideration under the ITB.
There are several things to keep an eye on in any year that will facilitate a successful audit season.
1. Management’s responsibilities:
- Review financial statements, whether prepared by management or an external party.
- Design, implement and maintain internal controls relevant to the preparation and fair presentation of financial statements.
- Prepare and review a complete financial reporting package of schedules and relevant documents that will be provided to the auditors.
2. Designate an audit point person from your team.
3. Verify the listing of accounts to be confirmed, including cash, debt and investment accounts. Sign all paper confirmations or give electronic authorization prior to year-end, if possible.
4. If the business has hard-to-value investments, prepare detailed supporting schedules and documentation. This should include a comprehensive write-up of the valuation methodology.
5. Discuss with your auditors if there are schedules or documentation you can provide in advance for possible interim testing.
In a year where nothing has been ordinary in the real estate industry, spending time discussing business activities and planning with your auditors could help make the year-end audit process as efficient as possible.