a comprehensive guide real estate sales · 5.10 requirement to provide management services without...

Financial reporting developments A comprehensive guide

Real estate sales Accounting Standards Codification 360-20 (before the adoption of ASC 606, ASC 610-20 and ASC 842)

Revised March 2019

To our clients and other friends

We are pleased to provide you with this updated edition of our Financial reporting developments publication, Real estate sales. This publication addresses the guidance for real estate sales under Accounting Standards Codification (ASC) 360-20, Property, Plant and Equipment — Real Estate Sales.

While the guidance in ASC 360-20 was issued more than 30 years ago, determining if and when to recognize profit on real estate sales transactions and the amount of profit to recognize continues to be a challenge. ASC 360-20 is a complex, rules-based standard that requires companies to evaluate both the form and economic substance of a sales transaction. The evaluation has become more challenging as real estate transactions have continued to evolve and have become increasingly complex.

The guidance for real estate transactions will change when an entity adopts the new revenue recognition standard and the new leases standard issued by the Financial Accounting Standards Board (FASB or Board).

The new revenue recognition guidance, which is largely codified in ASC 606, Revenue from Contracts with Customers, will supersede ASC 360-20 for all real estate sales to customers, except those involving a sale and leaseback of real estate. The new revenue guidance also includes consequential amendments that modify the guidance in ASC 845, Nonmonetary Exchanges, for nonmonetary exchanges involving real estate.

ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets, which the FASB created as part of the new revenue standard, will generally apply to sales of real estate to noncustomers that do not meet the definition of a business, including partial sales.

All of the new revenue guidance is effective for public entities for fiscal years beginning after 15 December 2017, and for interim periods therein. Nonpublic entities are required to adopt the guidance for fiscal years beginning after 15 December 2018, and interim periods within fiscal years beginning after 15 December 2019. Early adoption is permitted.

The new leases standard, which is codified in ASC 842, Leases, will supersede the guidance in ASC 840, Leases, and ASC 360-20 for sale and leaseback transactions.

The new leases guidance is effective for public business entities and certain not-for-profit entities and employee benefit plans for fiscal years beginning after 15 December 2018, and for interim periods therein. For all other entities, it is effective for fiscal years beginning after 15 December 2019, and interim periods within fiscal years beginning after 15 December 2020. Early adoption is permitted for all entities.

We hope this publication will help you understand and successfully apply the provisions of ASC 360-20. Ernst & Young professionals are prepared to assist you in your understanding and are ready to discuss your particular concerns and questions.

March 2019

Financial Reporting Developments Real estate sales | i

Contents

1 Scope ........................................................................................................................ 5 1.1 Definition of real estate .......................................................................................................... 6 1.2 Sale of a business .................................................................................................................. 7 1.3 Integral equipment ................................................................................................................. 7 1.4 Transactions excluded from the scope of ASC 360-20 ............................................................. 9 1.5 In-substance real estate ....................................................................................................... 11

1.5.1 Applicability of ASC 360-20 to equity and cost method investments .............................. 11 1.6 Nonmonetary exchanges ...................................................................................................... 11

1.6.1 Nonmonetary transactions involving boot .................................................................... 12 1.6.2 Real estate ventures ................................................................................................... 15

1.7 Accounting for real estate syndication income ....................................................................... 15 1.8 Loss of a controlling financial interest in in-substance real estate ........................................... 16

2 General principles .................................................................................................... 17 2.1 Recognition of profit by the full accrual method ..................................................................... 17

2.1.1 Subsequent events ...................................................................................................... 19 2.2 Consummation of a sale ....................................................................................................... 19

2.2.1 Sale of an option to acquire real estate ......................................................................... 20 2.2.2 Consummation considerations specific to condominium sales ........................................ 21

2.3 Sales value .......................................................................................................................... 21 2.3.1 Computation of sales value .......................................................................................... 22 2.3.2 In substance additions to the sales price ....................................................................... 22 2.3.3 Discounting receivables ............................................................................................... 22 2.3.4 Calculating the sales value of improvements subject to a land lease ............................... 24 2.3.5 Calculating the sales value of partial sales of real estate ................................................ 25 2.3.6 Calculating the sales value of partnership interests ....................................................... 25 2.3.7 Calculating the sales value of the sale of an option by an option holder .......................... 26 2.3.8 Calculating the sales value when a transaction is initially accounted for

using the deposit method ............................................................................................ 26 2.4 Surrender of real estate in satisfaction of an entity’s obligation .............................................. 27

3 Initial and continuing investments ............................................................................. 31 3.1 Buyer’s initial investment ..................................................................................................... 31 3.2 Composition of buyer’s initial investment .............................................................................. 31

3.2.1 Irrevocable letters of credit .......................................................................................... 32 3.2.2 Applicability of the initial and continuing investment tests and the effects

of various forms of financing ....................................................................................... 34 3.2.3 Transfer of ownership interest as part of down payment ............................................... 39

3.3 Items excluded from buyer’s initial investment ...................................................................... 39 3.3.1 Payments made for improvements to the property ....................................................... 40 3.3.2 Funds provided or guaranteed by the seller to the buyer ............................................... 40

3.4 Size of buyer’s initial investment ........................................................................................... 43 3.4.1 Minimum initial investment requirements ..................................................................... 44

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3.4.2 Calculation of minimum initial investment ..................................................................... 46 3.5 Buyer’s continuing investment .............................................................................................. 47

3.5.1 Customary amortization term ...................................................................................... 49 3.5.2 Initial and continuing investment considerations specific to the

homebuilding industry ................................................................................................. 49 3.5.2.1 Interaction of ASC 360-20 with ASC 860 ............................................................ 55 3.5.2.2 Nontraditional financing terms ........................................................................... 55

3.5.3 Continuing investment considerations specific to condominium sales ............................. 56 3.6 Release provisions ............................................................................................................... 56 3.7 Cumulative application of initial and continuing investment tests ............................................ 59

4 Future subordination and continuing involvement ...................................................... 63 4.1 Receivable subject to future subordination ............................................................................ 63 4.2 Continuing involvement ....................................................................................................... 63

5 Recognition of profit when the full accrual method is not appropriate.......................... 65 5.1 Sale not consummated ......................................................................................................... 65

5.1.1 Exception to consummation requirements for long-term construction projects ............... 66 5.1.2 Recognition of loss when sale not consummated ........................................................... 66

5.2 Buyer’s initial investment is not adequate .............................................................................. 66 5.2.1 Determining whether recovery of the cost of the property is reasonably assured ............ 67

5.2.1.1 Choosing the appropriate accounting method when recovery of the cost of the property is not reasonably assured .................................................... 67

5.2.1.2 Choosing the appropriate accounting method when recovery of the cost of property is reasonably assured ................................................................ 68

5.3 Buyer’s continuing investment is not adequate ...................................................................... 69 5.4 Receivable subject to future subordination ............................................................................ 71 5.5 Continuing involvement without transfer of risks and rewards ................................................ 72

5.5.1 Continuing involvement based on a contingency ........................................................... 74 5.6 Obligation or option to repurchase ........................................................................................ 74

5.6.1 Antispeculation clauses in real estate sales contracts .................................................... 75 5.6.2 Buy-sell clauses ........................................................................................................... 76

5.7 General partner holds a significant receivable from the buyer................................................. 77 5.8 Guarantee of the return of the buyer’s investment or a return on the buyer’s investment ........ 78 5.9 Requirement to initiate or support operations ....................................................................... 80

5.9.1 Implied support ........................................................................................................... 82 5.9.2 Reasonable assurance that future rentals will be adequate ............................................ 82 5.9.3 Estimating future rent receipts .................................................................................... 83 5.9.4 Profit recognition on performance of services .............................................................. 83 5.9.5 Application of the performance-of-services method when arrangement

includes support versus a guarantee ............................................................................ 89 5.10 Requirement to provide management services without compensation or at

compensation less than market rates .................................................................................... 93 5.11 Transaction is merely an option to purchase .......................................................................... 94

5.11.1 Sale of an option by an option holder............................................................................ 94 5.12 Partial sales of real estate .................................................................................................... 95 5.13 Condominium sales .............................................................................................................. 98

5.13.1 Construction is beyond a preliminary stage................................................................. 100

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5.13.2 Refund requirement .................................................................................................. 101 5.13.3 Reversion to rental property ...................................................................................... 101 5.13.4 Collectibility .............................................................................................................. 101 5.13.5 Aggregate proceeds and costs can be reasonably estimated ....................................... 104 5.13.6 Application of the percentage-of-completion method to a condominium project ........... 104 5.13.7 Applicability of the percentage-of-completion method to condominium sales ................ 106

5.14 Seller sells property improvements and leases the underlying land to the buyer .................... 106 5.15 Sale-leaseback transactions................................................................................................ 112

5.15.1 Sale of property subject to the seller’s preexisting lease .............................................. 113 5.16 Sales contract requires seller to develop property ............................................................... 113

5.16.1 Percentage-of-completion and home sales ................................................................. 117 5.17 Seller participates in future profits from the property without risk of loss .............................. 117

A Other recognition methods ...................................................................................... A-1 A.1 Installment method ............................................................................................................. A-1 A.2 Cost recovery method ......................................................................................................... A-6 A.3 Deposit method .................................................................................................................. A-9 A.4 Financing method ............................................................................................................. A-11 A.5 Leasing method ................................................................................................................ A-15 A.6 Profit-sharing method ....................................................................................................... A-16

B Sales of real estate (other than retail land sales) decision tree ................................... B-1 C Abbreviations used in this publication ...................................................................... C-1 D Index of ASC references in this publication ............................................................... D-1 E Summary of important changes ............................................................................... E-1

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Notice to readers:

This publication includes excerpts from and references to the FASB Accounting Standards Codification (the Codification or ASC). The Codification uses a hierarchy that includes Topics, Subtopics, Sections and Paragraphs. Each Topic includes an Overall Subtopic that generally includes pervasive guidance for the topic and additional Subtopics, as needed, with incremental or unique guidance. Each Subtopic includes Sections that in turn include numbered Paragraphs. Thus, a Codification reference includes the Topic (XXX), Subtopic (YY), Section (ZZ) and Paragraph (PP).

Throughout this publication references to guidance in the codification are shown using these reference numbers. References are also made to certain pre-codification standards (and specific sections or paragraphs of pre-Codification standards) in situations in which the content being discussed is excluded from the Codification.

This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions.

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Financial Reporting Developments Real estate sales | 5

1 Scope

Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales Scope and Scope Exceptions 360-20-15-1 This Subtopic establishes standards for recognition of profit on all real estate sales transactions, other than retail land sales (see Topic 976 for retail land sales), without regard to the nature of the seller’s business.

360-20-15-2 Determining whether a transaction is in substance the sale of real estate requires judgment. However, in making that determination, one shall consider the nature of the entire real estate component being sold (that is, the land plus the property improvements and integral equipment), and not the land only, in relation to the entire transaction. Further, that determination shall not consider whether the operations in which the assets are involved are traditional or nontraditional real estate activities. For example, if a ski resort is sold and the lodge and ski lifts are considered to be affixed to the land (that is, they cannot be removed and used separately without incurring significant cost), then it would appear that the sale is in substance the sale of real estate and that the entire sale transaction would be subject to the provisions of this Subtopic. Transactions involving the sale of underlying land (or the sale of the property improvements or integral equipment subject to a lease of the underlying land) shall not be bifurcated into a real estate component (the sale of the underlying land) and a non-real-estate component (the sale of the lodge and lifts) for purposes of determining profit recognition on the transaction.

360-20-15-3 The guidance in this Subtopic applies to the following transactions and activities:

a. All sales of real estate, including real estate with property improvements or integral equipment. The terms property improvements and integral equipment as they are used in this Subtopic refer to any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost. Examples include an office building, a manufacturing facility, a power plant, and a refinery.

b. Sales of property improvements or integral equipment subject to an existing lease of the underlying land should be accounted for in accordance with paragraphs 360-20-40-56 through 40-59.

c. The sale or transfer of an investment in the form of a financial asset that is in substance real estate.

d. The sale of timberlands or farms (that is, land with trees or crops attached to it).

e. Real estate time-sharing transactions (see Topic 978).

f. Loss of a controlling financial interest (as described in Subtopic 810-10) in a subsidiary that is in substance real estate because of a default by the subsidiary on its nonrecourse debt.

ASC 360-20 establishes guidance for recognizing profit on all real estate transactions (other than retail land sales) regardless of the nature of the seller’s business. That is, ASC 360-20 applies equally to a financial services entity selling its corporate headquarters as it does to a homebuilder selling a recently completed home or a real estate investment trust selling a pre-existing building.

1 Scope


The guidance in ASC 360-20 should not be applied to retail land sales. ASC 976, Real Estate-Retail Land, defines retail land sales as sales, on a volume basis, of lots that are subdivisions of large tracts of land. These types of sales are generally speculative in nature and are characterized by very small down payments. The risk to the seller in these types of transactions is high because the seller is unable to enforce the buyer’s note against the buyer’s general credit and the buyer is generally entitled to a full refund if the contract is cancelled within an established cancellation period. Retail land sales do not include sales of lots to builders; sales of homes, buildings, and parcels of land to builders and others; sales of time-sharing interests if the sales are in substance sales of real estate; and sales of options to purchase real estate. We believe it will be rare for sales of real estate to qualify as retail land sales. Therefore, detailed guidance on retail land sales has not been included in this publication (refer to ASC 976-605 for guidance on retail land sales).

Note:

The Financial Accounting Standards Board (FASB) issued a new revenue recognition standard, ASC 606, Revenue from Contracts with Customers (ASC 606), ASC 610-20, Other Income – Gains and Losses (ASC 610-20), and a new leases standard (ASC 842, Leases). ASC 606 and ASC 610-20 replace ASC 360-20 for all real estate sales transactions, except those involving a sale and leaseback of real estate. The guidance in ASC 842 will replace the guidance in ASC 360-20 for sale and leaseback transactions involving real estate. ASC 606 and ASC 610-20 also include consequential amendments that modify the guidance in ASC 845, Nonmonetary Exchanges, for nonmonetary exchanges involving real estate.

Effective date

ASC 606 and ASC 610-20 is effective for public entities for annual reporting periods beginning after 15 December 2017 (2018 for calendar-year public entities) and interim periods therein. Nonpublic entities will be required to adopt the standard for annual reporting periods beginning after 15 December 2018, and interim periods within annual reporting periods beginning after 15 December 2019. Early adoption is permitted for all entities.

ASC 842 will be effective for public business entities (PBEs) for annual periods beginning after 15 December 2018 (2019 for calendar-year PBEs), and interim periods within those years. For all other entities, the standard is effective for annual periods beginning after 15 December 2019 (2020 for all other calendar-year entities), and interim periods beginning after 15 December 2020 (2021 for all other calendar-year entities). Early adoption is permitted for all entities.

Please refer to our Financial reporting developments (FRD) publications, Revenue from contracts with customers (ASC 606) and Lease Accounting (ASC 842) for further information on these standards

Unless otherwise noted, the ASC 360-20, Real Estate Sales and 970-605 Revenue Recognition-Real Estate General, and certain sections of ASC 845-Nonmonetary Exchanges will be superseded after the effective dates of ASC 606, ASC 610-20 and ASC 842.

1.1 Definition of real estate ASC 360-20 applies to “all real estate sales transactions,” and clarifies that the real estate sales guidance should be applied to sales of real estate with property improvements or integral equipment that cannot be removed and used separately from the real estate without incurring significant costs. For example, improvements made to land so that the land can be used for waste disposal (i.e., a landfill) cannot be separated from the land. Other examples of property improvements or integral equipment that would be subject to ASC 360-20 include office buildings, manufacturing facilities, power plants, and refineries. Pursuant to ASC 360-20-15-2, transactions involving the sale of land and property improvements or integral equipment should not be bifurcated into a real estate component and a non-real estate component to determine profit recognition on the transaction.

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1 Scope


Additionally, sales of options to purchase real estate in the future, including the sale of an option by a property owner and the resale of an option by an option holder that is not the property owner, are sales of real estate and are subject to ASC 360-20 (see section 2.2.1 and section 5.11 for additional guidance on accounting for transactions involving the sale of options or in substance options).

Determining whether a transaction involves real estate is a matter of judgment that depends on the relevant facts and circumstances. Companies should focus on the physical attributes of the combined asset being sold (i.e., land with improvements or integral equipment) to determine if the nature of the combined asset is more like real estate (e.g., long-lived, non-removable, such as a building) or equipment (e.g., temporary, movable, such as a vehicle).

1.2 Sale of a business ASC 360-20 does not differentiate between the sale of real estate and the sale of a business. That is, a transaction is not excluded from the scope of ASC 360-20 simply because it involves the sale of a business. Shopping centers, hotels, motels, marinas, and mobile home parks, which could be considered businesses, are all specifically mentioned in ASC 360-20 as being within its scope. ASC 360-20 also should be applied to the sale of the stock or net assets of a subsidiary or a segment of a business that contains real estate if the transaction is, in substance, the sale of real estate (ASC 360-20-15-10(b) — see section 1.4).

Companies must use judgment to determine whether a transaction is, in substance, the sale of real estate. The nature of the entire real estate component being sold (i.e., the land plus improvements and integral equipment), and not the land alone, should be considered in relation to the entire transaction to determine whether the substance of the transaction is the sale of real estate. For example, if a company transfers the stock of an operating hotel to a third party in exchange for cash, the real estate component (i.e., the land and the hotel, which cannot be removed and used separately from the land without incurring significant cost) represents a large portion of the entire transaction. The combined assets being sold are, in substance, real estate, and the transaction is subject to the provisions of ASC 360-20. However, if the company sells all of its hotels in Europe, including the rights to the brand name, the real estate component may represent a smaller portion of the entire transaction. The substance of the arrangement does not appear to be, in substance, the sale of real estate, and the transaction would not be subject to ASC 360-20.

1.3 Integral equipment Excerpt from Accounting Standards Codification Master Glossary

Integral equipment

Integral equipment is any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost.

Property, Plant, and Equipment — Real Estate Sales

Scope and Scope Exceptions

360-20-15-4 The determination of whether equipment is integral equipment shall be based on the significance of the cost to remove the equipment from its existing location (which would include the cost of repairing damage done to the existing location as a result of the removal), combined with the decrease in the fair value of the equipment as a result of that removal.

1 Scope


360-20-15-5 At a minimum, the decrease in the fair value of the equipment as a result of its removal is the estimated cost to ship and reinstall the equipment at a new site. If there are multiple potential users of the leased equipment, the estimate of the fair value of the equipment as well as the costs to ship and install the equipment shall assume that the equipment will be sold to the potential user that would result in the greatest net cash proceeds to the seller (current lessor).

360-20-15-6 The nature of the equipment, and the likely use of the equipment by other potential users, shall be considered in determining whether any additional diminution in fair value exists beyond that associated with costs to ship and install the equipment.

360-20-15-7 When the combined total of both the cost to remove plus the decrease in fair value (for leasing transactions, the information used to estimate those costs and the decrease in fair value shall be as of lease inception) exceeds 10 percent of the fair value of the equipment (installed) (for leasing transactions, at lease inception), the equipment is integral equipment.

360-20-15-8 The phrase cannot be removed and used separately without incurring significant cost contains both of the following distinct concepts:

a. The ability to remove the equipment without incurring significant cost

b. The ability of a different entity to use the equipment at another location without significant diminution in utility or fair value.

Integral equipment is defined as “any physical structure or equipment attached to the real estate that cannot be removed and used separately without incurring significant cost.” Companies should base their assessment of the significance of costs to remove and use equipment separately on an estimate of:

• The cost to remove the equipment from its existing location, which includes the cost of repairing damage done to the existing location as a result of the removal, and

• The decrease in the value of the equipment as a result of the removal, which, at a minimum, should include the cost to ship and reinstall the equipment at a new site. Companies should consider the nature of the equipment and the likely use of the equipment by other potential users in determining whether any additional decrease in value exists beyond that associated with the costs to ship and install the equipment. If there are multiple potential users of the equipment, companies should assume the equipment will be sold to the potential user that would result in the greatest net cash proceeds to the seller (i.e., the least decrease in value).

Once the costs to remove equipment from its existing location and the decrease in value of the equipment have been calculated, the seller must determine if these costs are significant. When the combined total of both the cost to remove plus the decrease in value exceeds 10% of the fair value of the equipment (installed) the equipment is integral equipment.

The following illustrates the integral equipment calculation:

(Costs incurred on removal — including repairs) + (The greater of loss in fair value upon

removal or cost to ship and reinstall) = Total costs

Equipment would be integral if: Total costs > 10% of fair value of equipment (installed)

1 Scope


Illustration 1-1: Integral equipment

Facts:

Company X sells an already constructed cellular tower located on a plot of land owned by Company X to Company Y for $1,100,000. The selling price is presumed to be fair value for purposes of this example. The companies enter into a concurrent 30-year lease agreement for the land on which the tower is located with Company X serving as the lessor. Company X estimates that the cost to remove the tower, including the cost to repair damage to the existing location as a result of the removal, will be $50,000, and the cost to ship and reinstall the tower at a new location will be $70,000. Company X does not anticipate a diminution in the fair value of the equipment beyond that associated with the cost to ship and reinstall the equipment.

Analysis:

Because the cost of removal combined with the diminution in value exceeds 10 percent of the fair value of the tower (($50,000 + $70,000) ÷ $1,100,000 = 10.9 percent), the cost to remove the tower and use it separately is deemed to be significant. Therefore, the tower is integral equipment and its sale is subject to the provisions of ASC 360-20. The sale of the integral equipment and the concurrent lease of the land should be evaluated together in accordance with ASC 360-20 (see 5.14 for guidance on accounting for sales of property improvements or integral equipment with an underlying lease of the land).

1.4 Transactions excluded from the scope of ASC 360-20 ASC 360-20 identifies specific transactions that are excluded from its scope:

Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales


360-20-15-10 The guidance in this Subtopic does not apply to the following transactions and activities:

a. The sale of only property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, except for sales of property improvements or integral equipment with the concurrent lease (whether explicit or implicit in the transaction) of the underlying land to the buyer

b. The sale of the stock or net assets of a subsidiary or a segment of a business if the assets of that subsidiary or that segment, as applicable, contain real estate, unless the transaction is, in substance, the sale of real estate

c. Exchanges of real estate for other real estate (see Topic 845)

d. The sale of securities that are accounted for in accordance with Topic 320 (Sales of such securities are addressed in Topic 860.)

e. Retail land sales

f. Natural assets such as those that have been extracted from the land (for example, oil, gas, coal, and gold). Mineral interests in properties include fee ownership or a lease, concession, or other interest representing the right to extract oil or gas subject to such terms as may be imposed by the conveyance of that interest. Mineral interests in properties also include royalty interests, production payments payable in oil or gas, and other nonoperating mineral interests in properties operated by others. See Topic 932.

1 Scope


Pending Content: Transition date: (P) December 16, 2017; (N) December 16, 2018 | Transition guidance: ASC 825-10-65-2

360-20-15-10 The guidance in this Subtopic does not apply to the following transactions and activities:

a. The sale of only property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, except for sales of property improvements or integral equipment with the concurrent lease (whether explicit or implicit in the transaction) of the underlying land to the buyer

b. The sale of the stock or net assets of a subsidiary or a segment of a business if the assets of that subsidiary or that segment, as applicable, contain real estate, unless the transaction is, in substance, the sale of real estate

c. Exchanges of real estate for other real estate (see Topic 845)

d. The sale of securities that are accounted for in accordance with Topic 320 or Topic 321 (Sales of such securities are addressed in Topic 860.)

e. Retail land sales

f. Natural assets such as those that have been extracted from the land (for example, oil, gas, coal, and gold). Mineral interests in properties include fee ownership or a lease, concession, or other interest representing the right to extract oil or gas subject to such terms as may be imposed by the conveyance of that interest. Mineral interests in properties also include royalty interests, production payments payable in oil or gas, and other nonoperating mineral interests in properties operated by others. See Topic 932.

The guidance in ASC 360-20 does not apply to the sale of property improvements or integral equipment without a concurrent (or contemplated) sale of the underlying land, unless there is a concurrent lease of the underlying land to the buyer. For example, if a manufacturer sells a customer a cellular tower (integral equipment) that will be placed on land already owned by the customer, the sale would not be subject to the provisions of ASC 360-20. However, if the cellular tower is located on land owned by the manufacturer and the manufacturer sells the tower and the land or sells the tower with a concurrent lease (explicit or implicit) of the land, the entire transaction is subject to ASC 360-20. See section 5.14 for additional discussion of sales of property improvements or integral equipment with a concurrent lease of the underlying land.

Two of the other exclusions from the scope of ASC 360-20 are discussed further in section 1.2 and section 1.5.

Additionally, sales of natural assets that have been removed from the land (e.g., mined ore and harvested timber) are not subject to ASC 360-20. However, the sale of land inclusive of these assets is within the scope of ASC 360-20.

1 Scope


1.5 In-substance real estate Transactions should be considered real estate sales if they are in substance sales of real estate. Examples of transactions that could be in substance the sale of real estate include the sale of corporate stock of enterprises with substantial real estate, sales of partnership interests, and sales of time-sharing interests. ASC 976-10-15-4 provides an example of a sale of a partnership interest that is in substance a sale of real estate. A sale of a partnership interest that should be considered a sale of real estate would involve a company forming a partnership, arranging for the partnership to acquire property directly from third parties, and selling an interest in the partnership to investors who become limited partners. Additionally, the sale or transfer of an investment in the form of a financial asset that is in substance real estate is in the scope of ASC 360-20.

1.5.1 Applicability of ASC 360-20 to equity and cost method investments ASC 360-20-15-10 (see section 1.4) provides one exception to the requirement that the sale or transfer of in-substance real estate that is in the form of a financial asset should be accounted for in accordance with the provisions in ASC 360-20 (i.e., under the exception the sale is not treated as a sale of real estate, but rather as a sale or transfer or a financial asset). This exception applies to sales or transfers of marketable investments that are accounted for in accordance with ASC 320, Investments-Debt and Equity Securities. Such sales or transfers should be accounted for in accordance with ASC 860, Transfers and Servicing, as opposed to ASC 360-20. Consequently, if a marketable investment in a real estate investment trust (or REIT) is accounted for in accordance with ASC 320, any sales or transfers of that ownership interest in a REIT must be accounted for in accordance with ASC 860. The sale of an investment in a consolidated entity, an investment accounted for under the equity method, or a cost method investment that is outside the scope of ASC 320 (i.e., a cost method investment in a nonmarketable security) that is in substance real estate is subject to the provisions of ASC 360-20.

1.6 Nonmonetary exchanges Exchanges of real estate for other real estate are not within the scope of ASC 360-20. Instead, such transactions should be accounted for in accordance with ASC 845, Nonmonetary Transactions.

ASC 845 addresses the measurement of a nonmonetary transaction (i.e., fair value versus book value), but does not address the timing of profit recognition. Therefore, although nonmonetary exchanges of real estate are excluded from the scope of ASC 360-20, we would question whether it is appropriate to recognize profits on nonmonetary exchanges of real estate when the criteria for recognizing profit in ASC 360-20 have not been satisfied (e.g., if continuing involvement exists).

In general, the accounting for a nonmonetary transaction should be based on the fair values of the assets exchanged. Thus, the cost of a nonmonetary asset received in exchange for another nonmonetary asset ordinarily is measured based on the fair value of the asset given up or, if more clearly evident, the fair value of the asset received. A gain or loss is recognized if the cost of the nonmonetary asset recognized differs from the carrying amount of the asset given up. If one of the parties in a nonmonetary transaction could have elected to receive cash instead of the nonmonetary asset, the cash that could have been received may be evidence of the fair value of the nonmonetary assets exchanged. See our FRD, Fair Value Measurement, for additional guidance on determining fair value.

ASC 845-10-30-3 provides for three exceptions to the general principle of accounting for nonmonetary transactions at fair value. If one of these three exceptions is met, the transaction is accounted for based on the book value of the asset given up (after reduction for impairment, if applicable), which results in no gain or loss recognition. The three exceptions identified are:

• When neither the fair value of the nonmonetary asset received nor the fair value of the nonmonetary asset relinquished can be determined within reasonable limits.

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1 Scope


• When the transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers other than the parties involved in the exchange.

• When the transaction lacks commercial substance. Commercial substance exists if the entity’s future cash flows are expected to significantly change as a result of the exchange. Future cash flows are evaluated for significance by comparing the configuration (risk, timing, and amount) of the future cash flows of the asset received to those of the asset relinquished and by comparing the entity-specific values of the assets exchanged.

The following example excerpted from the AICPA Technical Practice Aid—TPA 6600.07, illustrates the appropriate accounting for an exchange of real estate held for sale in the ordinary course of business for real estate to be sold in the same line of business to facilitate sales to customers:

Excerpt from TPA 6600.07 Inquiry: A real estate company is engaged in developing residential communities, but they occasionally sell undeveloped parcels of land. The company has entered into an agreement whereby it will exchange land zoned for industrial use having a cost basis of $10,000 for residential land having a fair value of $50,000.

Is it proper to record the land received at $50,000 and recognize a gain of $40,000?

Reply: APB Opinion No. 29, paragraph 20(b), indicates that “an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers … ” does not culminate an earnings process. This exchange represents only a shift in real estate held as inventory. Therefore, the exchange should be reported on the basis of the recorded amount of the nonmonetary asset given up, $10,000.

Although the above TPA was issued prior to the elimination of the concept of “culmination of an earnings process” from the guidance for nonmonetary transactions codified in ASC 845, the conclusion reached in this TPA does not change as a result of that concept being eliminated.

As discussed above, the timing of profit recognition is not addressed in ASC 845. Therefore, we would question whether it is appropriate to recognize profits on nonmonetary exchanges of real estate when the criteria for recognizing profit in ASC 360-20 have not been satisfied.

1.6.1 Nonmonetary transactions involving boot Nonmonetary transactions are exchanges and nonreciprocal transfers that involve little or no monetary assets or liabilities. Some exchanges of nonmonetary assets involve a small portion of monetary consideration, referred to as boot, even though the exchange is essentially nonmonetary.

Excerpt from Accounting Standards Codification Nonmonetary Transactions-Overall Scope and Scope Exceptions

845-10-15-15 Paragraph 360-20-15-10(c) indicates that the accounting for exchanges of real estate is covered by this Topic and not by that Subtopic 360-20. However, under paragraph 845-10-25-6, an exchange of nonmonetary assets that would otherwise be based on recorded amounts under paragraph 845-10-30-3 but that involves boot shall be considered a monetary (rather than nonmonetary) transaction if the boot is at least 25 percent of the fair value of the exchange. As a result, the guidance is different for exchanges of real estate held for sale in the ordinary course of business [or] for real estate to be sold in the same line of business when the boot is at least 25 percent of the fair value of the exchange (referred to as exchanges of similar real estate).

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1 Scope


845-10-15-16 For the receiver of boot, the monetary portion shall be accounted for under Subtopics 360-20 and 976-605 as the equivalent of a sale of an interest in the underlying real estate, and the nonmonetary portion shall be accounted for in accordance with this Subtopic.

845-10-15-17 For the payer of boot, the monetary portion shall be accounted for as an acquisition of real estate, and the nonmonetary portion shall be accounted for pursuant to this Subtopic.

Recognition

845-10-25-6 An exchange of nonmonetary assets that would otherwise be based on recorded amounts but that also involves monetary consideration (boot) shall be considered monetary (rather than nonmonetary) if the boot is significant. Significant shall be defined as at least 25 percent of the fair value of the exchange. If the boot in a transaction is less than 25 percent, the pro rata gain recognition guidance in paragraph 845-10-30-6 shall be applied by the receiver of boot, and the payer of boot would not recognize a gain.

845-10-25-7 A transaction involving an exchange of similar real estate that is considered a monetary transaction because boot is at least 25 percent of the fair value of the exchange shall be allocated between two components: a monetary portion and a nonmonetary portion.

845-10-25-8 See Section 360-20-15 for guidance on when an asset is considered real estate.

Initial Measurement

845-10-30-23 Paragraph 845-10-25-7 addresses allocation of certain transactions between two components: a monetary portion and a nonmonetary portion. The allocation between the monetary and nonmonetary portions of the transaction shall be based on their relative fair values at the time of the transaction.

ASC 845-10-25-6 describes the amount of boot that would cause an exchange of nonmonetary assets to be considered monetary. If the monetary consideration is less than 25 percent of the fair value of the exchange, the transaction is considered nonmonetary. If monetary consideration equals or exceeds 25 percent, the transaction is considered monetary. In applying this guideline, “fair value of the exchange” is the estimated fair value of the consideration given up or, if more clearly evident, the fair value of the consideration received.

ASC 845 provides special guidance for exchanges of real estate involving boot. If an exchange of real estate meets one of the conditions of ASC 845-10-30-3 (see section 1.6) for measurement on a carryover basis, but is considered a monetary transaction because boot is at least 25 percent of the fair value of the exchange, the transaction should be allocated between two components: a monetary portion and a nonmonetary portion. The basis of the consideration given up should be allocated between the monetary and nonmonetary portions based on the relative fair value of each component at the time of the transaction.

The receiver of boot should account for the monetary portion of the transaction under ASC 360-20, as the equivalent of a sale of an interest in the underlying real estate. The nonmonetary portion of the transaction should be accounted for based on the recorded amount (after reduction, if appropriate, for



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1 Scope


an indicated impairment in value) of the nonmonetary asset relinquished pursuant to ASC 845. For the payer of boot, the monetary portion of the transaction should be accounted for as an acquisition of real estate, and the nonmonetary portion should be accounted for based on the recorded amount of the nonmonetary asset relinquished pursuant to ASC 845.

Illustration 1-2: Exchanges of real estate involving monetary consideration

Facts:

Company A transfers ten condominium units held for sale in the ordinary course of business with a fair value of $1,000,000 and a net book value of $800,000 to Company B. Company B transfers $300,000 cash and eight condominium units held for sale in the ordinary course of business in a different geographical area, with a fair value of $700,000 and a net book value of $500,000 to Company A. The fair value of each of the condominiums exchanged is clearly evident. Both companies are in the same line of business and have entered into the exchange to facilitate sales to customers (i.e., to offer units in different geographical areas). Neither party has any continuing involvement with the real estate transferred to the other.

Analysis:

Because the boot in this transaction is more than 25 percent of the fair value of the exchange ($300,000 cash received ÷ $1,000,000 fair value of the exchange = 30%), the transaction should be allocated between a monetary portion and a nonmonetary portion. This transaction should be accounted for by each party as follows:

Company A

The monetary portion of the transaction represents 30 percent of the fair value of the exchange. Therefore, the transaction should be allocated to the monetary portion of the transaction as follows:

Total consideration: $1,000,000 * 30% = $300,000

Net book value of asset given up: $800,000 * 30% = $240,000

A gain of $60,000 should be recognized on the monetary portion of the transaction ($300,000 — $240,000). The nonmonetary portion of the transaction does not qualify for gain recognition because it involves an exchange of property held for sale in the ordinary course of business for property to be sold in the same line of business to facilitate sales to customers. The new basis of the real estate acquired in the transaction will be $560,000 ($800,000 net book value of real estate given up less $240,000 monetary portion).

Company B

The monetary portion of the transaction represents an acquisition of real estate for the monetary consideration paid of $300,000. The nonmonetary portion of the transaction does not qualify for gain recognition because it involves an exchange of property held for sale in the ordinary course of business for property to be sold in the same line of business to facilitate sales to customers. The accounting basis of the new property equals $800,000 ($500,000 net book value of the real estate given up plus $300,000 total monetary consideration paid).

When an exchange includes boot that is less than 25 percent of the fair value of the exchange and the transaction does not qualify to be accounted for at fair value, ASC 845 allows the receiver of the boot to record a gain on the exchange to the extent the money received exceeds a proportionate share of the book value of the asset surrendered.

1 Scope


1.6.2 Real estate ventures Although nonmonetary transactions may involve a direct exchange of real estate, in practice, nonmonetary transactions are most often seen in the formation of a real estate venture. For example, a company may contribute real estate to a venture in exchange for a 50 percent non-controlling interest in the venture. The other party in the venture may contribute cash, real estate, or other assets. Regardless of the form of the contribution of other parties to a transaction, ASC 845-10-15-20 excludes contributions of real estate to a real estate venture from the scope of ASC 845 (see ASC 970-323, Real Estate-General — Investment Equity Method and Joint Ventures, for the accounting guidance for equity method investments and joint ventures).

ASC 970-323 provides guidance on contributions of real estate to a real estate venture. In accordance with ASC 970-323-30-3, an investor that contributes real estate to the capital of a real estate venture should generally record its investment at the book value of the real estate contributed and not recognize a profit on the transaction, because the economic substance of the transaction is a contribution of capital and not a sale of real estate. However, ASC 970-323-30-3 notes that some transactions that are structured as capital contributions are actually, in economic substance, sales. These types of transactions are subject to the provisions of ASC 360-20.

For example, Investor X enters into a transaction with Investor Y in which Investor X contributes real estate with a fair value of $5,000 and Investor Y contributes $2,500 in cash, which Investor X immediately withdraws. The only asset in this venture is the real estate and following the contributions and withdrawals, each investor has a 50 percent interest in the venture. Assuming Investor X is not committed to reinvest the $2,500 in the venture, the substance of this transaction is a sale of a one-half interest in the real estate by Investor X for $2,500 in cash, and the transaction should be accounted for in accordance with ASC 360-20.

See section 5.12 for additional guidance on accounting for partial sales of real estate.

1.7 Accounting for real estate syndication income Syndication activities are efforts to directly or indirectly sponsor the formation of entities that acquire interests in real estate by raising funds from investors. Entities that perform syndication activities earn commissions and fees performing a variety of services and activities, including organizing partnerships, selling real estate to the partnerships, and arranging for the partnerships to purchase real estate directly from (or sell it directly to) third parties. ASC 970-605, Real Estate-General — Revenue Recognition, provides guidance for recognizing income from real estate syndication activities, including the following guidance related to the recognition of profit on the sale of real estate by syndicators to partnerships:

Excerpt from Accounting Standards Codification Real Estate — General — Revenue Recognition

Recognition

970-605-25-5 Subtopic 360-20 applies to the recognition of profit on the sale of real estate by syndicators to partnerships. The guidance in that Subtopic shall also be applied to the recognition of profit on real estate syndication transactions even if the syndicators never had ownership interests in the properties acquired by the real estate partnerships. For purposes of applying the profit recognition criteria in that Subtopic to transactions in which syndicators never had such ownership interests, the syndicators should recognize profit on the transactions in the same way that they would have recognized such profit had they acquired the real estate and sold it to the partnerships.

1 Scope


ASC 970-605 provides that all sales of real estate arranged by syndicators are subject to the scope of ASC 360-20, even if the syndicators never had ownership of the real estate. The sales value used to calculate profit on the transaction (see section 2.3 for discussion of sales value) should include all fees charged by the syndicators except fees for future services and syndication fees (i.e., compensation for selling debt or equity interests in partnerships, including commissions and reimbursements of expenses). Refer ASC 970-605 for detailed guidance on accounting for real estate syndication income.

1.8 Loss of a controlling financial interest in in-substance real estate The deconsolidation and derecognition guidance in Subtopic 810-10 specifically excludes from its scope transactions that result in a loss of a controlling financial interest in in-substance real estate, including in-substance real estate (or any real estate) that meets the definition of a business. Instead entities should apply the sale of real estate guidance in ASC 360-20 and ASC 976-605 (see section 19.2.1 of our FRD, Consolidation: Determination of a controlling financial interest and accounting for changes in ownership interests). We believe the exclusion from ASC 810-10 and applicability of ASC 360-20 and 976-605 applies generally to all losses of controlling interests (e.g., sale, transfer, foreclosure, dilution of ownership interest and other arrangements in which control is surrendered) in in-substance real estate. See section 2.4 below for guidance specific to the application of the sale and profit recognition requirements to losses of control of real estate and in-substance real restate in satisfaction of an entity’s non-recourse obligation and upon default of non-recourse debt.

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2 General principles

These general principles apply to all real estate sales, other than retail land sales.

2.1 Recognition of profit by the full accrual method Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-3 Profit shall be recognized in full when real estate is sold, provided that both of the following conditions are met:

a. The profit is determinable, that is, the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated.

b. The earnings process is virtually complete, that is, the seller is not obliged to perform significant activities after the sale to earn the profit.

Unless both conditions exist, recognition of all or part of the profit shall be postponed. Recognition of all of the profit at the time of sale or at some later date when both conditions exist is referred to as the full accrual method in this Subtopic.

360-20-40-4 In accounting for sales of real estate, collectibility of the sales price is demonstrated by the buyer’s commitment to pay, which in turn is supported by substantial initial and continuing investments that give the buyer a stake in the property sufficient that the risk of loss through default motivates the buyer to honor its obligation to the seller. Collectibility shall also be assessed by considering factors such as the credit standing of the buyer, age and location of the property, and adequacy of cash flow from the property.

360-20-40-5 Profit on real estate sales transactions shall not be recognized by the full accrual method until all of the following criteria are met:

a. A sale is consummated (see the following paragraph).

b. The buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property (see paragraphs 360-20-40-9 through 40-24).

c. The seller’s receivable is not subject to future subordination (see paragraph 360-20-40-25).

d. The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale and does not have a substantial continuing involvement with the property (see paragraph 360-20-40-26).

Profit on a sale of a partial interest in real estate shall be subject to the same criteria for profit recognition as a sale of a whole interest.



ASC 360-20-40-3 details what may be referred to as the underlying principles of ASC 360-20. That is, profit on a real estate sale may be recognized in full on the date of sale, provided:

• The profit is determinable (i.e., collectibility is reasonably assured or the amount that will not be collected can be estimated), and

• The earnings process is virtually complete (i.e., the seller does not have substantial continuing involvement).

If these general principles are not met, full profit recognition (and, in some cases, sales recognition) is postponed. ASC 360-20 later describes, in detail, how to determine whether these general principles have been satisfied and the appropriate accounting to apply in other circumstances. In general, if collectibility is not reasonably assured, profit recognition is deferred until such time as collectibility is assured or cash is collected. If the earnings process is incomplete, profit recognition generally shifts from the time of sale to the time of the seller’s performance on the contract. A sale should not be recorded if a seller’s continued involvement in a property carries essentially the same risks as ownership of the property.

ASC 360-20-40-4 provides general guidance on assessing collectibility. In assessing collectibility, a seller must consider the buyer’s commitment to pay for the property based on the buyer’s initial and continuing investments in the property sold. The seller should also consider other collectibility factors, such as the credit standing of the buyer, the age and location of the property, and the adequacy of cash flow from the property, even if the initial and continuing investments are considered adequate. Chapter 3 provides further guidance on assessing the adequacy of a buyer’s initial and continuing investments.

ASC 360-20-40-5 provides an overview of the detailed guidance that should be followed to meet the conditions set forth in ASC 360-20-40-3, noting that profit cannot be recognized by the full accrual method until:

• A sale is consummated (see section 2.2),

• The buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property (see Chapter 3),

• The seller’s receivable is not subject to future subordination (see Chapter 4), and

• The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale, and does not have a substantial continuing involvement with the property sold (see Chapter 5).

Illustration 2-1: Evaluating the criteria for full accrual profit recognition

Facts:

A retail shopping center is sold by Highrise, Inc. (a real estate development company) to Property Investors, Inc. for $10,000,000 ($2,500,000 in cash and a 20-year, 12 percent note from Property Investors for $7,500,000, with principal and interest payable quarterly). The current market interest rate for transactions with similar risk is 12 percent and the customary amortization term for similar mortgages is 20 years (with principal and interest payable quarterly). A binding contract has been signed by both parties, all closing conditions have been met, and all consideration has been exchanged. The note is not subject to future subordination and Highrise has no continuing involvement with the property that would result in the retention of substantial risks or rewards of ownership. Property Investors’ initial and continuing investments in the transaction meet the minimum thresholds set for them by ASC 360-20 and no other collectibility issues are present. The carrying amount of the real estate is $9,500,000.



Analysis:

Because all of the conditions for recognizing profit on the full accrual method have been satisfied, all profit associated with this sale should be recognized on consummation of the sale and the following entry should be recorded:

Cash $ 2,500,000

Note receivable 7,500,000

Real estate $ 9,500,000 Gain on sale of real estate 500,000

2.1.1 Subsequent events Questions often arise regarding whether events that take place subsequent to the end of a reporting period may be taken into consideration in determining whether the requirements for recognizing profit under the full accrual method have been satisfied. For example, a transaction may meet all of the requirements of ASC 360-20-40-5, except that the buyer’s initial investment is not adequate. If the buyer makes an additional payment (or pays the entire receivable balance) subsequent to year-end but before the seller’s financial statements are issued, some may argue that full profit recognition was delayed initially because of uncertainty as to the collectibility of the receivable and the resolution of this uncertainty subsequent to year-end should result in full profit recognition in the year of sale. However, this accounting is not appropriate because all of the conditions for recognizing profit under the full accrual method were not satisfied as of the end of the reporting period. ASC 360-20 provides guidance on the appropriate accounting method to apply when all the criteria for recognizing profit under the full accrual are not met. Therefore, this guidance should be applied until all criteria are satisfied. If the initial investment is not adequate as of the end of the reporting period, the guidance in ASC 360-20-40-31 should be applied as of year-end (see section 5.2) and profit should not be recognized in full until the period in which all of the conditions for recognizing profit under the full accrual method are satisfied.

2.2 Consummation of a sale Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-7 A sale shall not be considered consummated until all of the following conditions are met: a. The parties are bound by the terms of a contract.

b. All consideration has been exchanged.

c. Any permanent financing for which the seller is responsible has been arranged.

d. All conditions precedent to closing have been performed. Paragraph 360-20-40-28 provides an exception to this requirement if the seller is constructing office buildings, condominiums, shopping centers, or similar structures.

Usually, those four conditions are met at the time of closing or after closing, not when an agreement to sell is signed or at a preclosing.



A sale generally is consummated at the time of closing or after closing, but not at the time a contract is entered into or at preclosing. The following conditions must be satisfied for a sale to be considered consummated:

• The parties are bound by the terms of a contract (e.g., both parties have signed a contract and no rescission period exists or the rescission period has expired).

• All consideration has been exchanged. Consideration includes all cash and non-cash consideration to be exchanged, including any notes receivable from the buyer and legal evidence of transfer of ownership (e.g., title) from the seller. For example, if a seller has received a down payment but has not yet received a mortgage note for the remainder of the purchase price, all consideration has not been exchanged and a sale has not been consummated.

• Any permanent financing for which the seller is responsible has been arranged. This condition only applies if the seller has an obligation to arrange permanent financing with a third party and not if the seller is directly providing permanent financing.

• All conditions precedent to closing have been performed. Conditions precedent to closing generally include obtaining a certificate of occupancy for the property being sold. ASC 360-20-40-28 provides an exception to this requirement for sales of condominiums, shopping centers, office buildings, and similar structures that involve long construction periods. Sellers of such real estate may recognize profit using the percentage-of-completion method (a subset of the full accrual method) during construction even though a certificate of occupancy has not been obtained (see section 5.1). See section 5.16 for additional guidance on accounting for long-term construction projects and section 5.13 for guidance on accounting for condominium projects.

If a sale is not consummated because one or more of the conditions listed above are not satisfied, the deposit method of accounting should be applied until all of the conditions have been met. Refer to Appendix A for guidance on the application of the deposit method.

Subsequent events

If a transaction does not meet one or more of the criteria listed above before the end of a reporting period, but subsequently meets all requirements prior to the issuance of the seller’s financial statements, the sale should not be recognized until the period in which all of the conditions have been satisfied. For example, if a seller does not sign a contract until the day after year-end, even if the buyer has signed the contract and all other requirements for consummation have been satisfied, both parties are not bound by the contract at year-end and the sale should not be considered consummated. The transaction should be accounted for using the deposit method until the period in which the required conditions for consummation are satisfied.

2.2.1 Sale of an option to acquire real estate In some situations, a property owner sells a buyer an option to purchase real estate in the future. Because all consideration has not been exchanged (i.e., the legal right to the property and the full sales price of the property have not been exchanged), a sale has not been consummated. Because a sale has not been consummated, any funds received under such an arrangement should be treated as a deposit until the option expires or is exercised. Recognition of a sale or profit on such a transaction is not appropriate, regardless of the amount of the payment received from the buyer. The sale of an option by an option holder that is not the property owner is a sale of an interest in real estate and profit recognition may or may not be appropriate depending on the specific facts and circumstances. See section 5.11 for additional guidance on accounting for transactions involving the sale of options or in-substance options.



2.2.2 Consummation considerations specific to condominium sales ASC 360-20-40-28 provides an exception to the requirement that all conditions precedent to closing be performed prior to consummation for condominium sales and other long-term construction projects (i.e., during construction) (see section 5.1). As a result, it may be possible to record profit on a condominium sale prior to closing if certain conditions are met (see section 5.13). However, this exception does not extend to the requirement that all consideration must be exchanged before a transaction is considered consummated. Thus, all consideration must be received from the buyer of a condominium unit prior to recognizing any profit. In assessing compliance with this requirement, the legal form of the contract must be considered. For sales of condominiums that are still under construction, consideration generally includes an initial, non-refundable deposit and a receivable due on delivery of the completed unit. If the buyer does not have a legal obligation to pay the balance of the receivable on delivery of the completed unit, but rather has an option to purchase the unit, all consideration has not been exchanged, and a sale has not been consummated.

Illustration 2-2: Buyer is obligated to pay at end of construction

Facts:

A condominium developer sells a condominium unit to an individual who plans to use the unit as a second residence. The contract of sale requires an initial, non-refundable 20 percent deposit with the balance due on closing.

Analysis:

Because the buyer is contractually required to pay the balance of the receivable on closing, this structure would satisfy the requirement that all consideration be exchanged, even if damages are contractually limited to the down payment in the event of breach of contract by the buyer.

Illustration 2-3: Buyer has an option to purchase at end of construction

Facts:

A buyer makes a nonrefundable payment of 20 percent of the sales price to the seller for the option to close on completion of construction.

Analysis:

This arrangement would not satisfy the consideration criterion because the buyer has not provided all consideration necessary to purchase the unit from the seller (i.e., there is no receivable due on completion of the condominium unless the buyer exercises its option to purchase the condominium).

2.3 Sales value Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-8 Sales value shall be determined by both of the following:

a. Adding to the stated sales price the proceeds from the issuance of a real estate option that is exercised and other payments that are in substance additional sales proceeds. These nominally may be management fees, points, or prepaid interest or fees that are required to be maintained in an advance status and applied against the amounts due to the seller at a later date.



b. Subtracting from the sale price a discount to reduce the receivable to its present value and by the net present value of services that the seller commits to perform without compensation or by the net present value of the services in excess of the compensation that will be received. Paragraph 360-20-40-43(d) specifies appropriate accounting if services are to be provided by the seller without compensation or at less than prevailing rates

2.3.1 Computation of sales value An important term encountered in applying ASC 360-20 is “sales value”. The sales value is used in determining the profit that can be recognized as well as in evaluating compliance with the initial and continuing investment tests. The sales value can be defined with the following equation: Sales Value = (A+B)-(C+D), where:

A = the stated sales price

B = other proceeds that are, in substance, additions to the sales price (e.g., proceeds received from the previous issuance of a real estate option that is exercised, management fees, points, or prepaid fees or interest that are maintained in an advance status and applied against amounts due to the seller at a later date)

C = any discount needed to reduce the receivable to its present value based on current market rates commensurate with the risk involved

D = any services that the seller commits to perform without compensation or for which the net present value of the services is in excess of the compensation that will be received (see section 5.10)

ASC 360-20 does not provide for an increase in sales value due to above market pricing for either seller financing or services. This prohibition is consistent with the general focus in ASC 360-20 on the delay versus the acceleration of profit.

2.3.2 In substance additions to the sales price In addition to payments made in connection with closing (e.g., points, management fees, or prepaid fees), the terms of an agreement may provide for other payments to or on behalf of a seller that may be considered in substance additions to the sales price. These other payments may relate to services that have been or will be performed by the seller or third parties. Judgment is required to determine whether these payments are in substance additions to the sales price.

ASC 360-20 allows a seller to recognize profit on the sale of land even if there is an accompanying agreement that requires the seller to develop the property in the future, to construct facilities on the land, or to provide off-site improvements or amenities, if future costs of development can be reasonably estimated at the time of sale (see section 5.16). In such situations, payments made (or to be made) by the buyer for improvements should be included in the sales value and the calculation of the initial and continuing investment tests, even if the payments are not due until the improvements are complete.

2.3.3 Discounting receivables In determining the sales value of a transaction, notes receivable should be discounted on a net present value basis. The discount rate should be the rate at which the yield on the note is equal to a market yield. The guidance for imputing interest in ASC 835-30, Interest — Imputation of Interest, notes that “the objective of the guidance in this Subtopic is to approximate the rate for a note that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions with the option to pay the cash price on purchase or to give a note for the amount of the purchase which bears the prevailing rate of interest to maturity” (ASC 835-30-10-1).



The discount rate applied in each transaction will depend on the creditworthiness of the buyer, the priority of the receivable (e.g., first or second mortgage), the value of collateral, the amortization period, and other payment terms. The market rate should not be determined by comparing the interest rate on a transaction with the rate charged by the seller for other similar transactions. The market rate should be the rate an independent third-party lending institution would charge for a similar financing.

A discount decreases the sales value of a transaction, resulting in a reduction in the gain from the sale of real estate. If a loss is anticipated as a result of a discount, it should be addressed in accordance with the accounting guidance for the impairment and disposal of long-lived assets in ASC 360-10. A decrease in the sales value also reduces the payments required to meet the initial and continuing investment tests.

Illustration 2-4: Discounting receivables in a real estate sales transaction

Facts:

An office building is sold by Highrise, Inc. (a real estate development company) to Property Investors, Inc. for $10,000,000 ($2,500,000 in cash and a 20-year, 10 percent note from Property Investors for $7,500,000 with principal and interest payable quarterly). Quarterly principal and interest payments will be $217,700. A contract has been signed by both parties, all closing conditions have been met, and all consideration has been exchanged. The note receivable is not subject to future subordination and Highrise is not involved with the property after the sale in any way that would result in the retention of substantial risks or rewards of ownership.

The current market interest rate for transactions with similar risk is 12 percent and the customary amortization term for similar mortgages is 20 years. The carrying amount of the real estate is $8,500,000. This example, while not showing the calculation, presumes the initial and continuing investment tests are met.

Analysis:

The receivable from Property Investors must be discounted to bring its yield to a current market rate. Accordingly, the note receivable should be discounted by Highrise, using an interest rate of 12 percent. Instead of Highrise recognizing a gain of $1,500,000 ($10,000,000 — $8,500,000) on the sale, a gain of $574,540 should be recognized, computed as follows:

Quarterly principal & interest payment $ 217,700 Present value factor for 80 quarterly payments at 12% x 30.20 Estimated market value of note receivable 6,574,540 Down payment 2,500,000 Sales Value 9,074,540 Carrying amount of real estate sold 8,500,000 Gain on sale of real estate $ 574,540

The journal entry to record the sale, giving effect to 12 percent market rate of interest on the note receivable, is as follows:

Cash $ 2,500,000 Note receivable 7,500,000

Real estate $ 8,500,000 Note receivable discount 925,460 Gain on sale of real estate 574,540

The discount on the note should be amortized as additional interest income on an effective yield basis. See ASC 310-20, Receivables — Nonrefundable Fees and Other Costs, for discussion of the effective yield method.



2.3.4 Calculating the sales value of improvements subject to a land lease Improvements may be sold to a buyer with a concurrent lease of the land on which the improvements are located. The seller generally owns or leases the land and executes a lease or sublease with the buyer of the improvements. However, in some situations the buyer may assume a lease from a third-party lessor. In situations where improvements are sold subject to an underlying land lease (whether or not the seller remains as the lessor), the sales value used to evaluate the adequacy of the buyer’s initial and continuing investments should include the present value of the lease payments for the land over the term of the primary indebtedness, if any, on the improvements. If there is no debt on the improvements, the seller should use a customary amortization term on primary debt for the type of improvements being sold. The present value of the lease payments for the land should be included in the calculation regardless of whether the lease is from the seller or a third-party because the land lease is another form of buyer financing that must be considered in determining whether the buyer is committed to pay for the property.

The following example from ASC 360-20 illustrates these concepts (refer to Chapter 3 for additional information on minimum initial investment requirements and section 5.14 for additional information on the limits a lease places on profit recognition if the leased land is owned by the seller of the improvements and examples of the profit calculation):


Implementation Guidance and Illustrations

Case A: Primary Land Lease — Land Owned by Third Party Lessor — Nonqualifying

360-20-55-26 This Case has the following assumptions.

Assumptions: Sales price of improvements $ 875,000

Represented by proceeds of: Cash down payment $ 125,000 Loan by insurance company—lien on leasehold improvements, 28-year term, 8 1/2%, payable in equal monthly installments of principal and interest

657,000

Note received by seller from buyer: 12-year term, 9 1/2%, payable in equal monthly installments of principal and interest

93,000

$ 875,000

Land lease for 99 years @ $19,000 per year, net, payable monthly in advance

Cost of constructing improvements—$750,000

No continuing involvement by seller

Computations: Present value of 336 monthly payments on land lease of $1,583.33 discounted at 8 1/2% (interest rate on loan from insurance company): $1,583.33 + ($1,583.33 x 127.9071) $ 204,000 Loan from insurance company 657,000 Equivalent primary debt 861,000

Note receivable from buyer 93,000 Total debt or equivalent 954,000

Down payment 125,000 Sales value $ 1,079,000



360-20-55-27 Because 15% of the sales value of the improvements is $161,850, the initial investment of $125,000 (about 12% of adjusted sales value) is inadequate to recognize profit on the sale of improvements. The second test is therefore irrelevant.

EY Note: The calculation of the present value of the land lease in this example is based on the primary indebtedness term of 336 months (28 years) versus the 99-year land lease term. As noted previously, the sales value used to evaluate the adequacy of the buyer’s initial and continuing investments should include the present value of the lease payments for the land over the term of the primary indebtedness on the improvements or, if there is no debt on the improvements, over a customary amortization terms on primary debt for the type of improvements being sold (see ASC 360-20-40-58 — see section 5.14).

2.3.5 Calculating the sales value of partial sales of real estate As discussed in section 5.12, a sale is a partial sale of real estate if the seller retains an equity interest in the property or has an equity interest in the buyer. For partial sales of real estate, the sales value should be based on the portion of the real estate being sold and not the full value of the real estate.

Illustration 2-5: Calculating the sales value of a partial sale

Facts:

Highrise, Inc. sells land to XYZ Development in exchange for $100,000 in cash, a $500,000 note from the third-party owner of XYZ Development, and a 40 percent interest in XYZ Development.

Analysis:

Highrise has sold 60 percent of the land for a sales price of $600,000. The sales value used to complete the initial and continuing investment tests should be $600,000 and not $1,000,000 (the value of 100 percent of the land).

See section 5.12 for additional guidance on accounting for partial sales of real estate.

2.3.6 Calculating the sales value of partnership interests As discussed in section 1.5, a sale of a partnership interest may be an in-substance sale of real estate if the assets of the partnership are primarily real estate. If a partnership interest is sold that is an in-substance sale of real estate, the sales value of the real estate should be determined based on the total consideration being exchanged (e.g., assumption of partnership debt) and not just the sales price of the partnership interest.

Illustration 2-6: Calculating the sales value of a partnership interest

Facts:

Highrise Partnership is a 50/50 partnership between Investor A and Investor B. The only asset in the partnership is real estate and the only liability is a note payable for $600,000. Investor A agrees to sell its interest in the partnership to Investor C for $250,000.

Analysis:

The sales value used to calculate the initial and continuing investment tests (refer to Chapter 3 for discussion of initial and continuing investments) should be the sales price of the partnership interest ($250,000) plus 50 percent of the partnership’s debt ($300,000), or $550,000 in total.



2.3.7 Calculating the sales value of the sale of an option by an option holder As discussed in section 2.2.1, if a property owner enters into an arrangement to sell an option in the property, the arrangement should be treated as a deposit until the option expires or is exercised. Recognition of a sale or profit on such a transaction is not appropriate, regardless of the amount of the payment received from the buyer.

However, the sale of an option by an option holder that is not the property owner is a sale of an interest in real estate and profit recognition under the full accrual method may be appropriate if the initial and continuing investment tests are satisfied. In determining the sales value to be used to calculate the required initial and continuing investments, both the sales price of the option and the exercise price of the option should be considered (i.e., the buyer’s initial and continuing investments to the extent applicable should be based on the total amount that must be paid to acquire the property).

The following example illustrates these concepts:

Illustration 2-7: Sale of an option by an option holder

Facts:

Company A paid $25,000 for a transferable option to purchase land for an additional $500,000 from Company X. Company X is the owner of the land. Company A sells its option to Company B for $100,000 ($50,000 cash and a note for $50,000).

Analysis:

The profit on the sale of the option by Company A to Company B may be recognized if all of the criteria for recognizing profit under the full accrual method are satisfied. The sales value used to calculate the adequacy of the initial and continuing investments should be the sales price of the option ($100,000) plus the exercise price of the option ($500,000), or $600,000 in total (resulting in an initial down payment of 8.3 percent). In this example, the sale of the option by Company A would not meet the initial investment requirements of ASC 360-20 (refer to 3.4 for further details).

Alternatively, if the seller received the entire $100,000 selling price in cash, it would not be necessary to include the exercise price of the option in the initial and continuing investment tests, because the seller would have received all amounts to which it is entitled and the buyer’s commitment to pay for the property would not be a factor in the seller’s recognition of profit (see section 3.2.2 for further details).

See section 5.11 for additional guidance on accounting for sales of options by option holders.

2.3.8 Calculating the sales value when a transaction is initially accounted for using the deposit method If a transaction is initially accounted for using the deposit method (e.g., because a sale has not been consummated (see section 2.2) or the initial investment test is not satisfied (see Chapter 3)), any interest payments received by the seller (except interest not subject to refund that is used to offset carrying charges—refer to Appendix A) are recorded as a deposit. In the future, when the transaction qualifies to be accounted for as a sale (i.e., under the full accrual, cost recovery, installment, or reduced-profit method) such payments are included in the calculation of the gain on sale. Therefore, in determining whether such a transaction meets the initial and continuing investment tests, the interest payments recorded as a deposit should be included in the calculation of the sales value. Refer to Appendix A for information on the application of the deposit method and the calculation of the sales value in such situations.



2.4 Surrender of real estate in satisfaction of an entity’s obligation Real estate is sometimes surrendered in exchange for satisfaction of a Company’s indebtedness. Such a transaction occurs generally in one of two ways:

1. An exchange of the real estate for a release from the related indebtedness

2. A loss of a controlling financial interest (as described in Subtopic 810-10) in a subsidiary that is in substance real estate as a result of a default by the subsidiary on its nonrecourse debt

Both transactions are subject to the sale and profit recognition guidance of ASC 360-20-40. That is, determining if derecognition of the real estate (as well as the related debt, depreciation and operating income from the real estate) is appropriate and the measurement of profit (if any) would depend on whether:

a. A sale is consummated (section 2.2).

b. The buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property (Chapter 3).

c. The seller’s receivable is not subject to future subordination (sections 4.1 and 5.4).

d. The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale and does not have a substantial continuing involvement with the property (sections 4.2 and 5.5).

Subtopic 810-10, generally requires that a parent deconsolidate a subsidiary if the parent ceases to have a controlling financial interest in the subsidiary. However certain exceptions apply, including when the subsidiary is in substance real estate. In such real estate related situations, ASC 360-20’s guidance on real estate sales would apply.

The guidance in Subtopic 360-20 also applies to situations when a parent ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt. ASC 360-20 guidance is generally applicable to all losses of controlling interests (i.e., sale, transfer, foreclosure, dilution of ownership interest and other arrangements in which control is surrendered) in in-substance real estate, including transfers of real estate in satisfaction of an entity’s obligations.

The following examples illustrates the application of the sale of real estate guidance when the reporting entity ceases to have a controlling financial interest in the in substance real estate subsidiary as a result of a default by the subsidiary on its nonrecourse debt and the real estate is transferred in satisfaction of the nonrecourse indebtedness

Excerpt from Accounting Standards Codification Property, Plant and Equipment — Real Estate Sales

Illustrations

Example 8: Conveyance of Real Estate to the Lender in Full Satisfaction of the Entity’s Obligation

360-20-55-69 This Example uses the following assumptions:

a. A reporting entity establishes a single-purpose entity with $200,000 of equity to purchase commercial real estate

b. The single-purpose entity is wholly owned and consolidated by the reporting entity



c. The single-purpose entity borrows $1 million from a lender on a nonrecourse basis (for which the lender’s recourse is limited to the assets of the single-purpose entity) to acquire real estate for $1.2 million

d. The single-purpose entity has no other significant assets or liabilities other than the real estate and related nonrecourse debt

e. The reporting entity’s ownership interest in the single-purpose entity is considered in substance real estate.

Years later, the carrying value and fair value of the real estate and the carrying value of the debt are as follows.

As of June 30, 20X1, before the impairment loss on real estate

Carrying value of real estate $ 1,000,000 Fair value of real estate $ 600,000 Carrying amount of related nonrecourse indebtedness $ 800,000

As of December 30, 20X1, before the transfer of real estate

Carrying value of real estate $ 600,000 Fair value of real estate $ 600,000 Carrying amount of related nonrecourse indebtedness $ 800,000

For simplicity purposes, this Example ignores the recurring accounting that is associated with the continuing ownership of real estate (for example, depreciation and other property expenses) and the associated indebtedness (for example, debt service paid or accrual of interest if unpaid) in the period between June 30, 20X1, and December 31, 20X1. Also, for simplicity purposes, this Example ignores consideration of Subtopic 470-60 with respect to measurement and disclosure (derecognition of in substance real estate is addressed by this Subtopic as illustrated in this Example).

360-20-55-70 By applying the guidance in paragraphs 360-10-35-16 through 35-36 for long-lived assets classified as held and used, the entity recognizes a $400,000 impairment loss on the real estate on June 30, 20X1. The entity applies the guidance in this Topic that requires that it measure the impairment loss without regard to the carrying amount of the single-purpose entity’s nonrecourse indebtedness.

360-20-55-71 As of September 30, 20X1, the single-purpose entity defaults on its obligation to the lender and expects to transfer the ownership of the real estate to the lender to satisfy the nonrecourse obligation. As a result of defaulting on the obligation, the reporting entity applies the guidance in Topic 810 and concludes that it ceases to have a controlling financial interest in the single-purpose entity. Although the reporting entity has a plan to transfer ownership of the real estate to the lender, a transfer has not occurred as of the reporting date and, therefore, the derecognition criteria in paragraph 360-20-40-7 have not been met. The reporting entity should not derecognize the in substance real estate as of September 30, 20X1.

360-20-55-72 On December 31, 20X1, an exchange of the real estate for a release from the nonrecourse indebtedness (in accordance with paragraph 405-20-40-1) occurs, and a sale is consummated in accordance with paragraph 360-20-40-7. The reporting entity need not evaluate the adequacy of the lender’s investment in accordance with paragraphs 360-20-40-15 through 40-16 because the single-



purpose entity has been completely released from its nonrecourse indebtedness and has received all consideration to which it is entitled. If the single-purpose entity was not fully released or had not received all amounts it was entitled to, then the initial and continuing investment requirements for the full accrual method of profit recognition would be applicable. Therefore, upon completion of the exchange and satisfaction of the requirements for the full accrual method of profit recognition, the reporting entity would report a $200,000 gain as a result of the release (extinguishment) of the nonrecourse indebtedness.

360-20-55-73 The reporting entity would need to consider whether the single-purpose entity has been fully released from the nonrecourse indebtedness and whether it or the reporting entity has other related and continuing obligations to the lender (through, for example, a guarantee or other forms of contingent consideration) and then evaluate whether it has conveyed the usual risks and rewards of ownership. If the reporting entity provides a guarantee or if the lender has recourse to the reporting entity or other assets of the reporting entity, the reporting entity would need to assess the nature of the continuing involvement in accordance with this Subtopic.

360-20-55-74 Paragraphs 360-20-55-68 through 55-72 illustrate when the single-purpose entity exchanges real estate at the same time as and in exchange for a release from the related nonrecourse indebtedness. In some circumstances, the single-purpose entity might legally transfer the real estate to the lender without contemporaneously obtaining evidence of a legal release of its related indebtedness from the lender. In those circumstances, in accordance with paragraph 405-20-40-1(b), the transfer of real estate accomplishes a legal release of the reporting entity, unless the reporting entity has provided a guarantee to the lender or the lender has recourse to the reporting entity or other assets of the reporting entity.

The following example illustrates the application of the sale of real estate guidance when there has been a loss of a controlling financial interest in a subsidiary that is in substance real estate as a result of a default by the subsidiary on its nonrecourse debt and the real estate is not transferred in satisfaction of the nonrecourse indebtedness.

Excerpt from Accounting Standards Codification Property, Plant and Equipment — Real Estate Sales

Illustrations

Example 9: Effect of Loss of Controlling Financial Interest in an Entity That is in Substance Real Estate

360-20-55-76 For this Example, assume the same facts as those in Example 8. Also assume that the reporting entity ceases to have a controlling financial interest in the single-purpose entity as a result of default on its nonrecourse obligation and would otherwise be required to deconsolidate the single-purpose entity in accordance with Topic 810. However, the reporting entity and the lender wish to defer the income and transfer tax consequences of a legal transfer of the property and a legal extinguishment of the related debt. The reporting entity and lender agree to maintain their existing legal relationship until a third-party purchaser of the property is identified. Accordingly, the parties agree that the single-purpose entity will not make future payments to the lender, the reporting entity retains its legal ownership of all of the equity of the single-purpose entity, and the debt remains legally outstanding. During the time that the property continues to be held by the single-purpose entity, the lender makes substantially all of the operating decisions with respect to the property and receives all of the cash flows from the



property’s operations. The reporting entity does not expect to have future participation in the management or economics of the single-purpose entity (because the fair value of the property is significantly less than the carrying amount of the related indebtedness). In addition, the reporting entity has waived its rights of ownership of the single-purpose entity, which provides the lender with the ability to foreclose and otherwise sell or transfer the underlying property without the reporting entity’s consent. However, the reporting entity does have the ability to cure the event of default and retain ownership of the real estate.

360-20-55-77 In this Example, derecognition of the in substance real estate by the reporting entity in its consolidated statement of financial position is not appropriate before the date that the reporting entity’s interest in the real estate is conveyed to the lender or a third-party purchaser and the single-purpose entity is released from its debt obligation.


3 Initial and continuing investments

ASC 360-20-40-3 provides two general criteria for recognizing profit under the full accrual method (see section 2.1). One of these criteria is that “the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated.” Collectibility of the sales price is demonstrated by the buyer’s commitment to pay for the property and must be evaluated unless the seller has unconditionally received all amounts it is entitled to without retaining any risk related to the buyer’s financing (see section 3.2.2 for further discussion). The seller should assess the buyer’s commitment to pay for the property by evaluating the buyer’s initial and continuing investments in the property as well as other factors influencing collectibility. The initial and continuing investments should give the buyer a large enough stake in the property that the risk of loss through default motivates the buyer to honor its obligation to the seller. ASC 360-20-40-9 through 40-24 (discussed here in Chapter 3) provides detailed guidance on determining whether the buyer’s initial and continuing investments are sufficient to demonstrate the buyer’s commitment to pay for the property.

3.1 Buyer’s initial investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-9 Adequacy of a buyer’s initial investment shall be measured by its composition (see the following paragraph and paragraph 360-20-40-13) and its size compared with the sales value of the property (see paragraph 360-20-40-18).

The buyer’s initial investment is considered adequate when the buyer has demonstrated:

• A commitment to pay for the property, and

• There is a reasonable likelihood that the seller will collect the receivable.

The adequacy of the initial investment is determined by its composition and size.

3.2 Composition of buyer’s initial investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-10 The buyer’s initial investment shall include only the following:

a. Cash paid as a down payment.

b. The buyer’s notes supported by irrevocable letters of credit from an independent established lending institution, that is, an unrelated institution such as a commercial bank unaffiliated with the seller.



c. Payments by the buyer to third parties to reduce existing indebtedness on the property.

d. Other amounts paid by the buyer that are part of the sales value.

Other consideration received by the seller, including other notes of the buyer, shall be included as part of the buyer’s initial investment only when that consideration is sold or otherwise converted to cash without recourse to the seller.

ASC 360-20-40-10 details the types of consideration that can be included in a buyer’s initial investment. This list is considered to be all-inclusive and no other forms of consideration should be included when evaluating the adequacy of a buyer’s initial investment.

The purpose of the initial and continuing investment tests is to support the collectibility of the sales price by demonstrating the buyer’s commitment to pay. The buyer’s initial and continuing investments must give the buyer a sufficient stake in the property such that the risk of loss through default motivates the buyer to honor its obligation to the seller. Therefore, the composition of the initial investment is limited to cash paid by the buyer or a demonstrated commitment by the buyer to honor its obligation (i.e., irrevocable letters of credit). Other consideration received from the buyer, such as marketable securities or notes of the buyer (i.e., notes held by the buyer from third parties, such as a receivable from the buyer’s customer, not notes issued by the buyer to the seller at the time of the transaction), should not be included in the buyer’s initial investment until that consideration is converted to cash without recourse to the seller.

A note from a buyer (i.e., seller financing) that is not supported by an irrevocable letter of credit from an independent established lending institution should not be included in the buyer’s initial investment, even if it has been sold to a third party without recourse. The sale of a receivable to a third party does not demonstrate the buyer’s commitment to honor its obligation. However, if the sale of a receivable results in the seller receiving all funds to which it is entitled without recourse, full profit recognition may be appropriate (see section 3.2.2 for additional guidance).

3.2.1 Irrevocable letters of credit Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-11 An irrevocable financial instrument, such as a surety bond, from an established independent insuring institution (such as the Federal Housing Administration or Veterans Administration) insuring that the instrument has all the rights and obligations of an irrevocable letter of credit may be considered by the seller to be equivalent to an irrevocable letter of credit and included as part of the buyer’s initial and continuing investment in determining whether it is appropriate to recognize profit under the full accrual method. The requirement in this Subtopic to demonstrate the buyer’s commitment to pay is an important criterion that must be met before profit is recognized by the full accrual method.

360-20-40-12 Mortgage insurance shall not be considered the equivalent of an irrevocable letter of credit in the determination of whether it is appropriate to recognize profit under the full accrual method because the purchase of mortgage insurance is not deemed to demonstrate a commitment by the buyer to honor its obligation to pay for the property.




360-20-55-3 A seller of owner-occupied single-family residential homes that finances a sale under an Federal Housing Administration or Veterans Administration government-insured program may use the normal down payment requirements or loan limits established under those programs as a surrogate for the down payment criteria set forth in paragraphs 360-20-55-1 through 55-2 and may record profit under the full accrual method provided that the mortgage receivable is insured from loss under the Federal Housing Administration or Veterans Administration program. In that specific circumstance, departure from the minimum initial investment criteria of this Section is justified because all of the credit risk associated with the receivable from the sale is transferred to the governmental agency. However, in all other circumstances (for example, seller financing using private mortgage insurance) the minimum initial investment criteria set forth in this Section shall be followed.

A note from a buyer may be included in the buyer’s initial investment if it is supported by an irrevocable letter of credit from an independent established lending institution. An “independent established lending institution” is an unrelated institution, usually a commercial bank, that issues letters of credit in the normal course of business. The irrevocable letter of credit should be for a term that is at least as long as the term of the note from the buyer. Additionally, if the note does not require current payments of interest, the irrevocable letter of credit should cover the principal and interest, such that the irrevocable letter of credit equals the balance that will be due at the end of the note term.

Occasionally sellers will accept surety bonds to support a buyer’s note instead of an irrevocable letter of credit. As noted in ASC 360-20-40-11, an irrevocable financial instrument, such as a surety bond, may be considered equivalent to an irrevocable letter of credit and included as part of the initial and continuing investments if the following conditions are satisfied:

• The instrument is from an established independent insuring institution, and

• The instrument has all the rights and obligations of an irrevocable letter of credit (i.e., the seller’s rights of collection, the surety’s obligation for payment, and the surety’s recourse to the buyer under the instrument in the event of default are the same as those of an irrevocable letter of credit).

Questions have arisen as to whether government or private mortgage insurance covering a portion of a mortgage balance should be considered equivalent to an irrevocable letter of credit when performing the initial and continuing investment tests. ASC 360-20-40-12 notes that mortgage insurance should not be considered equivalent to an irrevocable letter of credit because the purchase of mortgage insurance does not demonstrate a commitment by the buyer to pay for the property.

However, pursuant to ASC 360-20-55-3, sellers may record profit under the full accrual method (i.e., the initial and continuing investment requirements are satisfied) for all loans insured under current Federal Housing Administration (FHA) or Veterans Administration (VA) programs, even if these programs require less of a down payment than the minimum initial investment requirements of ASC 360-20-55-2 (see section 3.4.1 for discussion of minimum initial investment requirements).




3.2.2 Applicability of the initial and continuing investment tests and the effects of various forms of financing ASC 360-20 provides the following guidance related to the applicability, composition, and application of the initial and continuing investment tests.

Applicability


Derecognition

360-20-40-14 The sale of real estate often involves significant financing relative to the sales price. That financing may be provided by independent third parties, the seller, or both. The financing may involve a nonrecourse mortgage (that is, the lender’s only recourse upon default of the buyer is to repossess the underlying real estate) and it may involve the buyer’s assumption of preexisting recourse or nonrecourse mortgage obligations of the seller.

360-20-40-15 In considering how profit should be recognized under this Subtopic when a real estate sales transaction involves various forms of financing, the initial and continuing investment requirements for the full accrual method of profit recognition of this Subtopic shall be applicable unless the seller receives any of the following as the full sales value of the property:

a. Cash, without any seller contingent liability on any debt on the property incurred or assumed by the buyer

b. The buyer’s assumption of the seller’s existing nonrecourse debt on the property

c. The buyer’s assumption of all recourse debt on the property with the complete release of the seller from those obligations

d. Any combination of such cash and debt assumption.

360-20-40-16 When the seller has unconditionally received all amounts it is entitled to from the sale and is not at risk related to the financing, the buyer’s commitment to pay for the property is not a factor in the seller’s recognition of profit.

The purpose of the initial and continuing investment tests is to support the collectibility of the sales price by demonstrating the buyer’s commitment to pay for the property, not to measure the consideration received by the seller. ASC 360-20-40-16 notes that the initial and continuing investment tests are not applicable if the seller has unconditionally received all amounts it is entitled to without retaining any risk related to the buyer’s financing.



Illustration 3-1: Seller receives full sales value in cash

Facts:

Land is sold for $100,000, and the seller receives $100,000 in cash ($15,000 directly from the buyer and $85,000 from a first mortgage secured by the property). The seller is not contingently liable for the mortgage nor does it have any other risks related to the buyer’s financing.

Analysis:

Because the seller received the full sales value of the property in cash, without any contingent liability on the debt incurred by the buyer or any other risk related to the buyer’s financing, the initial and continuing investment requirements are not applicable and full profit recognition is appropriate (assuming all other criteria for recognizing profit under the full accrual method have been satisfied).

Illustration 3-2: Seller receives full sales value received through combination of cash and

debt assumption

Facts:

Assume the same facts as Illustration 3-1 above, except instead of obtaining a mortgage on the property, the buyer assumes the seller’s existing nonrecourse debt on the property of $85,000 and the seller is released from any obligation.

Analysis:

Because 100 percent of the sales value is paid through cash and the buyer’s assumption of the seller’s existing nonrecourse debt on the property (without any contingent seller obligation), the initial and continuing investment requirements are not applicable and full profit recognition is appropriate (assuming all other criteria for recognizing profit under the full accrual method have been satisfied).

Composition


Derecognition

360-20-40-17 To recognize profit by the full accrual method, debt incurred by the buyer that is secured by the property, whether incurred directly from the seller or other parties or indirectly through assumption, and payments to the seller from the proceeds of such indebtedness shall not be included as part of the buyer’s initial investment. A sufficient amount of the buyer’s own cash or other qualifying forms of investment demonstrates the buyer’s commitment to pay for the property; however, the buyer’s borrowing secured by the property does not demonstrate such a commitment.

The purpose of the initial (and continuing) investment test(s) is to assess the buyer’s commitment to pay for the property versus to measure the consideration received by the seller. As a result, a buyer should contribute its own cash or another qualifying form of investment to demonstrate a commitment to pay for the property being purchased (i.e., to satisfy the initial investment test). Proceeds from debt secured by the property being purchased does not demonstrate this commitment, even if the debt is with a third party and the seller receives cash from the proceeds of the indebtedness. For example, if a buyer finances a purchase of real estate with an $80,000 second mortgage from a third party secured by the property and a $20,000 first mortgage to the seller, even though the seller receives $80,000 in cash from the second mortgage, the buyer’s initial investment is zero because the debt incurred by the buyer is secured by the property.



If a note receivable from a buyer is sold to a third party, with or without recourse, proceeds received should still be excluded from the buyer’s initial investment. However, if the seller has received all amounts to which it is entitled and has no remaining risk related to the buyer’s financing, the seller need not consider the adequacy of the buyer’s initial and continuing investments in determining whether it is appropriate to recognize profit on the transaction (ASC 360-20-40-16).

Illustration 3-3: Sale of note receivable when seller has not received the full sales value

Facts:

Real estate is sold for $100,000. Consideration consists of an $80,000 first mortgage note from the seller and a $20,000 second mortgage note from the seller, both secured by the property. The $20,000 second mortgage is sold by the seller to a third party without recourse.

Analysis:

Even though the $20,000 second mortgage is sold without recourse, the amount received from the sale of the note may not be included in the buyer’s initial investment. The sale of the note to a third party does not support the collectibility of the sales price by demonstrating the buyer’s commitment to pay for the property.

Illustration 3-4: Sale of note receivable when seller has received the full sales value

Facts:

Assume the same fact as in Illustration 3-3, except the buyer secures a new $80,000 first mortgage from a third party or assumes an existing $80,000 mortgage secured by the property that is without recourse.

Analysis:

When the $20,000 second mortgage is sold without recourse, the seller has unconditionally received all amounts it is entitled to without retaining any risk related to the buyer’s financing. Therefore, the initial and continuing investment tests are no longer applicable and the profit on the transaction should be recognized in full when the note is sold (assuming all other criteria for recognizing profit under the full accrual method have been satisfied).

Application


Derecognition

360-20-40-32 Under the installment, cost recovery, and reduced-profit recognition methods, debt incurred by the buyer that is secured by the property, whether incurred directly from the seller or other parties or indirectly through assumption, and payments to the seller from the proceeds of such indebtedness shall not be considered buyer’s cash payments. However, if the profit deferred under the applicable method exceeds the outstanding amount of seller financing and the outstanding amount of buyer’s debt secured by the property for which the seller is contingently liable, the seller shall recognize the excess in income.



If the continuing investment test is not satisfied, profit should be recorded using the installment, cost recovery, or reduced-profit method (assuming all other criteria for recognizing a sale have been satisfied). Debt incurred that is secured by the property, including debt for which the seller is not contingently liable, should not be included in the calculation of profit under these methods unless the profit deferred exceeds the outstanding amount for which the seller is at risk (i.e., the outstanding amount of seller financing and the buyer’s debt secured by the property for which the seller is contingently liable).

Illustration 3-5: Deferred profit exceeds the outstanding amount for which the seller is at risk

Facts:

Real estate with a cost of $70,000 is sold for $100,000. Consideration consists of a first mortgage from a third party of $80,000 and a $20,000 second mortgage from the seller, both secured by the property.

Analysis:

Under the installment method, which is discussed in detail in Appendix A, profit is generally recognized as cash is received. In this situation, although the seller receives $80,000 from the proceeds of the third-party first mortgage, because the debt is secured by the property, it should not be included in the calculation of profit recognized in accordance with the installment method on the date of sale. However, because the profit deferred under the installment method is $30,000 ($100,000 selling price less $70,000 cost), and the seller is not contingently liable for the $80,000 first mortgage, profit of $10,000 may be recognized ($30,000 deferred profit less $20,000 seller financing) on the date of sale.

Under the cost recovery method (refer to Appendix A for detailed discussion of the cost recovery method), profit is deferred until the cost of the property is recovered through cash payments. Similar to the installment method, although the $80,000 received should not be included in the calculation of the costs recovered, because the profit deferred under the cost recovery method is $30,000, and the seller is not contingently liable for the $80,000 first mortgage, profit of $10,000 may be recognized on the date of sale.

Illustration 3-6: Deferred profit does not exceed the amount for which the seller is at risk

Facts:

Assume the same facts as in Illustration 3-5, except consideration consists of the assumption of the seller’s recourse note of $80,000 (the seller remains contingently liable) and a $20,000 second mortgage from the seller, both secured by the property.

Analysis:

No profit would be recognized on the date of sale because there is no part of the consideration that is not seller financing or debt for which the seller is contingently liable.



Examples

The following table from ASC 360-20 provides examples of profit recognition with various financing scenarios:



360-20-55-55 This Example illustrates the guidance in paragraphs 360-20-40-14 through 40-17 and 360-20-40-32. This Example has the following assumptions:

a. Sales price: $100

b. Seller’s basis in property sold: $70

c. Initial investment requirement: 20%

d. All mortgage obligations meet the continuing investment requirements of this subtopic.

360-20-55-56 The following table illustrates profit recognition with various forms of financing.

Components of cash

received by seller at closing Profit recognized at date of sale

(c)

Situation

Cash received by

seller at closing

Buyer’s initial

investment

Buyer’s independent 1st mortgage

Assumption of seller’s

nonrecourse mortgage

Seller financing

(a)

Assumption of seller’s recourse mortgage

(b)

Recognition under

paragraphs topic/

subtopic/ section Full accrual Installment

Cost recovery

1 $ 100 $ 20 $ 80 15 through 16 $ 30 2 100 0 100 15 through 16 30 3 20 20 $ 80 15 through 16 30 4 0 0 100 15 through 16 30 5 20 20 $ 80(1) 17 30 6 20 20 $ 80 17 30 7 80 20 60 20(2) 17 30 8 20 20 60 20(2) 17 30 9 20 20 20(2) 60 17 30

10 0 0 100 32 $ 0 $ 0 11 0 0 100(1) 32 0 0 12 0 0 20(2) 80 32 0 0 13 80 0 80 20(2) 32 10 10 14 10 10 90(1) 32 3 0 15 10 10 90 32 3 0 16 90 10 80 10(2) 32 20 20 17 10 10 80 10(2) 32 20 20 18 10 10 10(2) 80 32 3 0

(a) First or second mortgage indicated in parentheses. (b) Seller remains contingently liable. (c) The profit recognized under the reduced-profit method is dependent on various interest rates and payment terms. An illustration is not presented due to the complexity of

those factors and the belief that this method is not frequently used in practice. Under this method, the profit recognized at the consummation of the sale would be less than under the full accrual method, but normally more than the amount under the installment method.



3.2.3 Transfer of ownership interest as part of down payment Questions have arisen as to whether purchased property or other assets pledged as security for a note (i.e., collateral) should be included as part of the buyer’s initial investment in determining whether profit may be recognized under the full accrual method. ASC 360-20 provides the following example that addresses this issue:



360-20-55-65 This Example illustrates the guidance in paragraph 360-20-40-9.

360-20-55-66 In this Example, before a real estate sale, Party A has a 75 percent interest in the real estate and Party B has the other 25 percent interest. Party A sells its interest to Party B and receives a 10 percent cash down payment and a note for the balance of the sales price. For this transaction, paragraph 360-20-55-2 specifies a minimum required initial investment of 15 percent of the sales value. Party B pledges the 100 percent interest in the property as security for the note to Party A; no debt is outstanding on the property.

360-20-55-67 This Subtopic precludes profit recognition under the full accrual method for this transaction because purchased property or other assets pledged as security for a note should not be included as part of the buyer’s initial investment.

Profit should not be recognized under the full accrual method for the transaction described above, because purchased property or other assets pledged as security for a note should not be included as part of a buyer’s initial investment. Adequate collateral pledged to support a receivable is not an indication that the buyer’s initial investment is adequate. Because the cash down payment was only 10 percent of the sales value in the above example, the initial investment is inadequate.

3.3 Items excluded from buyer’s initial investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-13 The initial investment shall not include any of the following: a. Payments by the buyer to third parties for improvements to the property

b. A permanent loan commitment by an independent third party to replace a loan made by the seller

c. Any funds that have been or will be loaned, refunded, or directly or indirectly provided to the buyer by the seller or loans guaranteed or collateralized by the seller for the buyer. As an example, if unimproved land is sold for $100,000, with a down payment of $50,000 in cash, and the seller plans to loan the buyer $35,000 at some future date, the initial investment is $50,000 minus $35,000, or $15,000.




ASC 360-20-40-10 details the types of consideration that qualify to be included in a buyer’s initial investment (see section 3.2). ASC 360-20-40-13 provides a description of specific items that may not be included in the buyer’s initial investment.

3.3.1 Payments made for improvements to the property Payments made by a buyer to a third party for improvements to the property should not be included in the buyer’s initial investment, even if these payments support the buyer’s commitment to pay for the property (e.g., if the cost of improvements is significant compared to the cost of the property, payments made for the improvements support the buyer’s commitment to the overall project). Such payments do not increase the consideration received by the seller and would only benefit the seller if it becomes necessary to foreclose on the property and the improvements add value to property (e.g., modifications made to a building that would allow the buyer to operate a fast food restaurant franchise may not be considered valuable to another buyer that cannot use the property for the same purpose). However, if the seller is responsible for making improvements to the property (see section 5.16), up-front payments made by the buyer to the seller for improvements may be included in the initial investment because the payments are part of the total consideration received by the seller for the property. Such payments should also be included in the calculation of the transaction’s sales value (see section 2.3).

3.3.2 Funds provided or guaranteed by the seller to the buyer Any funds that have been or will be loaned, refunded, or directly or indirectly provided to the buyer by the seller or loans guaranteed or collateralized by the seller for the buyer should not be included as part of the buyer’s initial investment. Such amounts should be deducted from the initial investment even if they are not specifically related to the initial investment. For example, if a down payment of $100,000 is made for an undeveloped tract of land and the seller agrees to loan the buyer $75,000 in the future to be used to develop the property, the $75,000 must be deducted from the down payment of $100,000, resulting in an initial investment of $25,000.

ASC 360-20-40-20 provides an exception to the requirement to deduct a future loan commitment from the initial investment if the seller is an established lending institution, the future loan is on normal terms at a fair market interest rate, and the agreement stipulates that the proceeds of the loan must be used to develop the property (see section 3.5).

A seller has directly or indirectly provided funds to a buyer if the buyer receives cash that is used to make payments on the property from the seller or based on the seller’s credit. Indirect financing may take many forms and the seller should evaluate other transactions with the buyer as well as transactions with third parties for an indication that the seller has indirectly provided funds to the buyer. Examples of indirect funding may include:

• Inducements, such as collateral or guarantees, provided by the seller to third-party lenders so that the lenders will make loans to the buyer

• Purchases made by the seller from third parties, who will loan funds to the buyer

• Refinancing of existing loans between the buyer and seller at or near the date of sale

• Donations from the seller to a non-profit organization that in turn will loan or give funds to the buyer to assist with the down payment

Funds provided to the buyer by related parties of the seller and loans guaranteed or collateralized by related parties of the seller should also be considered funds provided or guaranteed by the seller. Related parties are defined in the ASC Master Glossary, as follows:



Excerpt from Accounting Standards Codification Master Glossary

Related Parties

Related parties include:

a. Affiliates of the entity

b. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity

c. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management

d. Principal owners of the entity and members of their immediate families

e. Management of the entity and members of their immediate families

f. Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests

g. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

Illustration 3-7: Funds provided by seller in a prior transaction

Facts:

Highland Bank, an established lending institution, sells an apartment building to XYZ Development Company for $2,500,000, payable through a cash down payment of $625,000 and a 10-year note for $1,875,000. The bank has a prior unrelated loan to the buyer that is current and is not changed by the terms of the current sales transaction.

Analysis:

The prior unrelated loan does not represent funds directly or indirectly provided to the buyer in the current transaction and should not be deducted from the initial down payment in determining the adequacy of the buyer’s initial investment. However, if the prior unrelated loan was refinanced at or near the date of sale (e.g., the underlying property has a loan to value ratio of 40 percent and is refinanced based on a current 80 percent loan to value ratio) the benefit received by the buyer would be considered funds provided by the seller and should be subtracted from the initial down payment in determining the adequacy of the buyer’s initial investment.



Illustration 3-8: Funds provided by seller through revolving line of credit

Facts:

Assume the same facts as Illustration 3-7 above, except the buyer draws down $400,000 from an existing revolving line of credit from the seller that has no restrictions on the use of the funds borrowed.

Analysis:

The funds received by the buyer from the line of credit would be considered funds provided by the seller and should be subtracted from the initial down payment in determining the adequacy of the buyer’s initial investment. However, if the bank (an established lending institution as described in ASC 360-20-40-10 — refer to section 3.2) agreed to loan funds to the buyer in the future to be used specifically for development of the apartment building on normal terms bearing interest at a fair market interest rate, those funds need not be subtracted from the initial down payment.

Illustration 3-9: Funds provided by a related party of the seller

Facts:

Highrise, Inc. sells an apartment building to XYZ Development Company for $2,500,000, payable through a cash down payment of $625,000 and a 10-year note for $1,875,000. XYZ borrows the $625,000 used for the down payment from Highland Bank, an established lending institution. Highrise, Inc. has an investment in Highland Bank that is accounted for under the equity method.

Analysis:

Because Highland Bank is an equity method investee of the seller, Highrise, Inc., the funds obtained from Highland Bank would be considered funds provided by the seller and should be subtracted from the initial down payment in determining the adequacy of the buyer’s initial investment.

Illustration 3-10: Seller guarantee

Facts:

Land is sold for $100,000, and the seller receives $100,000 in cash ($15,000 directly from the buyer and $85,000 from a third-party first mortgage secured by the property and guaranteed by the seller).

Analysis:

Although the seller received the full sales value of the property in cash, the seller is contingently liable on the debt on the property incurred by the buyer. As a result, the initial and continuing investment requirements are applicable in this situation (see section 3.2.2). The adequacy of the initial investment should be evaluated based on the $15,000 cash contributed directly by the buyer (refer to section 3.4 for minimum initial investment requirements).



3.4 Size of buyer’s initial investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-18 The buyer’s initial investment shall be adequate to demonstrate the buyer’s commitment to pay for the property and shall indicate a reasonable likelihood that the seller will collect the receivable. Lending practices of independent established lending institutions provide a reasonable basis for assessing the collectibility of receivables from buyers of real estate. Therefore, to qualify, the initial investment shall be equal to at least a major part of the difference between usual loan limits and the sales value of the property. Guidance on minimum initial investments in various types of real estate is provided in paragraphs 360-20-55-1 through 55-2.

For a seller to support collectibility of the sales price, the buyer’s initial investment must be sufficient to demonstrate the buyer’s commitment to pay. ASC 360-20-40-18 provides general guidance indicating that the initial investment should equal at least a major part of the difference between the sales value and usual loan limits established by independent lending institutions (i.e., the amount being financed should not be significantly more than the amount a lending institution would allow in an independent transaction). ASC 360-20-55-1 and ASC 360-20-55-2 provide specific guidance on minimum initial investments based on usual loan limits. The table provided in ASC 360-20-55-2 sets a floor on the initial investment that in some cases must be exceeded. That is, the initial investment cannot be lower than set forth in ASC 360-20-55-2. See section 3.4.1 and section 3.4.2 for further details.

If a buyer’s initial investment is not adequate, the seller should first evaluate whether the initial investment is so low that the transaction is, in effect, the sale of an option. As discussed in section 2.2.1, sales of options should be accounted for as deposits. If the transaction is not a sale of an option and recovery of the cost of the property is not reasonably assured (see section 5.2.1), the seller should apply the cost recovery method or the deposit method to the transaction (see Appendix A for discussion of these methods and section 5.2.1.1 for guidance on determining which method to apply). If recovery of the cost of the property is reasonably assured and the risks and rewards of property ownership have been transferred to the buyer, then the seller should apply the installment method or the cost recovery method (see section 5.2.1.2 for guidance on determining which method to apply).

If a buyer’s initial investment exceeds the minimum requirements in ASC 360-20-55-1 and ASC 360-20-55-2 and the buyer’s continuing investment is considered adequate, collectibility of the seller’s receivable must still be assessed in the context of other collectibility factors, such as the credit standing of the buyer, the age and geographical location of the property, and the adequacy of cash flow from the property.



3.4.1 Minimum initial investment requirements The following guidance includes a table that provides minimum initial investment requirements for various types of properties:



360-20-55-1 Minimum initial investment requirements for sales, other than retail land sales, that are to be accounted for by the full accrual method are specified in paragraph 360-20-40-18. The table of minimum initial investments in the following paragraph is based on usual loan limits for various types of properties. However, lenders’ appraisals of specific properties may differ. Therefore, if a recently placed permanent loan or firm permanent loan commitment for maximum financing of the property exists with an independent established lending institution, the minimum initial investment should be whichever of the following is greater:

a. The minimum percentage of the sales value (see paragraph 360-20-40-8) of the property specified in the following paragraph

b. The lesser of:

1. The amount of the sales value of the property in excess of 115 percent of the amount of a newly placed permanent loan or firm permanent loan commitment from a primary lender that is an independent established lending institution

2. Twenty-five percent of the sales value.

360-20-55-2 This table does not cover every type of real estate property. To evaluate initial investments on other types of property, entities may make analogies to the types of properties specified, or the risks of a particular property can be related to the risks of the properties specified. Use of this table is illustrated in Example 1 (see paragraph 360-20-55-22).

Minimum Initial

Investment Expressed as a Percentage of Sales Value

Land Held for commercial, industrial, or residential development to commence within two years after sale 20 Held for commercial, industrial, or residential development to commence after two years 25 Commercial and Industrial Property Office and industrial buildings, shopping centers, and so forth:

Properties subject to lease on a long-term lease basis to parties with satisfactory credit rating; cash flow currently sufficient to service all indebtedness 10 Single-tenancy properties sold to a buyer with a satisfactory credit rating 15 All other 20




Other income-producing properties (hotels, motels, marinas, mobile home parks, and so forth):

Cash flow currently sufficient to service all indebtedness 15 Start-up situations or current deficiencies in cash flow 25

Multifamily Residential Property Primary residence:

Cash flow currently sufficient to service all indebtedness 10 Start-up situations or current deficiencies in cash flow 15

Secondary or recreational residence: Cash flow currently sufficient to service all indebtedness 15 Start-up situations or current deficiencies in cash flow 25

Single-Family Residential Property (including condominium or cooperative housing) Primary residence of the buyer 5(a) Secondary or recreational residence 10(a)

____________________________________________

(a) If collectibility of the remaining portion of the sales price cannot be supported by reliable evidence of collection experience, the minimum initial investment shall be at least 60 percent of the difference between the sales value and the financing available from loans guaranteed by regulatory bodies such as the Federal Housing Administration or the Veterans Administration, or from independent, established lending institutions. This 60-percent test applies when independent first-mortgage financing is not used and the seller takes a receivable from the buyer for the difference between the sales value and the initial investment. If independent first mortgage financing is used, the adequacy of the initial investment on sales of single-family residential property should be determined in accordance with the preceding paragraph.

360-20-55-4 One type of real estate property identified in the table of minimum initial investment requirements is commercial and industrial property. Although operating facilities such as manufacturing facilities, power plants, and refineries are not specified, those types of operating facilities meet the description of an industrial property.

360-20-55-5 Other types of industrial property include the following:

a. Land and/or improvements that can be adapted for industrial use

b. A combination of land, improvements, and machinery integrated into a functioning unit to assemble, process, and manufacture products from raw materials or fabricated parts

c. Factories that render service, for example, laundries, dry cleaners, storage warehouses

d. Properties that produce natural resources, for example, oil wells.

The above table does not cover every type of real estate. If a transaction involves a type of real estate not specifically covered by this table, the seller may analogize to a type of real estate that is covered if the risks associated with each type of property are similar.

There is one exception to minimum requirements in the above table. As discussed in section 3.2.1, a seller of single-family residential homes that finances a sale under a Federal Housing Administration or Veterans Administration government-insured program may use the normal down payment requirements or loan limits established under those programs as a surrogate for the down payment requirements of ASC 360-20.



3.4.2 Calculation of minimum initial investment The table of minimum initial investments in section 3.4.1 was based on usual loan limits for various types of properties at the time the guidance in ASC 360-20 was issued. Although there may have been changes to loan terms since the guidance in ASC 360-20 was originally issued, the minimum percentage requirements specified in this table must still be applied. However, if a recently placed permanent loan or firm permanent loan commitment for maximum financing of the property exists with an independent established lending institution, the guidance in ASC 360-20-55-1 must be applied and the minimum investment may be greater than that noted in the table of minimum initial investments. ASC 360-20-55-1 requires that the minimum initial investment be whichever of the following is greater:

• The minimum percentage of the sales value of the property specified in the table in paragraph ASC 360-20-55-2, or

• The lesser of:

• The amount of the sales value of the property in excess of 115 percent of the amount of a newly placed permanent loan or firm permanent loan commitment from a primary lender that is an independent established lending institution

• Twenty-five percent of the sales value

Illustration 3-11: Minimum initial investment test

Facts:

A real estate venture sells land to a homebuilder (that will commence development of the land within the next two years) for $200,000. Consideration consists of $40,000 in cash paid at closing, $120,000 of proceeds from a new first mortgage note from an independent established lending institution for the maximum financing available (i.e., maximum loan to value with an established lending institution), and a $40,000 second mortgage from the lender.

Analysis:

The minimum initial investment calculated in accordance with ASC 360-20-55-2 is $40,000 (the minimum initial investment percentage for land held for residential development to commence within two years after sale is 20 percent). However, the minimum initial investment calculated in accordance with ASC 360-20-55-1 is $50,000 calculated as follows:

The lesser of: Sales value $ 200,000 115 percent of newly placed first mortgage ($120,000 X 115%) (138,000) Sales value in excess of 115 percent of the newly placed loan $ 62,000 Or Twenty-five percent of the sales value ($200,000 X 25%) $ 50,000

Because the minimum initial investment is the greater of the amount required under ASC 360-20-55-1 or ASC 360-20-55-2, the minimum initial investment is $50,000 and the initial investment requirement has not been satisfied. This transaction should be accounted for under the deposit, cost recovery, or installment method.



3.5 Buyer’s continuing investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-19 The buyer’s continuing investment in a real estate transaction shall not qualify unless the buyer is contractually required to pay each year on its total debt for the purchase price of the property an amount at least equal to the level annual payment that would be needed to pay that debt and interest on the unpaid balance over no more than the following:

a. Twenty years for debt for land

b. The customary amortization term of a first mortgage loan by an independent established lending institution for other real estate

360-20-40-20 For the purpose of evaluating the buyer’s continuing investment, contractually required payments by the buyer on its debt shall be in the forms specified in paragraph 360-20-40-10 as acceptable for an initial investment. Except as indicated in the following sentence, funds to be provided directly or indirectly by the seller (see paragraph 360-20-40-13[c]) shall be subtracted from the buyer’s contractually required payments in determining whether the initial and continuing investments are adequate. If a future loan on normal terms from an established lending institution bears a fair market interest rate and the proceeds of the loan are conditional on use for specified development of or construction on the property, the loan need not be subtracted in determining the buyer’s investment.

For a seller to recognize profit under the full accrual method, the buyer must continue to demonstrate a commitment to pay for the property after the initial investment is made. To show this commitment, the buyer is required to increase its investment in the property each year. The buyer’s continuing investment is considered adequate when the buyer is contractually required to pay each year on its total debt an amount at least equal to level annual payments necessary to fund principal and interest. These payments should result in the amortization of the total debt over a maximum term of:

• Twenty years for land.

• The “customary amortization term” of a first mortgage loan by an independent, established lending institution for property other than land (see section 3.5.1 for further details).

Amounts included in the continuing investment test should be limited to the forms of consideration described in ASC 360-20-40-10 (see section 3.2).

The continuing investment test should be performed on the buyer’s total debt on the property sold and not just the amount due to the seller. For example, if a buyer obtains a first mortgage from an independent lending institution and a second mortgage from the seller, the buyer must be contractually required to pay an amount at least equal to level annual payments necessary to fund principal and interest on both loans. However, these loans need not be amortized proportionally. Therefore, in the above example, if the first mortgage contractually requires the buyer to pay an amount that would satisfy the continuing investment test for both loans for a period of time, the buyer need not be contractually required to make any payments on the second mortgage during that period. However, if the buyer is not required to make any payments on the seller’s mortgage for a period of time, collectibility factors other than the buyer’s initial and continuing investment (see section 2.1 for further details) should be considered.



The buyer must be contractually required to make the first annual payment on its outstanding debt within one year of the date of sale, unless the buyer’s initial investment is in excess of the minimum requirement (see section 3.4). An initial investment in excess of the minimum requirement may be applied to the continuing investment in determining the adequacy of the continuing investment (see section 3.7 for examples of the allocation of an excess initial investment to the continuing investment).

The seller should apply the initial and continuing investment tests cumulatively when the sale is consummated and annually thereafter (see section 3.7 for additional information). If the initial investment test is satisfied but the continuing investment test is not, the reduced-profit method may be applied in certain circumstances (see section 5.3). If the requirements for applying the reduced-profit method are not satisfied, the seller should recognize profit under the installment or cost recovery method (see section 5.2.1.2 for guidance on determining which method to apply).

Illustration 3-12: Sale financed through mortgage with interest-only terms for the first five years

Facts:

Land is sold for $1,000,000. Consideration includes a $200,000 cash down payment and an $800,000 note to the seller at a market interest rate. The buyer will commence residential development of the land within two years. The terms of the note call for interest-only payments for the first five years. After five years, the buyer will make level annual payments of principal and interest over the next 15 years, so that the balance is paid in full at the end of 20 years.

Analysis:

The buyer’s continuing investment is not adequate. Although the terms of the note require the note to be repaid within the maximum term of 20 years, the interest-only payments in the first five years are less than the annual payment that would be required to amortize the note evenly over 20 years. Because the buyer’s initial investment equals the minimum required initial investment (20 percent on land held for residential development to commence within two years after sale), there is no excess down payment to apply to the continuing investment shortfall. The transaction should be accounted for under the reduced-profit, installment, or cost recovery method (see sections 5.2.1.2 and 5.3 for guidance in determining which method to apply).

Illustration 3-13: Sale financed through mortgage with reduced payments due in first five years and balloon payment due at the end of five years

Facts:

Land is sold for $1,000,000. Consideration includes a $200,000 cash down payment and an $800,000 note to the seller at the market interest rate. The buyer will commence residential development of the land within two years. The terms of the note call for level annual payments for the first five years based on a 30-year amortization schedule with the balance due at the end of five years.

Analysis:

The buyer’s continuing investment is not adequate. Although the terms of the note require the note to be repaid in five years, which is less than the maximum term of 20 years, the payments due in the first five years are less than the annual payment that would be required to amortize the note evenly over 20 years. The transaction should be accounted for under the reduced-profit, installment, or cost recovery method (see sections 5.2.1.2 and 5.3 for guidance in determining which method to apply).



Illustration 3-14: Sale financed through mortgage with standard payments due in first five years and balloon payment due at the end of five years

Facts:

Assume the same facts as Illustration 3-13, except the first five years of payments are based on a 20-year amortization schedule.

Analysis:

The buyer’s initial and continuing investments are adequate. Other collectibility factors, such as the buyer’s credit standing and the buyer’s ability to make a large balloon payment at the end of five years, should also be considered. The seller should recognize profit on the transaction in full (the full accrual method), provided all other criteria for recognizing profit under the full accrual method have been satisfied.

3.5.1 Customary amortization term For property other than land, the buyer’s continuing investment is considered adequate when the buyer is contractually required to make payments each year that are at least equal to the level annual payments necessary to repay the total debt and interest on the property over no more than the customary amortization term of a first mortgage loan by an independent established lending institution. ASC 360-20 does not provide specific guidance on what represents a “customary amortization term.” Nontraditional forms of lending (e.g., 40-year mortgage loans) should not be used for determining customary amortization terms. Instead, industry standard products should define the term (e.g., 30-year residential mortgage loans).

The customary term requirement in ASC 360-20-40-19 (see section 3.5) relates only to the mortgage amortization period and not other mortgage terms that may be customary in the current environment. For example, even if a large portion of mortgages offered in the current market conditions include graduated payments (i.e., payments that increase over time), these terms should not be used in performing the continuing investment test. The continuing investment test requires a calculation of level annual payments that would be required to repay the debt and interest over a customary amortization term. This concept is reinforced in ASC 360-20-40-35.


Derecognition

360-20-40-35 A sale involving a graduated payment mortgage that does not meet the continuing investment tests in this Subtopic (because of the negative loan amortization) shall not result in full immediate profit recognition.

3.5.2 Initial and continuing investment considerations specific to the homebuilding industry Nontraditional forms of seller financing, such as minimal down payment mortgages, non-amortizing loans, negative amortization loans, and combination seller extended first and second mortgages (i.e., ”piggyback” loans), often affect a homebuilder’s ability to meet the initial and continuing investment requirements. A buyer’s continuing investment is considered adequate when the buyer is contractually required to make payments each year that are at least equal to the level annual payments necessary to repay the total debt and interest on the property over no more than the customary amortization term of a first mortgage loan by an independent established lending institution, which is 30 years for the sale of homes in the United States at the time of this publication.



A buyer should contribute its’ own cash or another qualifying form of investment to demonstrate a commitment to pay for the property being purchased. Debt secured by the property being purchased does not demonstrate this commitment, even if the seller receives cash by selling the receivable without recourse to a third party. However, in accordance with ASC 360-20-40-16, if the seller has unconditionally received all amounts it is entitled to from the sale and is not at risk related to the financing, the buyer’s commitment to pay for the property is not a factor in the seller’s recognition of profit (see section 3.2.2).

Illustration 3-15: Sale of primary residence with no down payment required

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a primary residence. Customer finances the purchase through Homebuilder’s residential mortgage subsidiary. The terms of the mortgage are zero percent down with a 30-year amortization.

Analysis:

The buyer’s initial investment is not adequate (initial investment is less than the minimum initial investment requirement of five percent). Therefore, Homebuilder should account for the transaction under the installment, cost recovery, or deposit method (see section 5.2.1).

Illustration 3-16: Sale of secondary residence with five percent down payment required

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a secondary residence. Customer finances the purchase through Homebuilder’s residential mortgage subsidiary. The terms of the mortgage are five percent down with a 30-year amortization.

Analysis:

The buyer’s initial investment is not adequate (initial investment is less than the ten percent minimum requirement for a secondary home). Therefore, Homebuilder should account for the transaction under the installment, cost recovery, or deposit method at the date of sale (see section 5.2.1).

It may often be difficult for a seller to determine whether a buyer plans to use a home as a primary or secondary residence. Sellers should obtain sufficient documentation to support that a home will be used as a primary residence (e.g., verify that buyer does not own another residence, obtain written confirmation from buyer that home will be used as a primary residence). If a seller is unable to determine whether a home will be used as a primary or secondary residence, the seller should assume that it will be used as a secondary residence, and an initial investment of at least ten percent would be required to recognize profit under the full accrual method.



Illustration 3-17: Sale of primary residence with interest-only terms

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a primary residence. Customer finances the purchase through Homebuilder’s residential mortgage subsidiary. The terms of the mortgage are five percent down with interest-only payments due for the first five years of the 30-year loan term.

Analysis:

The buyer’s continuing investment is not adequate. Although the terms of the note require the note to be repaid within the maximum term of 30 years, the interest-only payments in the first five years are less than the annual payment that would be required to amortize the note evenly over 30 years. Because the buyer’s initial investment equals the minimum required initial investment, there is no excess down payment to apply to the continuing investment shortfall. Therefore, Homebuilder should account for the transaction under the reduced-profit, installment, or cost recovery method (see sections 5.2.1.2 and 5.3). The accounting treatment would be the same if, instead of interest-only payments for the first five years, the loan contained a feature that gave the borrower an option to make interest-only payments for a portion of the loan period.

Illustration 3-18: No down payment required, homebuilder has commitment from third party to

purchase mortgage

Facts:

Assume the same facts as in Illustration 3-15, except the homebuilder has a commitment from a third party to purchase all mortgages that meet certain criteria in 90 days. The mortgage from Customer meets the third party’s criteria.

Analysis:

The commitment by a third party to purchase a loan in the future is not one of the forms of consideration allowed in ASC 360-20 for an initial down payment. In addition, the initial and continuing investment tests are applicable unless the seller receives all proceeds without recourse. As a result, the initial investment test has still not been satisfied and the transaction should be accounted for under the installment, cost recovery, or deposit method (see section 5.2.1).

Illustration 3-19: Interest-only terms, homebuilder has commitment from third party to

purchase mortgage

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a primary residence. Customer finances the purchase through Homebuilder’s residential mortgage subsidiary. The terms of the mortgage are five percent down with interest-only payments due for the first five years of the 30-year loan term. Homebuilder has a commitment from a third party to purchase all mortgages that meet certain criteria in 90 days. The mortgage from Customer meets the third party’s criteria.

Analysis:

A commitment by a third party to purchase a loan in the future is not one of the forms of consideration allowed for in ASC 360-20. In addition, the initial and continuing investment tests are applicable unless the seller receives all proceeds without recourse. As a result, the continuing investment test has not been satisfied and Homebuilder should account for the transaction under the reduced-profit, installment, or cost recovery method (see sections 5.2.1.2 and 5.3).



Illustration 3-20: No down payment required, receivable is transferred to SPE that is consolidated by homebuilder

Facts:

Assume the same facts as in Illustration 3-15, except that Homebuilder, in conjunction with the closing of the sale, transfers the receivable to an SPE that, while funded by a third party, is consolidated by Homebuilder under ASC 810, Consolidations.

Analysis:

The transfer of a receivable to a consolidated entity (whether consolidated under voting or economic control models) is not one of the forms of consideration allowed for in ASC 360-20 for an initial down payment. Because the SPE is consolidated by the seller of the real estate, the receivable has not been transferred by the seller and the buyer’s initial investment is not adequate. As a result, Homebuilder should account for the transaction under the installment, cost recovery, or deposit method at the date of sale (see section 5.2.1).

Illustration 3-21: No down payment required, receivable is transferred to unconsolidated SPE

without recourse

Facts:

Assume the same facts as in Illustration 3-15, except that Homebuilder, in conjunction with the closing of the sale, transfers the receivable to an SPE that is not consolidated by Homebuilder. Homebuilder receives cash in return for the transferred receivables and has no continuing involvement with the transferred receivables (i.e., no servicing responsibilities, no participation in future cash flows, and no recourse obligations other than standard representations and warranties that the financial assets transferred met the delivery requirements under the arrangements, which is objectively determinable at the time of transfer).

Analysis:

Normal representations and warranties (e.g., the borrower meets a listing of objectively verifiable conditions as of the date of sale) that are solely within the control of the seller and have been verified to exist (and do not relate to the subsequent performance of the loan) would not be viewed as recourse in assessing whether the seller has retained any risk related to the financing. Therefore, because Homebuilder has unconditionally received all amounts it is entitled to from the sale and is not at risk related to the financing, the initial and continuing investment requirements are not applicable. Homebuilder should recognize profit under the full accrual method at the time the receivable is transferred to the SPE, assuming all other criteria for recognizing profit under the full accrual method have been satisfied.



Illustration 3-22: Sale of primary residence partially financed by an independent lending institution

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a primary residence. Customer finances the purchase with 3 percent down, a first mortgage from an independent bank for 80 percent, and a second mortgage from Homebuilder’s residential mortgage subsidiary for 17 percent. The second mortgage is not subject to future subordination. Both mortgages are secured by the property.

Analysis:

The sale does not meet the initial investment test (initial down payment is less than the minimum five percent required). Although Homebuilder received 83 percent of the sales price in cash (3 percent directly from Customer and 80 percent from the proceeds of the first mortgage), in accordance with the guidance on the computation of the initial and continuing investments in ASC 360-20-40-17 (see section 3.2.2), the 80 percent received from the first mortgage should not be included in the initial investment because the debt is secured by the property. If Customer defaults on the second mortgage and Homebuilder forecloses on the property, the property will be encumbered by the first mortgage. Therefore, Homebuilder should account for this transaction under the installment, cost recovery, or deposit method (see section 5.2.1).

Illustration 3-23: Sale partially financed by an independent lending institution and seller’s

financing sold without recourse

Facts:

Assume the same facts as in Illustration 3-22, except that in conjunction with the closing of the sale, the 17-percent second mortgage from Homebuilder is transferred to an SPE that is not consolidated by Homebuilder. Homebuilder receives cash in return for the transferred receivables and has no continuing involvement with the transferred receivables (i.e., no servicing responsibilities, no participation in future cash flows, and no recourse obligations other than standard representations and warranties that the financial assets transferred met the delivery requirements under the arrangements, which is objectively determinable at the time of transfer).

Analysis:

Because Homebuilder has unconditionally received all amounts it is entitled to from the sale and is not at risk related to the financing, the initial and continuing investment requirements are not applicable. Homebuilder should recognize profit under the full accrual method at the time the receivable is transferred to the SPE, assuming all other criteria for recognizing profit under the full accrual method have been satisfied.



Illustration 3-24: Sale financed through two mortgages with different terms

Facts:

Homebuilder sells a completed single family home to Customer who is purchasing the home as a primary residence. Customer finances the purchase with five percent down, a first mortgage for 80 percent, and a second mortgage for 15 percent, both from Homebuilder’s residential mortgage subsidiary. The first mortgage amortizes normally over a 30-year period, whereas the second mortgage is a home equity line of credit consisting of a non-amortizing loan with a balloon principal payment due at the end of five years. The first and second mortgages are not subject to future subordination and are both secured by the property.

Analysis:

While the buyer’s initial investment is adequate (five percent required for a primary residence), the buyer’s continuing investment is not adequate due to a non-amortizing loan over the first five years. Although the payment terms for each mortgage do not have to be the same, the combined annual payments must at least equal the level annual payment necessary to repay the total debt and interest on the property over 30 years. Therefore, Homebuilder should account for the transaction under the reduced-profit, installment, or cost recovery method at the date of sale (see sections 5.2.1.2 and 5.3).

Illustration 3-25: Sale financed through two mortgages with different terms, one of which is

sold without recourse

Facts:

Assume the same facts as in Illustration 3-24, except that in conjunction with the closing of the sale, the 15-percent second mortgage is transferred to an SPE that is not consolidated by Homebuilder. Homebuilder receives cash in return for the transferred receivables and has no continuing involvement with the transferred receivables (i.e., no servicing responsibilities, no participation in future cash flows, and no recourse obligations other than standard representations and warranties that the financial assets transferred met the delivery requirements under the arrangements, which is objectively determinable at the time of transfer).

Analysis:

Because Homebuilder has not unconditionally received all amounts it is entitled to from the sale, the buyer’s commitment to pay continues to be a factor in Homebuilder’s recognition of profit. In accordance with the guidance on the composition of the initial and continuing investments in ASC 360-20-40-17 (see section 3.2.2), the 15-percent mortgage that has been transferred should not be included in the initial investment because the debt is secured by the property. The buyer has not demonstrated a commitment to pay as a result of the transfer of the receivable to a third party. If Customer defaults on the first mortgage and Homebuilder forecloses on the property, the property will be encumbered by the second mortgage. Therefore, Homebuilder should account for this transaction under the installment, cost recovery, or deposit method (see section 5.2.1). Cash received on the 15-percent mortgage should only be included in the calculation of profit under these methods to the extent profit deferred exceeds the outstanding amount for which the seller is at risk (see section 3.2.2).



3.5.2.1 Interaction of ASC 360-20 with ASC 860

ASC 860, Transfers and Servicing, permits companies to recognize sales of receivables in many instances when recourse obligations are retained. Additionally, a transfer of a note receivable without recourse may not qualify as a sale under ASC 860 if certain requirements of ASC 860 are not met.

A question has arisen as to whether a note receivable that has been transferred with recourse in a transfer that qualifies as a sale under ASC 860 or a note receivable that has been transferred without recourse in a transfer that does not qualify as a sale under ASC 860 should be included in the initial and continuing investment tests.

As discussed in section 3.2.2, we do not believe that notes receivable transferred with or without recourse should be included in the initial and continuing investment tests when the debt is secured by the property, because such a transfer does not demonstrate the buyer’s commitment to pay for the property. However, we believe if the seller has received all amounts to which it is entitled and has no remaining risk related to the buyer’s financing (i.e., no recourse), the seller need not consider the adequacy of the buyer’s initial and continuing investments in determining whether it is appropriate to recognize profit on the transaction. If the transfer of a note receivable without recourse does not qualify as a sale under ASC 860, the transfer is accounted for as a secured borrowing. In such a situation, it appears the note has not been converted to cash, and the initial and continuing investment tests would continue to be applicable.

3.5.2.2 Nontraditional financing terms

Nontraditional forms of seller financing may prevent a seller from recognizing profit under the full accrual method because the initial or continuing investment requirements are not satisfied or because the nontraditional financing creates other collectibility concerns (see section 2.1). Additionally, it may be necessary for the seller to provide additional disclosures about nontraditional financing terms that give rise to a concentration of credit risk. The following excerpt from ASC 825, Financial Instruments, describes features that may increase credit risk and require disclosure:

Excerpt from Accounting Standards Codification Financial Instruments-Overall


825-10-55-1 The terms of certain loan products may increase a reporting entity’s exposure to credit risk and thereby may result in a concentration of credit risk as that term is used in this Subtopic, either as an individual product type or as a group of products with similar features. Possible shared characteristics on which significant concentrations may be determined include, but are not limited to, the following:

a. Borrowers subject to significant payment increases

b. Loans with terms that permit negative amortization

c. Loans with high loan-to-value ratios.

Judgment is required to determine whether loan products have terms that give rise to a concentration of credit risk that require disclosure.



3.5.3 Continuing investment considerations specific to condominium sales The reference to the adequacy of the buyer’s initial and continuing investments in ASC 360-20-40-5 (see section 2.1) is in the context of post-sale seller financing (e.g., seller finances a first mortgage for buyer through its mortgage subsidiary). However the initial and continuing investment tests also apply to condominium sales accounted for using the percentage-of-completion method during the construction period (see section 5.13 for further discussion).

3.6 Release provisions Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-21 An agreement to sell property (usually land) may provide that part or all of the property may be released from liens securing related debt by payment of a release price or that payments by the buyer may be assigned first to released property. If either of those conditions is present, a buyer’s initial investment shall be sufficient both to pay release prices on property released at the date of sale and to constitute an adequate initial investment on property not released or not subject to release at that time in order to meet the criterion of an adequate initial investment for the property as a whole.

360-20-40-22 If the release conditions described in the preceding paragraph are present, the buyer’s investment shall be sufficient, after the released property is paid for, to constitute an adequate continuing investment on property not released in order to meet the criterion of an adequate continuing investment for the property as a whole (see paragraphs 360-20-40-19 through 40-20).

360-20-40-23 If the amounts applied to unreleased portions do not meet the initial and continuing-investment criteria as applied to the sales value of those unreleased portions, profit shall be recognized on each released portion when it meets the criteria in paragraph 360-20-40-5 as if each release were a separate sale.

A real estate sales agreement (generally an agreement to sell unimproved land) may allow for a release of a portion of the property from the seller’s liens securing the seller’s receivable if a release price is paid or the agreement may provide that the buyer’s payments may first be assigned to released property. If either of these conditions is present, the buyer’s initial and continuing investments must be sufficient to cover both the release price on any property released and the minimum amount required to constitute an adequate initial and continuing investment on property not released. In determining whether the continuing investment is adequate, the seller should look ahead to future release dates to be satisfied that the continuing investment test is still met assuming those releases occur. If the initial and continuing investments are not adequate, the seller should recognize profit as if each released portion were a separate sale.



Illustration 3-26: Down payment is not sufficient to cover both the release price and the minimum initial investment

Facts:

XYZ Developer sells 100 parcels of land to Homebuilder at $10,000 per parcel, or $1,000,000. Homebuilder will commence development of the land within two years. The transaction is financed through a $250,000 cash down payment and a $750,000 mortgage from XYZ Developer with a term of 15 years at an interest rate of 10 percent (considered to be the market rate). The agreement stipulates that 10 parcels are to be released on closing and the remaining parcels can be released individually for a payment of 110 percent of the selling price ($11,000 per parcel) at a rate of five parcels per year.

Analysis:

The initial investment test for this transaction is calculated as follows:

Sales value $ 1,000,000 Less: Sales value of parcels released at closing (10 parcels X $10,000) (100,000) Sales value of unreleased property 900,000 Required initial investment percentage 20% Minimum initial investment $ 180,000 Down Payment $ 250,000 Less: down payment used to release property (10 parcels X $10,000) (100,000) Initial investment to be applied against unreleased property $ 150,000

Because the initial down payment is not adequate ($180,000 minimum versus $150,000 actual), full accrual profit recognition on the entire sale is not appropriate. However, XYZ Developer should account for the release of the 10 parcels at closing as a separate sale and recognize profit on those parcels, assuming the other criteria for recognizing profit under the full accrual method have been satisfied.

Illustration 3-27: Initial and continuing investments are not sufficient to cover both the release

price and the minimum initial and continuing investments

Facts:

XYZ Developer sells 100 parcels of land to Homebuilder at $10,000 per parcel, or $1,000,000. Homebuilder will commence development of the land within two years. The transaction is financed through a $250,000 cash down payment and a $750,000 mortgage from XYZ Developer with a term of 15 years at an interest rate of 10 percent (considered to be the market rate). The agreement stipulates that 5 parcels are to be released on closing and Homebuilder can release 5 parcels at the end of each year for a payment of 110 percent of the selling price ($11,000). Any payments made by Homebuilder may be assigned to released property (i.e., the sales agreement does not require Homebuilder to make a separate payment to release property if the initial down payment and principal payments made to-date exceed the total release price for all property released to-date).



Analysis:

The initial investment test for this transaction is calculated as follows:

Sales value $ 1,000,000 Less: Sales value of parcels released at closing (5 parcels X $10,000) (50,000) Sales value of unreleased property 950,000 Required initial investment percentage 20% Minimum initial investment $ 190,000 Down Payment $ 250,000 Less: down payment used to release property (5 parcels X $10,000) (50,000) Initial investment to be applied against unreleased property $ 200,000

Because the buyer’s initial down payment is adequate ($190,000 minimum versus $200,000 actual), the adequacy of the continuing investment should be evaluated. Because the continuing investment test requires that annual payments be at least equal to level payments necessary to amortize the loan over 20 years and the term of the loan is amortizing over 15 years, the transaction appears to meet the continuing investment test on the date of sale. However, it is necessary to take into consideration future releases of property. In determining whether the continuing investment is adequate, the seller must look ahead to all future release dates to be satisfied that the continuing investment test is still met assuming those releases occur.

At the end of the first year, 5 parcels with a total release price of $55,000 (5 parcels X $11,000) are released. No additional payments from the buyer are made, because, under the terms of the sale agreement, the principal payments of $22,738 (calculated by amortizing the $750,000 mortgage over 15 years at an interest rate of 10 percent) and the $200,000 initial investment that was not used to release the first 5 parcels may be used to release this property. The adequacy of the buyer’s investment in the unreleased property at the end of the first year (after 10 parcels have been released) is calculated as follows:

Remaining unpaid balance at the end of year 1: Sales price $ 1,000,000 Less: Down payment (250,000) Principal payments (22,738) Remaining unpaid balance $ 727,262 Maximum unpaid balance allowed: Sales value of unreleased parcels (90 parcels X $10,000) (90 parcels remaining after 5 released at closing and 5 released at end of year 1) $ 900,000 Less: Required down payment ($900,000 X 20 percent) (180,000) Required amortization in year 1 of principal on unreleased parcels ($900,000 — $180,000) over 20 year maximum term (11,914) Maximum unpaid balance allowed $ 708,086

Because the remaining unpaid balance after the first release ($727,262) is more than the maximum unpaid balance ($708,086), full accrual profit recognition on the entire transaction on the date of sale is not appropriate. However, XYZ Developer should account for the releases as separate sales transactions and recognize profit as the releases occur, assuming all the criteria for recognizing profit under the full accrual method, including the initial and continuing investment tests, have been satisfied for each release. In the above example, because the buyer is required to pay 110 percent of the sales price for each individual release, either through the initial down payment, principal payments, or additional release payments, the initial and continuing investment tests are satisfied for each individual release at the time of the release.



3.7 Cumulative application of initial and continuing investment tests Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-24 Tests of adequacy of a buyer’s initial and continuing investments described in paragraphs 360-20-40-9 through 40-23 shall be applied cumulatively when the sale is consummated and annually afterward. If the initial investment exceeds the minimum prescribed, the excess shall be applied toward the required annual increases in the buyer’s investment.

The adequacy of the buyer’s initial and continuing investments should be evaluated on a cumulative basis on the date of sale and annually thereafter. Therefore, if the initial or continuing investment tests are not initially satisfied, the seller may recognize revenue under the full accrual method at a future date if the tests are satisfied at that time on a cumulative basis. For example, if the continuing investment test is not satisfied because a ten-year loan includes interest-only terms for the first five years, the cumulative payments received will eventually exceed those required under the continuing investment test because the term of the loan is for a shorter period than the customary amortization term. Such a sale should initially be accounted for under the reduced-profit, installment, or cost recovery method (see section 5.2.1.2 and section 5.3). At the time the continuing investment test is satisfied on a cumulative basis, profit may be recognized in full, assuming the test will continue to be satisfied on a cumulative basis for the remainder of the term and all other criteria for recognizing profit under the full accrual method have been met.

To determine whether the continuing investment requirements have been satisfied, the seller should schedule the minimum payments of principal and interest required to amortize the total debt on the property (including indebtedness to third parties) over the customary term of a first mortgage and compare the results to the principal and interest payments that the buyer is contractually obligated to make on all debt. If the buyer’s initial investment exceeds the minimum down payment required by ASC 360-20-55-1 and ASC 360-20-55-2 (see section 3.4), the excess should be applied to the buyer’s continuing investment.

There are two methods that have historically been used to allocate an excess down payment to the continuing investment. These two methods differ based on what is considered to be the total debt balance used to calculate the minimum payments of principal and interest required to amortize the total debt over a customary amortization period.

In Method 1, the “total debt” used in the calculation is the buyer’s actual debt. For example, if the initial down payment is $275,000, debt is $725,000, and the minimum initial investment is $200,000, the seller should calculate the minimum payments of principal and interest required to amortize $725,000 over the customary term of a first mortgage. This method is based on a literal reading of ASC 360-20-40-19 (see section 3.5). In accordance with ASC 360-20-40-24, the $75,000 excess initial investment should be applied to the continuing investment test.

Under Method 2, if there is an excess initial investment, the actual indebtedness on the property should be increased by the excess down payment when calculating the minimum annual payments of principal and interest required. For example, if the initial down payment is $275,000, debt is $725,000, and the minimum initial investment is $200,000, the seller should calculate the minimum level payments of principal and interest required to amortize $800,000 over the customary term of a first mortgage. Proponents of this method believe that if an excess down payment is applied toward the buyer’s required



continuing investment it should not also be used to reduce the total debt on which the continuing investment test is calculated. However, because in this situation the buyer, in effect, prepaid the excess down payment ($75,000 in this example), it should be assumed that interest is being earned on this excess down payment until it is needed to offset any continuing investment shortfalls. The rate used to calculate the interest on the excess down payment should be the same as the rate used to calculate the minimum level payments of principal and interest required to amortize the buyer’s debt over the customary term of a first mortgage.

Both Method 1 and Method 2 are considered acceptable. However, because Method 1 is based on a literal reading of ASC 360-20-40-19, Method 1 is the preferred method. This concept is reinforced in the accounting guidance for the application of the continuing investment test to condominium sales. In describing the application of the continuing investment test to condominium sales, ASC 360-20-40-53 states “the test shall be performed using a hypothetical loan between the seller and buyer for the amount of the purchase price less the buyer’s initial investment” (see section 5.13).

Illustration 3-28: Five year interest-only mortgage with excess down payment (Method 1)

Facts:

Company X sells land to a homebuilder for $1,000,000. The homebuilder will commence development within two years. Consideration includes a $275,000 cash down payment and a $725,000 mortgage at an interest rate of 10 percent (considered to be the market rate). The mortgage requires annual payments of interest only ($72,500) for five years with the principal due at the end of five years.

Analysis:

The minimum initial investment for this transaction is 20 percent, or $200,000. Therefore, there is an excess initial investment of $75,000 that may be applied against the continuing investment requirement. In accordance with ASC 360-20-40-19, the buyer must be contractually required to pay an amount at least equal to the level annual payment that would be needed to pay the debt and interest on the unpaid balance over no more than 20 years. Therefore, the seller should calculate the annual level payments required to amortize the outstanding debt of $725,000 over 20 years, which is $83,957, and compare these payments to the contractually required payments. The calculation of the continuing investment test is as follows:

Period Actual payments Minimum required

payments Current period

excess (deficiency) Cumulative excess

(deficiency) Date of sale 275,000 200,000 75,000 75,000 Year 1 72,500 83,957 (11,457) 63,543 Year 2 72,500 83,957 (11,457) 52,086 Year 3 72,500 83,957 (11,457) 40,629 Year 4 72,500 83,957 (11,457) 29,172 Year 5 797,500 83,957 713,543 742,715

Because there is a cumulative excess in actual payments over required payments each year, the initial and continuing investment tests have been satisfied and profit may be recognized on the date of sale under the full accrual method, assuming all other criteria for applying the full accrual profit method have been satisfied.



Illustration 3-29: Five-year interest-only mortgage with excess down payment (Method 2)

Facts: Assume the same facts as in Illustration 3-28, except Method 2 is used to calculate the required continuing investment.

Analysis: The minimum initial investment for this transaction is 20 percent, or $200,000. Therefore, there is an excess initial investment that should be applied against the continuing investment requirement. In accordance with ASC 360-20-40-19, the buyer must be contractually required to pay an amount at least equal to the level annual payment that would be needed to pay the debt and interest on the unpaid balance over no more than 20 years. Therefore, the seller should calculate the annual level payments required to amortize a note for $800,000 ($1,000,000 sales price less $200,000 minimum initial investment) over 20 years, which is $92,642, and compare these payments to the contractually required payments. The calculation of the continuing investment test is as follows:

Period Actual payments

Minimum required

payments

Current period excess

(deficiency) Interest earned

on excess at 10%

Cumulative excess

(deficiency) Date of sale 275,000 200,000 75,000 — 75,000 Year 1 72,500 92,642 (20,142) 7,500 62,358 Year 2 72,500 92,642 (20,142) 6,236 48,452 Year 3 72,500 92,642 (20,142) 4,845 33,155 Year 4 72,500 92,642 (20,142) 3,315 16,328 Year 5 797,500 92,642 704,858 1,796 722,983

Because there is a cumulative excess in actual payments over required payments each year, the initial and continuing investment tests have been satisfied and profit may be recognized on the date of sale under the full accrual method, assuming all other criteria for applying the full accrual profit method have been satisfied.

Illustration 3-30: Eight-year interest-only mortgage with excess down payment (Method 1)

Facts: Assume the same facts as in Illustration 3-28, except the mortgage requires payments of interest only ($72,500 each year) for eight years, with the principal due at the end of eight years.

Analysis: The calculation of the continuing investment test is as follows:




(deficiency) Date of sale 275,000 200,000 75,000 75,000 Year 1 72,500 83,957 (11,457) 63,543 Year 2 72,500 83,957 (11,457) 52,086 Year 3 72,500 83,957 (11,457) 40,629 Year 4 72,500 83,957 (11,457) 29,172 Year 5 72,500 83,957 (11,457) 17,715 Year 6 72,500 83,957 (11,457) 6,258 Year 7 72,500 83,957 (11,457) (5,199) Year 8 797,500 83,957 713,543 708,344

Because there is a cumulative deficit in year 7, the continuing investment test is not met at the date of sale. Therefore, the transaction should be accounted for under the reduced-profit, installment, or cost recovery method at the date of sale (refer to Appendix A for description of these methods).



Illustration 3-31: Below market rate of interest with excess down payment (Method 1)

Facts:

Company X sells land to a homebuilder for $1,000,000. The homebuilder will commence development within two years. The transaction in financed through a $300,000 down payment and a $700,000 mortgage at an interest rate of 8 percent (the market rate is 10 percent). The mortgage requires payments of $70,260 (the payments that would be required to amortize the note at 8 percent over 20 years) for the first five years with the balance due at the end of five years.

Analysis:

The seller must first calculate the discount on the transaction by calculating the present value of the payments due under the contract at the market rate of interest, or 10 percent, which is $647,950. The minimum initial investment is calculated as follows:

Present value of payments discounted at 10 percent $ 647,950 Face amount of mortgage (700,000) Discount (52,050) Sales value ($1,000,000 sales price less $52,050 discount) 947,950 Minimum initial investment percentage 20% Minimum initial investment $ 189,590

The seller should calculate the annual level payments required to amortize a note of $647,950 ($947,950 discounted sales value less $300,000 down payment) over 20 years, which is $75,034, and compare to the contractually requirement payments. The calculation of the continuing investment test is as follows:




(deficiency) Date of sale 300,000 189,590 110,410 110,410 Year 1 70,260 75,034 (4,774) 105,636 Year 2 70,260 75,034 (4,774) 100,862 Year 3 70,260 75,034 (4,774) 96,088 Year 4 70,260 75,034 (4,774) 91,314 Year 5 682,945 75,034 607,911 699,225

Because there is a cumulative excess in actual payments over required payments each year, the initial and continuing investment tests have been satisfied and profit may be recognized on the date of sale in accordance with the full accrual method, assuming all other criteria for applying the full accrual profit method have been satisfied.


4 Future subordination and continuing involvement

4.1 Receivable subject to future subordination Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-25 The seller’s receivable shall not be subject to future subordination. This restriction shall not apply if a receivable is subordinate to a first mortgage on the property existing at the time of sale or a future loan, including an existing permanent loan commitment, is provided for by the terms of the sale and the proceeds of the loan will be applied first to the payment of the seller’s receivable.

If a seller’s receivable is subject to future subordination, the seller should account for the transaction using the cost recovery method (refer to Appendix A for description of cost recovery method) assuming all other criteria for recognizing revenue under the full accrual method have been met (see section 2.1). If a future loan is provided for by the terms of the sale and the proceeds from the future loan will be applied first to the payment of the seller’s receivable or if the seller’s receivable is subordinate to a first mortgage on the property existing at the time of sale, the cost recovery method is not required and full profit recognition is appropriate if all other criteria for recognizing revenue under the full accrual method have been satisfied. For example, if Company A sells land to Company B and the terms of the contract indicate that the proceeds of any future loans secured by the property must first be used to repay any amounts due to Company A, Company A may recognize profit in accordance with the full accrual method (assuming all other criteria for recognizing revenue under the full accrual method have been satisfied). The most common form of future subordination is the sale of real estate where the borrower draws down funds on a third-party construction loan as post-sale development occurs. In such a situation, if the proceeds from the future loan are not applied first to the payment of the seller’s receivable, the cost recovery method should be applied.

4.2 Continuing involvement Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-26 If a seller is involved with a property after it is sold in any way that results in retention of substantial risks or rewards of ownership, except as indicated in paragraph 360-20-40-64, the absence-of-continuing-involvement criterion has not been met. Forms of involvement that result in retention of substantial risks or rewards by the seller, and accounting therefore, are described in paragraphs 360-20-40-37 through 40-63.

4 Future subordination and continuing involvement


A seller may continue to be involved in property after it has been legally sold. For example, a seller may agree to develop land or guarantee a return on the buyer’s investment for a period of time. When a seller has continuing involvement with property that has been sold, profit should generally be deferred and recognized as the seller’s performance obligations are completed or deferred in full until a later date (i.e., profit should not be recognized under the full accrual method). In certain cases a sale is not recorded. Refer to sections 5.5 – 5.17 for discussion of various forms of continuing involvement and the appropriate accounting to apply in each situation.


5 Recognition of profit when the full accrual method is not appropriate


Derecognition

360-20-40-1 This Section presents the real estate derecognition standards primarily from the perspective of the profit recognition upon a sale. It addresses various conditions that may or may not result in derecognition of the real estate asset (and related profit or loss recognition, if any). Depending on the specific conditions, a real estate sale transaction may not qualify as a final sale for accounting and reporting purposes. In such cases, the applicable standards provide different approaches to derecognizing the asset and recognizing the profit. In certain conditions, the deposit method (as described more fully in Section 360-20-55) results in the entity maintaining the real estate asset and continuing to depreciate the asset.

360-20-40-27 If a real estate sales transaction does not satisfy the criteria in paragraphs 360-20-40-3 through 40-26 for recognition of profit by the full accrual method, the transaction shall be accounted for as specified in paragraphs 360-20-40-28 through 40-64.

5.1 Sale not consummated Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-28 The deposit method of accounting described in paragraphs 360-20-55-17 through 55-20 shall be used until a sale has been consummated (see paragraph 360-20-40-7). Consummation usually requires that all conditions precedent to closing have been performed, including that the building be certified for occupancy. However, because of the length of the construction period of office buildings, apartments, condominiums, shopping centers, and similar structures, such sales and the related income may be recognized during the process of construction, subject to the criteria in paragraphs 360-20-40-61 through 40-63, even though a certificate of occupancy, which is a condition precedent to closing, has not been obtained.

360-20-40-29 If the net carrying amount of the property exceeds the sum of the deposit received, the fair value of the unrecorded note receivable, and the debt assumed by the buyer, the seller shall recognize the loss at the date the agreement to sell is signed. If a buyer defaults, or if circumstances after the transaction indicate that it is probable the buyer will default and the property will revert to the seller, the seller shall evaluate whether the circumstances indicate a decline in the value of the property for which an allowance for loss should be provided.

360-20-40-30 Paragraph 970-360-35-3 specifies the accounting for property that is substantially completed and that is to be sold.






5.1.1 Exception to consummation requirements for long-term construction projects In accordance with ASC 360-20, a sale has not been consummated, and profit should not be recognized under the full accrual method, if all conditions precedent to closing have not been satisfied. Conditions precedent to closing generally include obtaining a certificate of occupancy for the property being sold. ASC 360-20-40-28 (see section 5.1) provides an exception to this requirement for sales of condominiums, shopping centers, office buildings, and similar structures that involve long construction periods. Sellers of such real estate may recognize profit using the percentage-of-completion method during construction even though a certificate of occupancy has not been obtained. See section 5.13 for guidance on accounting for condominium projects under the percentage-of-completion method and related requirements.

5.1.2 Recognition of loss when sale not consummated If a sale has not been consummated, the seller should apply the deposit method to the transaction until the sale is consummated. The property should remain on the books of the seller, no receivable should be recorded, and any funds received should be reflected as a deposit liability. Any loss on the transaction (i.e., the carrying amount of the property is more than the total consideration received from the buyer, including the unrecorded receivable from the buyer and debt assumed by the buyer) should be recognized at the date the agreement is signed (or earlier, if applicable, based on the accounting guidance for the impairment or disposal of long-lived assets in ASC 360-10). Additionally, because a sale has not been recognized, the property should be evaluated for impairment in accordance with ASC 360-10 whenever indicators of impairment are present.

5.2 Buyer’s initial investment is not adequate Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-31 If the buyer’s initial investment does not meet the criteria specified in paragraphs 360-20-40-9 through 40-18 for recognition of profit by the full accrual method and if recovery of the cost of the property is reasonably assured if the buyer defaults, the installment method described in paragraphs 360-20-55-7 through 55-12 shall be used. If recovery of the cost of the property is not reasonably assured if the buyer defaults or if cost has already been recovered and collection of additional amounts is uncertain, the cost recovery method (described in paragraphs 360-20-55-13 through 55-15) or the deposit method (described in paragraphs 360-20-55-17 through 55-20) shall be used. The cost recovery method may be used to account for sales of real estate for which the installment method would be appropriate.

360-20-40-32 Under the installment, cost recovery, and reduced-profit recognition methods, debt incurred by the buyer that is secured by the property, whether incurred directly from the seller or other parties or indirectly through assumption, and payments to the seller from the proceeds of such indebtedness shall not be considered buyer’s cash payments. However, if the profit deferred under the applicable method exceeds the outstanding amount of seller financing and the outstanding amount of buyer’s debt secured by the property for which the seller is contingently liable, the seller shall recognize the excess in income.



If the buyer’s initial investment is not adequate, profit should not be recognized under the full accrual method (see sections 3.2 — 3.4 for guidance on evaluating the adequacy of the buyer’s initial investment). In such situations, the seller should carefully evaluate the characteristics of the transaction to determine which of the methods identified in ASC 360-20-40-31 (i.e., the installment method, the cost recovery method or the deposit method) should be applied (see section 5.2 and section 5.2.1 for additional guidance). See section 3.2.2 for further discussion of the recognition of profit under the installment, cost recovery, and reduced-profit recognition methods when the profit deferred exceeds the outstanding amount for which the seller is at risk (i.e., the outstanding amount of seller financing and the buyer’s debt secured by the property for which the seller is contingently liable).

5.2.1 Determining whether recovery of the cost of the property is reasonably assured Once the seller determines that the initial investment is not adequate, the seller should first evaluate whether the initial investment is so low that the transaction is, in effect, the sale of an option. As discussed in section 5.11, sales of options by the property owner should be accounted for as deposits. If a transaction is not in substance the sale of an option, the seller should next evaluate whether it is reasonably assured of recovering the cost of the property if the buyer defaults. In performing an evaluation of the recoverability of the cost of the property, the seller should consider whether there are any liens on the property that have priority over the seller’s interest and whether the property could be resold to another buyer at a price that would exceed the cost of the property.

If recovery of the cost of the property is not reasonably assured if the buyer defaults or if the cost of the property has already been recovered and collection of additional amounts is uncertain, the seller should apply the cost recovery method or the deposit method to the transaction (see section 5.2.1.1 for a discussion of how to determine which method to apply and Appendix A for a discussion of the application of these methods). If recovery of the cost of the property is reasonably assured and the risks and rewards of property ownership have been transferred to the buyer, the seller should apply the installment method or the cost recovery method (see section 5.2.1.2).

5.2.1.1 Choosing the appropriate accounting method when recovery of the cost of the property is not reasonably assured

ASC 360-20 indicates that the sale of an option by the property owner should be accounted for as a deposit. If a transaction is not, in substance, the sale of an option, the deposit method or cost recovery method should be applied if the initial investment test is not met and the seller is not reasonably assured of recovering the cost of the property if the buyer defaults. ASC 360-20 also indicates that the deposit or cost recovery method should be applied if the cost of the property has already been recovered and collection of additional amounts is uncertain. However, ASC 360-20 does not provide guidance on which method (deposit or cost recovery) to apply in a given situation. We believe the seller should evaluate the substance of the transaction to determine which method to apply.

The primary difference between the cost recovery method and the deposit method is that under the deposit method the seller does not recognize a sale or receivable or remove the property or any related debt assumed by the buyer from the balance sheet. The cost recovery method allows for the property to be removed from the balance sheet and a sale to be recognized (although profit is deferred until the cost of the property is recovered). Therefore, we believe if a transaction is in substance a sale, the cost recovery method should be applied. Alternatively, if the substance of the transaction is not a sale, the deposit method should be applied.



In determining whether the substance of a transaction is a sale, the seller should consider whether it has any continuing involvement with the property and the nature of that involvement. If the seller does not have any continuing involvement with the property, the substance of the transaction would likely be a sale and the seller should apply the cost recovery method to the transaction. If the seller continues to be involved with the property and that involvement would require the seller to account for the transaction as a financing, leasing, or profit-sharing arrangement if the initial investment test had been met (e.g., if the seller has an obligation to repurchase the property), the substance of the transaction is not a sale, and the seller should apply the deposit method to the transaction. Alternatively, if the seller’s continuing involvement would not preclude the seller from recognizing the transaction as a sale had the initial investment been adequate (e.g., the seller is required to develop the property in the future), the substance of the transaction appears to be a sale, and the seller may apply the cost recovery method.

When the initial investment is not adequate and continuing involvement exists, we do not believe it is appropriate for the seller to recognize profit using the installment or cost recovery method without taking into consideration the requirements of ASC 360-20-40-37 through 40-64 (see sections 5.5 — 5.17) for transactions that include continuing involvement (i.e., a failure to meet the initial investment test should not result in the seller recognizing more profit than the amount that would have been recognized had the initial investment been adequate). Likewise, we do not believe it is appropriate for the seller to recognize profit using one of the methods specified in ASC 360-20-40-37 through 40-64 without taking into consideration the profit that would be recognized under the installment or cost recovery method. Instead, the seller should take both methods into account when determining the amount and timing of profit to be recognized (e.g., the profit that would otherwise be recognized in accordance with the percentage-of-completion method would be reduced based on cash received to-date from the buyer in accordance with the installment or cost recovery method). Refer to sections 5.5 — 5.17 for guidance on the appropriate method to apply when the seller has continuing involvement in the property.

5.2.1.2 Choosing the appropriate accounting method when recovery of the cost of property is reasonably assured

If a buyer’s initial investment is not adequate but the seller is reasonably assured of recovering the cost of the property if the buyer defaults, the seller’s accounting for the transaction will depend on whether the seller has transferred substantially all of the risks and rewards of ownership to the buyer. If the seller has transferred all risks and rewards of ownership (i.e., there is no continuing involvement in the property) and any receivable is not subject to future subordination (see section 5.4 for details), the transaction would qualify to be accounted for using the installment method. However, ASC 360-20 notes that the cost recovery method may always be applied when a transaction qualifies for the installment method. If a seller chooses to apply the cost recovery method when a transaction qualifies for the installment method, this accounting policy should be consistently applied and disclosed (i.e., it would not be appropriate to switch between the installment method and the cost recovery method for similar transactions).

If the seller has some continuing involvement with the property, an analysis of the nature and extent of the seller’s continuing involvement must be performed to determine the appropriate accounting treatment for the transaction (sections 5.5 — 5.17 for discussion of the appropriate accounting treatment to apply when various forms of continuing involvement exist).

When the initial investment is not adequate and continuing involvement exists, we do not believe it is appropriate for the seller to recognize profit using the installment or cost recovery method without taking into consideration the requirements of ASC 360-20-40-37 through 40-64 (see sections 5.5 — 5.17) for transactions that include continuing involvement (i.e., a failure to meet the initial investment test should not result in the seller recognizing more profit than the amount that would have been recognized had the initial investment been adequate). Likewise, we do not believe it is appropriate for the seller to recognize profit using one of the methods specified in ASC 360-20-40-37 through 40-64 without taking into



consideration the profit that would be recognized under the installment or cost recovery method. Instead, the seller should take both methods into account when determining the amount and timing of profit to be recognized (e.g., the profit that would otherwise be recognized in accordance with the percentage-of-completion method would be reduced based on cash received to-date from the buyer in accordance with the installment or cost recovery method). Refer to sections 5.5 — 5.17 for guidance on the appropriate method to apply when the seller has continuing involvement in the property.

5.3 Buyer’s continuing investment is not adequate Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate

Derecognition

360-20-40-33 If the initial investment meets the criteria in paragraphs 360-20-40-9 through 40-18 but the continuing investment by the buyer does not meet the criteria in paragraphs 360-20-40-19 through 40-20 and 360-20-40-24, the seller shall recognize profit by the reduced profit method described in paragraphs 360-20-55-16 and 360-20-55-61 through 55-64 at the time of sale if payments by the buyer each year will at least cover both of the following:

a. The interest and principal amortization on the maximum first mortgage loan that could be obtained on the property

b. Interest, at an appropriate rate, on the excess of the aggregate actual debt on the property over such a maximum first mortgage loan (paragraphs 835-30-25-12 through 25-13 provide criteria for selecting an appropriate rate for present-value calculations).

360-20-40-34 If the criteria specified in the preceding paragraph for use of the reduced profit method are not met, the seller may recognize profit by the installment method (see paragraphs 360-20-55-7 through 55-12) or the cost recovery method (see paragraphs 360-20-55-13 through 55-15).

If the continuing investment test is not met but the initial investment is adequate, the reduced-profit method may be applied if the conditions described in ASC 360-20-40-33 above are satisfied. If the criteria for recognizing profit in accordance with the reduced-profit method are not satisfied, the seller should recognize profit in accordance with the installment or cost recovery method (see section 5.2.1.2 for additional guidance on accounting for transactions that may be accounted for under the cost recovery or installment method).

Illustration 5-1: Reduced profit method

Facts:

Company A sells a single-tenancy industrial building to Buyer B, which has a satisfactory credit rating, for $5,000,000. Consideration consists of $750,000 in cash paid on closing, a new first mortgage note from an independent established lending institution for the maximum amount available of $4,000,000, and a $250,000 second mortgage from the seller. Both notes are at a market rate of interest of 10%. The first mortgage requires level annual payments for 25 years (the assumed customary term for this type of loan). The second mortgage requires interest-only payments for 25 years, with the balance due at the end of the 25 years. Company A does not have any continuing involvement with the property and the seller’s receivable is not subject to future subordination.



Analysis:

The minimum initial investment for a single-tenancy industrial property sold to a buyer with a satisfactory credit rating is 15 percent of the sales value (see section 3.4). Therefore, the minimum initial investment of $750,000 is adequate. However, because the second mortgage does not require level annual payments of principal and interest over the customary mortgage term, the continuing investment test is not satisfied. Because payments made by the buyer each year will at least equal the interest and principal amortization on the maximum first mortgage loan that could be obtained on the property and interest, at a market rate, on the excess of the aggregate actual debt on the property over such a maximum first mortgage loan, the buyer should apply the reduced-profit method to the transaction.

The following excerpt from ASC 360-20 provides instructions and an example of the application of the reduced-profit method.


Reduced-Profit Method A reduced profit is determined by discounting the receivable from the buyer to the present value of the lowest level of annual payments required by the sales contract over the maximum period specified in paragraphs 360-20-40-19 through 360-20-40-20 and excluding requirements to pay lump sums.



360-20-55-16 As defined, a reduced profit is determined by discounting the receivable from the buyer to the present value of the lowest level of annual payments required by the sales contract over the maximum period specified in paragraphs 360-20-40-19 through 40-20 and excluding requirements to pay lump sums. The present value is calculated using an appropriate interest rate, but not less than the rate stated in the sales contract. Paragraphs 835-30-25-12 through 25-13 provide criteria for selecting an appropriate rate for present-value calculations. This method permits profit to be recognized from level payments on the buyer’s debt over the maximum term established in paragraphs 360-20-40-19 through 40-20 and postpones recognition of other profits until lump sum or other payments are made. See Example 6 (paragraph 360-20-55-60) for an illustration of the reduced-profit method.

Example 6: The Reduced-Profit Method

360-20-55-60 This example illustrates the reduced-profit method of accounting for the sale of real estate (see paragraph 360-20-55-16).

360-20-55-61 This Example assumes a sale of land that cost the seller $800,000 and is being sold for $1,000,000 with the following financing.

Buyer’s initial investment $ 250,000 First mortgage note payable to an independent lending institution (Terms—15 percent interest payable annually over 20 years: $79,881 per year including principal and interest) 500,000 Second mortgage note payable to seller (Terms—12 percent interest payable annually over 25 years: $31,875 per year including principal and interest) 250,000 Total selling price $ 1,000,000




360-20-55-62 The amortization term of the second mortgage (25 years) exceeds the term permitted by paragraphs 360-20-40-19 through 40-20 (20 years for sales of land). It is assumed that the payments by the buyer each year will meet the requirement in paragraphs 360-20-40-33 through 40-34, that the reduced-profit method is to be applied, and that the market interest rate is 16 percent.

360-20-55-63 The present value of $31,875 per year for 20 years at a market rate of 16 percent is $31,875 x 5.92884 = $188,982.

360-20-55-64 The profit to be recognized at the time of sale is reduced by the difference between the face amount of the seller’s receivable ($250,000) and the reduced amount ($188,982), or $61,018. The profit recognized at the time of sale is $1,000,000 (sales price) minus $800,000 (cost) minus $61,018, or $138,982. Additional profit of $61,018 is recognized as the second mortgage payments are received in Years 21 through 25.

If a sale qualifies for profit recognition under the reduced-profit method and the seller has some form of continuing involvement in the property, an analysis of the nature and extent of the seller’s continuing involvement must be performed to determine whether it is appropriate to apply the reduced-profit method or if the profit recognized should be further limited.

We do not believe it is appropriate for the seller to recognize profit using the reduced-profit method without taking into consideration the requirements of ASC 360-20-40-37 through 40-64 (see sections 5.5 — 5.17) for transactions that include continuing involvement (i.e., a failure to meet the continuing investment test should not result in the seller recognizing more profit than the amount that would have been recognized had the continuing investment test been adequate). Likewise, we do not believe it is appropriate for the seller to recognize profit using one of the methods specified in ASC 360-20-40-37 through 40-64 without taking into consideration the profit that would be recognized under the reduced-profit method. Instead, the seller should take both methods into account when determining the amount and timing of profit to be recognized. Refer to sections 5.5 — 5.17 for guidance on the appropriate method to apply when the seller has continuing involvement in the property.

5.4 Receivable subject to future subordination Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-36 If the seller’s receivable is subject to future subordination as described in paragraph 360-20-40-25, profit shall be recognized by the cost recovery method (see paragraphs 360-20-55-13 through 55-15).

Refer to Appendix A for discussion of the cost recovery method and section 4.1 for discussion of future subordination.

If a transaction includes a receivable subject to future subordination and the seller has some form of continuing involvement in the property, an analysis of the nature and extent of the seller’s continuing involvement must be performed to determine whether it is appropriate to apply the cost recovery method or if the profit therein should be limited (see section 5.2.1 for additional information).



We do not believe it is appropriate for the seller to recognize profit using the cost recovery method without taking into consideration the requirements of ASC 360-20-40-37 through 40-64 (see sections 5.5 — 5.17) for transactions that include continuing involvement (i.e., a receivable subject to future subordination should not result in the seller recognizing more profit under the cost recovery method than the amount that would have been recognized had the subordination not existed). Likewise, we do not believe it is appropriate for the seller to recognize profit using one of the methods specified in ASC 360-20-40-37 through 40-64 without taking into consideration the profit that would be recognized under the cost recovery method. Instead, the seller should take both methods into account when determining the amount and timing of profit to be recognized. Refer to sections 5.5 — 5.17 for guidance on the appropriate method to apply when the seller has continuing involvement in the property.

5.5 Continuing involvement without transfer of risks and rewards Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-37 If the seller has some continuing involvement with the property and does not transfer substantially all of the risks and rewards of ownership, profit shall be recognized by a method determined by the nature and extent of the seller’s continuing involvement. Generally, profit shall be recognized at the time of sale if the amount of the seller’s loss of profit because of continued involvement with the property is limited by the terms of the sales contract. The profit recognized shall be reduced by the maximum exposure to loss. Paragraphs 360-20-40-38 through 40-64 describe some common forms of continuing involvement and specify appropriate accounting if those forms of involvement are present. If the seller has some other form of continuing involvement with the property, the transaction shall be accounted for according to the nature of the involvement.

If the seller has continuing involvement in the property sold without transferring substantially all of the risks and rewards of ownership, the seller’s accounting for the transaction depends on the nature and extent of the seller’s involvement. ASC 360-20-40-37 through 40-64 (see sections 5.5 — 5.17) provide some examples of common forms of continuing involvement and the appropriate accounting to follow if any of those forms of continuing involvement are present.

Some common forms of continuing involvement include:

• The seller has an option (including a fair value purchase option) or obligation to repurchase the property or the terms of the transaction allow the buyer to compel the seller to repurchase the property (see section 5.6).

• The seller is a general partner in a limited partnership that acquires an interest in the property sold (or has an extended, noncancelable management contract requiring similar obligations) and holds a receivable from the buyer for a significant part of the sales price (see section 5.7). A significant receivable would be a receivable in excess of 15 percent of the maximum first-lien financing that could be obtained on the property.

• The seller guarantees the return of the buyer’s investment or a return on that investment for a limited or extended period (see section 5.8).

• The seller is required to initiate or support operations or continue to operate the property at its own risk (see section 5.9).



• The transaction is merely an option to purchase the property (see section 5.11).

• The seller has made a partial sale (i.e., the seller retains an equity interest in the property or has an equity interest in the buyer) (see section 5.12).

• The seller sells property improvements and leases the underlying land to the buyer of the improvements (see section 5.14).

• The sale of the property is accompanied by a leaseback to the seller of all or any part of the property for all or part of its remaining economic life (see section 5.15).

• The sales agreement, or accompanying agreement, requires the seller to develop the property in the future, to construct facilities on the land, or to provide off-site improvements or amenities (see section 5.16).

• The seller will participate in future operations from the property without risk of loss, such as participation in operating profits or residual values without further obligation (see section 5.17).

If the sales agreement contractually limits the seller’s exposure to loss from continuing involvement, profit, reduced by the seller’s maximum exposure to loss, should be recognized at the time of sale (assuming all other criteria for recognizing profit under the full accrual method have been satisfied). If the maximum exposure to loss is contractually limited, this general rule may be applied without referring to the more detailed guidance in ASC 360-20-40-37 through 40-64. This general rule may only be used when the maximum exposure to loss is explicitly stated in the contract or can be calculated based on the terms of the contract (i.e., it is not appropriate to simply estimate a maximum exposure to loss in accordance with ASC 450, Contingencies)

Illustration 5-2: Maximum exposure not specified

Facts:

Developer A sells an apartment building with a carrying amount of $1,500,000 to XYZ Management for $2,500,000, payable through a cash down payment of $625,000 and a 10-year amortizing note for $1,875,000. The sale agreement calls for Developer A to reimburse XYZ Management for any negative cash flows during the first year. The maximum reimbursement is not specified in the contract. However, based on experience with similar transactions, Developer A estimates that its maximum exposure to loss is $200,000. All other criteria for recognizing revenue under the full accrual method have been satisfied.

Analysis:

Because the maximum exposure to loss from continuing involvement is not limited by the terms of the contract, Developer A should account for this transaction as a support obligation in accordance with ASC 360-20-40-42 through 40-44 (see section 5.9 for detailed guidance on accounting for this type of transaction).



Illustration 5-3: Maximum exposure is specified

Facts:

Assume the same facts as in Illustration 5-2, except the sale agreement calls for Developer A to reimburse XYZ Management for any negative cash flows during the first year, up to a maximum of $250,000.

Analysis:

Because the maximum exposure to loss from continuing involvement of $250,000 is stated in the sales agreement and all other criteria for recognizing revenue under the full accrual method have been satisfied, Developer A may recognize $750,000 in profit ($2,500,000 sales price — $1,500,000 book value — $250,000 maximum loss exposure specified in the contract) at the time of sale. Developer A should defer the maximum exposure of $250,000 and not the estimated exposure of $200,000. At the end of the year, Developer A may recognize as profit any difference between the amount of profit deferred and the amount paid to XYZ Management under the support agreement.

5.5.1 Continuing involvement based on a contingency Certain real estate sale agreements include provisions that trigger some form of continuing involvement if a specific event takes place, such as the default of either the seller or the buyer. We believe that continuing involvement based on or triggered by a contingency (including default) should be considered continuing involvement regardless of the probability of the contingency occurring. For example, as a remedy or consequence of a default, a seller may be required to offer to purchase the property from the buyer or the buyer may have an obligation or option to offer the property for sale to the seller. Because the guidance for real estate sales in ASC 360-20 was designed to preclude sale accounting when any provision (other than a right of first refusal based on a bona fide third-party offer or an antispeculation clause as defined in ASC 360-20-40-39 — see section 5.6.1) exists that would enable (or compel) the seller to reacquire the property (whether automatic or under an option at either a stated value or fair value), the presence of such a provision would prevent a seller from recognizing a sale, even if the seller determines that it is remote that the contingency will occur. In these situations, the probability of contingency occurring only affects whether the arrangement should be accounted for as a financing, leasing, or profit-sharing arrangement. See section 5.6 for additional discussion of put and call options.

5.6 Obligation or option to repurchase Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-38 If the seller has an obligation to repurchase the property, or the terms of the transaction allow the buyer to compel the seller or give an option to the seller to repurchase the property, the transaction shall be accounted for as a financing, leasing, or profit-sharing arrangement rather than as a sale. A right of first refusal based on a bona fide offer by a third party ordinarily is not an obligation or an option to repurchase. See paragraph 360-20-55-21A for implementation guidance related to evaluating a buy-sell agreement in cases where the seller of the real estate has otherwise met the criteria to recognize a partial sale.




If a seller has an obligation or option to repurchase a property or the buyer can compel the seller to repurchase the property, the seller has not permanently transferred all of the risks and rewards of ownership to the buyer. Therefore, in such situations a sale should not be recorded and the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement. However, a right of first refusal based on a bona fide offer by a third party is ordinarily not considered an obligation or option to purchase the property. Additionally, a seller is not precluded from recording a sale and profit when the seller has committed to assist the buyer to resell the property to a third party, if the commitment is on a best-efforts basis and the seller receives appropriate compensation for its efforts.

While ASC 360-20 notes that it if an obligation or option to repurchase a property exists, the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement, it does not provide guidance as to when to use each of the three methods. We believe a seller should evaluate the nature of the obligation or option and, if an option exists, the likelihood of the option being exercised in determining which method to apply. If the seller will essentially repay the buyer its entire investment plus a return on that investment (i.e., when the seller is obligated or likely to exercise an option to repurchase the property at a price higher than the sales price or at an indeterminate price), we believe it would be most appropriate for the seller to account for the transaction as a financing arrangement. If the buyer is essentially paying for the use of the property for a period of time (i.e., when the seller is obligated or likely to exercise an option to repurchase the property at a price that is less than the sales price), we believe it would be most appropriate to account for the transaction as a leasing arrangement. In all other situations, we believe it would generally be most appropriate to apply the profit-sharing method. The following table summarizes different put and call features and the method (financing, leasing, or profit-sharing) we believe would be most appropriate to apply in each circumstance:

Method

Situation Financing Leasing Profit-sharing

Obligation to repurchase at:* Higher price X Indeterminate price X Lower price X Same price X Option to repurchase at: Higher price if it is likely the option will be exercised X Higher price if it is unlikely the option will be exercised X Indeterminate price if it is likely the option will be exercised X Indeterminate price if it is unlikely the option will be exercised X Lower price if it is likely the option will be exercised X Lower price if it is unlikely the option will be exercised X Same price X

* Whether contractually required or at the option of the buyer.

5.6.1 Antispeculation clauses in real estate sales contracts Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-39 Land sale agreements sometimes contain antispeculation clauses that require the buyer to develop the land in a specific manner or within a stated period of time. Antispeculation clauses may also prohibit certain uses of the property. If the buyer fails to comply with the provisions of the sales contract, the



seller has the right, but not the obligation, to reacquire the property. The seller’s contingent option described would not preclude recognition of a sale if the probability of the buyer not complying is remote. A number of factors might lead one to conclude that buyer noncompliance is remote, including the economic loss to the buyer from repurchase and the buyer’s perceived ability to comply with the provisions of the sales contract. A probability test would not be appropriate if the seller’s repurchase option is not contingent upon compliance by the buyer.

Land sale agreements sometimes contain “antispeculation” clauses that require the buyer to develop the land in a specific manner or within a stated period of time. These clauses also may limit how the buyer may use the property. If the buyer does not comply with these terms, the seller has a right, but not an obligation, to reacquire the property. Based on a literal reading of ASC 360-20-40-38 (see section 5.6) it would appear that such an arrangement should be recorded as a financing, leasing, or profit-sharing arrangement, and not a sale because of the seller’s option to repurchase the property.

However, ASC 360-20-40-39 provides an exception related to antispeculation clauses. A contingent option created by an antispeculation clause does not preclude a seller from recognizing a sale if the probability of the buyer not complying with the clause is remote. The seller’s analysis of the probability of noncompliance should include the economic loss to the buyer if the seller repurchased the property and the buyer’s perceived ability to comply with the provisions of the sales contract. If a seller’s repurchase option is not contingent on compliance by the buyer (e.g., if it is contingent on market conditions or compliance by the seller), it would not be appropriate for the seller to recognize a sale, even if the seller determines that it is remote that the option will be exercised. As discussed in section 5.6, if a seller’s repurchase option is not contingent on compliance by the buyer, the probability of the seller exercising an option only affects whether the arrangement should be accounted for as a financing, leasing, or profit-sharing arrangement.

5.6.2 Buy-sell clauses Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-55-21A This paragraph provides implementation guidance related to paragraph 360-20-40-38 regarding the transfer of risks and rewards. Determining whether the terms of a buy-sell clause indicate that the seller has transferred the usual risks and rewards of ownership and does not have substantial continuing involvement pursuant to that paragraph is a matter of judgment and requires consideration of all relevant facts and circumstances of the transaction at the time the real estate is sold. For purposes of this illustration, it is assumed that the seller of the real estate has met the criteria to recognize a partial sale, except for the potential effect of the buy-sell clause. A buy-sell clause, in and of itself, does not constitute a prohibited form of continuing involvement that would preclude partial sales treatment. However, a buy-sell clause should be evaluated, in consideration of all the relevant facts and circumstances, to determine whether the buy-sell clause gives the buyer an in-substance option to put its interest back to the seller or gives the seller an in-substance option to acquire the buyer’s interest in the real estate. In the case of sales of real estate to an entity that is partially owned by the seller and the arrangement between the seller and the other investor of the jointly owned entity includes a buy-sell clause, the buy-sell clause should be evaluated, in consideration of all the relevant facts and circumstances, to determine whether the buy-sell clause gives the buyer an in-substance option to put its interest in the jointly owned entity back to the seller or gives the seller an in-substance option to acquire the buyer’s interest in the jointly owned entity (thereby reacquiring the real estate).




Certain real estate sale transactions may involve two investors entering into an arrangement to form an entity in which one of the investors sells real estate to the entity. Such an arrangement may include a “buy-sell” clause that allows either of the investors to make an offer to acquire the other investor’s interest in the entity. The investor that receives the offer (the offeree) may elect to either sell its interest in the entity to the offeror at the offered price or buy-out the offeror’s interest at the same price.

Questions have arisen as to whether such clauses represent an option or obligation to repurchase the property that should be accounted for in accordance with ASC 360-20-40-38 (see section 5.6). Although the seller has the right to make an offer to repurchase the property (by offering to purchase the other investor’s interest in the entity), the other investor may choose not to sell its interest and may instead elect to purchase the seller’s interest in the entity. Additionally, if the other investor offers to purchase the seller’s interest in the property, the seller may elect to sell its interest versus purchasing the other investor’s interest. A buy-sell arrangement must be evaluated to determine if it is in substance a purchase option for the seller of real estate or in substance a put right for the buyer. If the seller would be compelled to offer to purchase the property, either contractually or economically, the buy-sell is effectively a put, resulting in a failed sale. If the buyer of the real estate would be contractually or economically compelled to accept the buy- sell offer, it is effectively a purchase option, resulting in a failed sale.

5.7 General partner holds a significant receivable from the buyer Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-40 If the seller is a general partner in a limited partnership that acquires an interest in the property sold (or has an extended, noncancelable management contract requiring similar obligations) and holds a receivable from the buyer for a significant part of the sales price, the transaction shall be accounted for as a financing, leasing, or profit-sharing arrangement. For this purpose, a significant receivable is a receivable in excess of 15 percent of the maximum first-lien financing that could be obtained from an independent established lending institution for the property. It would include any of the following:

a. A construction loan made or to be made by the seller to the extent that it exceeds the minimum funding commitment for permanent financing from a third party that the seller will not be liable for

b. An all-inclusive or wraparound receivable held by the seller to the extent that it exceeds prior-lien financing for which the seller has no personal liability

c. Other funds provided or to be provided directly or indirectly by the seller to the buyer

d. The present value of a land lease when the seller is the lessor (see paragraph 360-20-40-58).

When a general partner in a limited partnership sells an interest in property (i.e., a partial sale of real estate) to the partnership and holds a significant receivable from the partnership, the general partner should not record the transaction as a sale. Such transactions should generally be accounted for as profit-sharing arrangements because the general partner is effectively participating in the operating results of the property through its partnership interest and the significant receivable from the partnership. A “significant receivable” is defined as a receivable in excess of 15 percent of first-lien financing available from an independent established lending institution. This receivable from the buyer is not limited to amounts loaned to the buyer at the time of sale, but could include construction loans made or to be made by the seller, land leases, and other funds provided directly or indirectly by the seller (see section 3.3.2 for additional discussion of funds provided directly or indirectly by the seller).



Illustration 5-4: General partner’s receivable from a partial sale to a partnership

Facts:

An entity that is the general partner in a limited partnership sells a hotel to the limited partnership for $1,000,000. Consideration includes a $200,000 down payment, a $650,000 first mortgage (the maximum amount available) from a third-party lending institution, and a $150,000 second mortgage from the general partner.

Analysis:

The $150,000 second mortgage is a significant receivable from the buyer because it is more than 15 percent of the maximum first-lien financing that could be obtained from an independent established lending institution ($650,000 X 15 percent = $97,500). Therefore, no sale should be recorded and the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement. As discussed above, we believe it is generally most appropriate to account for such transactions as profit-sharing arrangements.

It should be noted that the buyer’s initial investment is not adequate in this example (the minimum required under ASC 360-20-55-1 is $250,000—see section 3.4.2 for guidance). If recovery of the cost of the property is not reasonably assured if the buyer defaults or if the cost of the property has already been recovered and collection of additional amounts is uncertain, the seller should apply the deposit method until recovery of the cost of the property is reasonably assured (see section 5.2.1.1). However, if recovery of the cost of the property is reasonably assured it would not be appropriate for the seller to simply apply the installment or cost recovery method and record a sale (see section 5.2.1.2) because a failure to meet the initial investment test should not create a more favorable result than the result that would be achieved if the initial investment was adequate. As a result, the transaction would still be required to be accounted for as a financing, leasing, or profit-sharing arrangement.

5.8 Guarantee of the return of the buyer’s investment or a return on the buyer’s investment Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-41 The seller may guarantee the return of the buyer’s investment or a return on that investment for a limited or extended period. For example, the seller guarantees cash flows, subsidies, or net tax benefits. If the seller guarantees return of the buyer’s investment or if the seller guarantees a return on the investment for an extended period, the transaction shall be accounted for as a financing, leasing, or profit-sharing arrangement. If the guarantee of a return on the investment is for a limited period, the deposit method shall be used until operations of the property cover all operating expenses, debt service, and contractual payments. At that time, profit shall be recognized on the basis of performance of the services required, as illustrated in paragraphs 360-20-55-44 through 55-48.

If a seller guarantees a return on a buyer’s investment for a limited period (e.g., three years), the seller should apply the deposit method to the transaction until operations of the property cover all operating expenses, debt service, and contractual payments. At that time, profit may be recognized on the basis of performance of the services required (see section 5.9 for guidance on applying the performance-of-services method).



Because of the high threshold for recognizing profit when a seller has guaranteed a return on a buyer’s investment for a limited period, a seller will not recognize any profit at the date of sale for such a transaction unless the amount of the guarantee is contractually limited in accordance with ASC 360-20-40-37 (see section 5.5) or the property sold is already operating and current operations of the property cover current operating expenses, debt service, and contractual payments.

If a seller guarantees a return on a buyer’s investment for an extended period of time or the return of the buyer’s investment over any period of time, the seller should account for the transaction as a financing, leasing, or profit-sharing arrangement (i.e., the transaction should not be recorded as a sale) unless the amount of the guarantee is contractually limited in accordance with ASC 360-20-40-37 (see section 5.5).

If a seller guarantees a return on a buyer’s investment for an extended period of time or the return of the buyer’s investment over any period of time, the appropriate accounting method (i.e., financing, leasing, or profit-sharing) will depend on the substance of the arrangement. If the arrangement includes a guarantee that will essentially provide the buyer a return of its entire investment plus a return on that investment (e.g., a 20-percent return per year for six years), it may be appropriate to account for the transaction as a financing arrangement. Alternatively, if the seller only guarantees a small return on the buyer’s investment (e.g., a 5-percent return per year for six years), it may be appropriate to account for the transaction as a profit-sharing arrangement. We believe sellers should generally only account for transactions using the leasing method when the seller is likely to receive the property back from the buyer in the future (e.g., the seller has an obligation to repurchase a property at a price that is less than the original selling price—see section 5.6). Therefore, we do not believe the leasing method should be applied when a seller is only guaranteeing a return of or on a buyer’s investment.

If a sales agreement contractually limits the seller’s guarantee, the seller may recognize profit, reduced by the seller’s maximum exposure to loss, at the time of sale (assuming all other criteria for recognizing profit under the full accrual method have been satisfied). See section 5.5 for additional information.

A guaranteed return on or of a buyer’s investment (ASC 360-20-40-41) may sometimes be confused with a support obligation as described in ASC 360-20-40-42 (see section 5.9). A seller’s obligation to support operations generally only guarantees the buyer will recover funds from the seller up to a breakeven (cash flow) amount and does not guarantee that the buyer will receive a return on or of its investment. See section 5.9 for additional discussion of support obligations and the appropriate accounting methodology to apply when such an obligation exists. The following examples illustrate these concepts:

Illustration 5-5: Guarantee of cash flows, including investor distributions

Facts:

Company A sells an operating property to a partially owned venture (with Company B). Company A guarantees that the cash flows of the venture for three years will be sufficient to meet all operating needs of the venture, including distributions to Company B.

Analysis:

By guaranteeing that the cash flows of the venture will be sufficient to meet all of the venture’s operating needs, including distributions to Company B, Company A is guaranteeing a return on the buyer’s investment. Because the guarantee is for a limited period (three years), the deposit method should be applied until actual operations of the property cover all operating expenses, debt service, and contractual payments. At that time, profit may be recognized on the basis of performance of the services required (see section 5.9 for further description of the performance-of-services method and section 5.9.5 for an example that illustrates the application of the performance-of-services method).



Illustration 5-6: Guarantee of cash flows, excluding investor distributions

Facts:

Company A sells an operating property to a partially owned venture (with Company B). Company A guarantees that the cash flows of the venture for three years will be sufficient to meet all operating needs of the venture, excluding distributions to Company B.

Analysis:

Because Company A’s guarantee excludes distributions to investors, Company A is not guaranteeing a return on the buyer’s investment, rather Company A has an obligation to support the operations of the property (see section 5.9 for a discussion of support obligations and the appropriate accounting methodology to apply when such an obligation exists).

5.9 Requirement to initiate or support operations Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-42 The seller may be required to initiate or support operations or continue to operate the property at its own risk, or may be presumed to have such a risk, for an extended period, for a specified limited period, or until a specified level of operations has been obtained, for example, until rentals of a property are sufficient to cover operating expenses and debt service.

360-20-40-43 If support is required or presumed to be required for an extended period of time, the transaction shall be accounted for as a financing, leasing, or profit-sharing arrangement. Support shall be presumed to be required if any of the following conditions exist:

a. A seller obtains an interest as a general partner in a limited partnership that acquires an interest in the property sold.

b. A seller retains an equity interest in the property, such as an undivided interest or an equity interest in a joint venture that holds an interest in the property.

c. A seller holds a receivable from a buyer for a significant part of the sales price and collection of the receivable depends on the operation of the property.

d. A seller agrees to manage the property for the buyer on terms not usual for the services to be rendered, and the agreement is not terminable by either the seller or the buyer. If the sales contract requires the seller to provide management services relating to the property after the sale without compensation or at compensation less than prevailing rates for the service required (see paragraph 360-20-40-8) or on terms not usual for the services to be rendered, compensation shall be imputed when the sale is recognized and shall be recognized in income as the services are performed over the term of the management contract.

e. If the sales contract does not stipulate the period during which the seller is obligated to support operations of the property, support shall be presumed for at least two years from the time of initial rental unless actual rental operations cover operating expenses, debt service, and other contractual commitments before that time. If the seller is contractually obligated for a longer



time, profit recognition shall continue on the basis of performance until the obligation expires. Calculation of profits on the basis of performance of services is illustrated in Example 2 (see paragraph 360-20-55-44).

360-20-40-44 If support is required or presumed to be required for a limited time, profit on the sale shall be recognized on the basis of performance of the services required. Performance of those services shall be measured by the costs incurred and to be incurred over the period during which the services are performed. Profit shall begin to be recognized when there is reasonable assurance that future rent receipts will cover operating expenses and debt service including payments due the seller under the terms of the transaction. Reasonable assurance that rentals will be adequate would be indicated by objective information regarding occupancy levels and rental rates in the immediate area. In assessing whether rentals will be adequate to justify recognition of profit, total estimated future rent receipts of the property shall be reduced by one-third as a reasonable safety factor unless the amount so computed is less than the rents to be received from signed leases. In this event, the rents from signed leases shall be substituted for the computed amount. Application of this method is illustrated in Example 2 (see paragraph 360-20-55-44).

A seller may agree to support the operations of a property up to a breakeven level of cash flows for a period of time. In transactions with support obligations, the seller is often involved in developing the property and may agree to operate the property at its own risk or reimburse the buyer for negative cash flows for a period of time. If a seller is required or presumed to be required to support the operations of a property for a limited period of time (e.g. three years), the seller may record a sale and account for the transaction under the performance-of-services method (assuming all other requirements for recognizing profit under the full accrual method are met). However, the seller may not begin to recognize profit under the performance-of-services method until there is reasonable assurance that future rent receipts will cover all operating expenses, debt service, and contractual payments, or the support obligation expires.

If a seller is required, or presumed to be required, to support the operations of property sold for an extended period, the seller should account for the transaction as a financing, leasing, or profit-sharing arrangement (i.e., the transaction should not be recorded as a sale). In such situations, the appropriate accounting method (i.e., financing, leasing, or profit-sharing) will depend on the substance of the arrangement. Because the nature of a support arrangement is to support the operations of a property up to a breakeven level and not to provide a buyer with a return of its investment or to allow the buyer to use the property for a period of time, the substance of such arrangements is generally more like that of a profit-sharing arrangement than a financing or leasing arrangement. Therefore, we would generally expect arrangements that include extended support obligations to be accounted for as profit-sharing arrangements.

If a sales agreement does not stipulate the period during which the seller is obligated to support operations of the property, the period of support should be presumed to be for at least two years from the time of initial rental, unless actual rentals cover all operating expenses, debt service, and contractual payments before that time. If the seller is presumed to support operations for longer than two years, the longer period should be used to recognize profit using the performance-of-services method (so long as the period is for a limited period of time). For example, if a seller is contractually obligated to support operations of a property until the property operates at a breakeven level, the seller should presume that support will be required for two years, even if objective information about occupancy levels and rental rates in the immediate area indicates that the property will break even in one year. If the property reaches breakeven after one year, any unrecognized profit on the transaction may be recognized (assuming all other criteria for recognizing profit under the full accrual method have been satisfied) because the seller no longer has continuing involvement in the property (the support obligation ceases once the property reaches breakeven). However, if the seller estimates that the property will not break even for six years, the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement.



If a sales agreement contractually limits the seller’s support obligation, profit, reduced by the seller’s maximum exposure to loss, may be recognized at the time of sale (assuming all other criteria for recognizing profit under the full accrual method have been satisfied). See section 5.5 for additional information.

A support obligation as described in ASC 360-20-40-42 may sometimes be confused with a guaranteed return on or of a buyer’s investment as described in ASC 360-20-40-41 (see section 5.8). A seller’s obligation to support operations only guarantees the buyer will recover funds from the seller up to a breakeven amount for a period of time and does not guarantee that the buyer will receive a return on or of its investment. See section 5.8 for additional discussion of guaranteed returns and the appropriate accounting methodology to apply when a guarantee exists.

5.9.1 Implied support A requirement to support operations may be contractual or implied. Pursuant to ASC 360-20-40-43 (see section 5.9), support should be presumed to be required when:

• The seller is, or becomes, a general partner in a limited partnership that acquires an interest in the property sold.

• The seller retains an equity interest in the property, such as an undivided interest or an equity interest in a joint venture that holds an interest in the property.

• The seller holds a receivable from a buyer for a significant part of the sales price and collection of the receivable depends on the operation of the property.

• A “significant receivable” is defined in ASC 360-20-40-40 as a receivable in excess of 15 percent of first-lien financing available from an independent established lending institution (see section 5.7). As discussed in section 5.7, if the seller holds a significant receivable from the buyer and is a general partner in the limited partnership buyer, a sale should not be recognized and the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement per ASC 360-20-40-40.

• The seller should presume that collection of the receivable depends on the operation of the property if the receivable is either nonrecourse to the property or is from an entity with little substantive assets other than the property.

• The seller agrees to manage the property for the buyer on terms that are not usual for the services being rendered (e.g., the seller will not be paid for management services unless profitability reaches a certain threshold) and the agreement cannot be terminated by either the seller or the buyer. The seller should look to other similar agreements to sell real estate and provide management services and to agreements to manage property that do not include the sale of the property to determine whether the terms of the agreement are not usual for the services being rendered.

5.9.2 Reasonable assurance that future rentals will be adequate According to ASC 360-20-40-44, reasonable assurance that future rentals will cover all operating expenses, debt service, and contractual payments would be indicated by objective information regarding occupancy levels and rental rates in the immediate area (see section 5.9). ASC 360-20-40-44 also indicates that total estimated future rent receipts should be reduced by a safety factor of one-third (unless the amount so computed is less than the rents to be received from signed leases) in assessing whether rentals will be adequate to justify recognition of profit. This sentence appears to imply that estimated future rentals must be reduced by a one-third safety factor in assessing whether there is reasonable assurance that future rentals will cover all operating expenses, debt service, and contractual payments. However, this interpretation is inconsistent with the example provided in ASC 360-20 (see section 5.9.4). Instead, we believe this sentence was meant to suggest that a safety-factor must be used to justify the amount of profit that is recognized when there is reasonable assurance that future



rentals will be adequate based on objective information regarding occupancy levels and rental rates in the immediate area. The assessment of whether there is reasonable assurance that future rentals will be adequate does not require the use of such a safety-factor. This interpretation is supported by ASC 360-20-55-46(b)(4) (see section 5.9.4).

5.9.3 Estimating future rent receipts As discussed in section 5.9.2, when a seller recognizes profit using the performance-of-services method (i.e., once there is reasonable assurance that rent revenue will be sufficient to cover operating expenses, debt service, and contractual payments), the projected rental revenue used to calculate the amount of profit to recognize each period must be reduced by a safety factor of one-third, unless the amount computed is less than the actual rents that will be received from signed leases. The following example illustrates the calculation of estimated future rent receipts, including a safety factor:



Schedule C: Calculations of Adjusted Projected Rental Revenue

360-20-55-49 Assume an office building under development is sold together with an agreement to support operations of the property for three years. The projected annual rent roll is $1,000,000 of which $350,000 is supported by signed lease agreements. The projected rental revenue for the first year of operation is $600,000; the second year $750,000; and the third year $1,000,000. At the time of sale, the amounts to be included in the calculation would be as follows.

Year Projected Rental Revenue Safety Factor

(33 ⅓ %) Adjusted Projected

Rental Revenue 1 $ 600,000 $ 200,000 $ 400,000 2 750,000 250,000 500,000 3 1,000,000 333,333 666,667

360-20-55-50 If at the time of sale there were signed lease agreements for $450,000, then the $450,000 would be used in year 1 because it is greater than the adjusted projected rental revenue. The adjusted projected rental revenue for Years 2 and 3 would remain $500,000 and $666,667, respectively.

5.9.4 Profit recognition on performance of services If a seller is required or presumed to be required to support the operations of property sold for a limited period of time, once there is reasonable assurance that future rent receipts will cover all operating expenses, debt service, and contractual payments, profit may be recognized on the basis of performance of the services required. The performance-of-services method is similar to the percentage-of-completion method, in that profit is measured based on the costs incurred and to be incurred over the period during which the services (sale and support) are performed. Costs include the cost of the property, operating expenses, and other costs incurred during the support period. Revenues used to calculate gross profit should include the sales price as well as estimated rent from operations during the support period, adjusted by a safety factor if the estimate is more than rent to be received from actual signed leases (see section 5.9.3). The following example illustrates the application of the performance-of-services method when the seller is required to support the operations of the property for a limited period of time and construct improvements (see section 5.16 for additional discussion of agreements that require a seller to develop property in the future):





Example 2: Profit Recognition—Sale of Property with Construction and Support Obligations by Seller

360-20-55-44 This Example illustrates the method of accounting required for a sale of property in which the seller is obligated to construct multifamily units and in which cash flow deficits are anticipated. The Example applies to obligations of the seller specified in paragraphs 360-20-40-41 through 40-44.

360-20-55-45 This Example has the following assumptions:

a. Entity X develops and sells multifamily residential projects. The Entity performs directly all developmental activities, including initial planning, site acquisition, obtaining of financing, and physical construction of the project.

b. During the year ended December 31, 19X1 the Entity began a project of 100 units. The project was planned and substantial activity had been performed in 19X1 but physical construction had not started as of December 31, 19X1. However, all contracts had been let, and the Entity had obtained construction financing.

c. On December 31, 19X1, the Entity sold the project to a limited partnership syndication (fully formed) in which it is the sole general partner, as illustrated in the following table.

Sales value $ 1,100,000 Represented by proceeds of: Cash down payment $ 165,000 Permanent financing assumed by the buyer, consisting of a 28-year 8 1/2% fully amortizing first mortgage loan by a conventional lender, payable in equal monthly payments of principal and interest to maturity 825,000 Second mortgage note received by the Entity payable in equal monthly installments including interest at 9 1/2% over 12 years 110,000 $ 1,100,000

d. The closing occurred on December 31, 19X1, and included delivery or performance of all of the following:

1. The Entity delivered to the buyer a legal title to the land and all existing improvements.

2. The Entity delivered to the buyer a firm commitment from an outside lender for permanent financing, and the buyer assumed permanent financing formerly in the name of the Entity.

3. The Entity received from the buyer $165,000 cash and a second mortgage note for $110,000.

4. The Entity signed a contract to deliver the completed project for a single price of $1,100,000.



e. Costs incurred by the Entity and total costs estimated to complete the project, as of December 31, 19X1, were as follows:

Costs

to Date

Estimated Costs to Complete

Total Estimated Costs

Land $ 117,000 $ 117,000 Feasibility, zoning, architectural 35,000 35,000 Finance and other 85,000 $ 10,000 95,000 Site improvements 20,000 20,000 Building construction 571,000 571,000 Total $ 237,000 $ 601,000 $ 838,000

f. The Entity has completed an extensive market research and feasibility study analyzing its cost estimates, the rent-up incubation period, and subsequent rent levels. The initial rent-up will commence in 19X2. Accordingly, a support period of two years is presumed for 19X3 and 19X4.

g. Based on its market analysis, the projected results are as follows.

19X2 19X3 19X4 Rental expense $ 37,000 $ 58,000 $ 58,000 Debt service 93,000 93,000 93,000 Total 130,000 151,000 151,000 Rental revenue (75,000) (150,000) (180,000) (a) Anticipated net deficit (surplus) in cash flow 55,000 1,000 (29,000) Safety factor of 1/3 of rental revenue 25,000 50,000 60,000 Adjusted anticipated net deficit in cash flow $ 80,000 $ 51,000 $ 31,000

(a) $180,000 equals 95% of gross scheduled rents.

h. Initial cost estimates by the Entity on previous projects have never varied from final costs by more than one-half of one percent of total costs.

360-20-55-46 Schedules A and B illustrate calculations of profit to be recognized in the period of sale, in the period of construction, and in each period in which the seller will support operations (19X2—19X4). All of the following features should be noted:

a. The percentage of estimated total profit to be recognized each period is determined by the ratio of gross costs incurred to the end of the period to total estimated gross costs of the project, including gross costs during the period of support of operations. (Construction costs should be included even if construction is performed by parties other than the seller.)

b. The estimated total profit that is the basis of the calculation in each period (that is, the profit to which the percentage in [a] is applied) is determined by adding the sales value and two-thirds of the projected revenue during the period of support of operations and deducting the estimated total costs of the project, including costs of operating the property and debt service.

1. Actual amounts of revenue and costs are substituted for estimated amounts in the calculation as the actual amounts are known. However, in this Example, remaining estimates of future revenue and expense are not changed because of actual results even though experience might indicate that projections of future amounts should be revised.



2. Projected and actual revenues in the calculation should exclude amounts that accrue to the buyer, for example, revenue in excess of the sum of operating expenses and debt service.

3. One-third of projected revenue should be excluded from the estimate of profit to provide a margin of safety (see [g] in the preceding paragraph). Actual results incorporated in the calculation need not be reduced by a safety factor.

4. The calculation illustrated should be applied only if objective information is available regarding occupancy levels and rental rates for similar property in the immediate area. This will provide reasonable assurance that rent revenue from the project will be sufficient to cover operating expenses and debt service, including payments due to the seller under the terms of the transaction. Unless that evidence is available, no profit should be recognized on the transaction until rent revenue actually reaches levels that assure coverage of those costs.

c. Schedule A shows calculation of profit to be recognized each period on the assumption that actual revenue and costs are the same as those projected in (g) in the preceding paragraph adjusted for the safety margin of one-third of revenue.

d. Schedule B shows calculation of profit to be recognized each period on the assumption that actual revenue and costs are the same as those projected in (g) in the preceding paragraph before adjustment for safety margin.

e. Schedule C illustrates the calculation of estimated future rent receipts by adjustment for a safety margin.

Schedule A: Example of Profit Calculation (Assuming Actual Rental Revenue Equals Adjusted Projection)

360-20-55-47 The following tables illustrate profit calculation.

Example of Profit Calculation (assuming actual rental revenue equals adjusted projection)

Revenues Sales value $ 1,100,000 Adjusted—projected rental revenue (a) 19X2 50,000 19X3 100,000 19X4 120,000 $ 1,370,000

(a) Two-thirds of projected revenue during periods of support of operations; this can also be calculated as projected rental expenses plus projected debt service less projected deficit cash flow.

Costs Total estimated costs of project (paragraph 360-20-55-45(e)) $ 838,000 Estimated rental expenses and debt service 130,000

19X2 151,000 19X3 151,000 19X4 1,270,000 Total projected profit $ 100,000



Profit to be recognized: Cost to date x Projected profit Total costs

Profit recognized in period of sale:

$ 237,000 x $ 100,000 = $ 18,661 1,270,000

Total profit to date $ 18,661 Less profit previously reported – Current profit recognition $ 18,661 Profit recognized in period of construction: $ 838,000 x $ 100,000 = $ 65,984 1,270,000

Total profit to date $ 65,984 Less profit previously recognized 18,661 Current profit recognition $ 47,323 Profit recognized during support period (19X2): $ 968,000 x $ 100,000 = $ 76,221 1,270,000

Total profit to date $ 76,221 Less profit previously recognized 65,984 Current profit recognition $ 10,237 Profit recognized during support period (19X3): $ 1,119,000 x $ 100,000 = $ 88,110 1,270,000

Total profit to date $ 88,110 Less profit previously recognized 76,221 Current profit recognition $ 11,889 Profit recognized during support period (19X4): $ 1,270,000 x $ 100,000 = $ 100,000 1,270,000

Total profit to date $ 100,000 Less profit previously recognized 88,110 Current profit recognition $ 11,890



Schedule B: Example of Profit Calculation (Assuming Actual Rental Revenue Equals Unadjusted Projection)

360-20-55-48 The following tables illustrate profit calculation.

Example of Profit Calculation (assuming actual rental revenue equals adjusted projection)

(in thousands)

Profit Recognized in Period of Sale

Profit Recognized in Period of

Construction

Profit Recognized during Support Period

19X2 19X3 19X4 Revenues Sales Value $ 1,100 $ 1,100 $ 1,100 $ 1,100 $ 1,100 Adjusted—projected rental revenue (a)

19X2 50 50 75(b) 75(b) 75(b) 19X3 100 100 100 150(b) 150(b) 19X4 120 120 120 150(c) 151(d) 1,370 1,370 1,395 1,475 1,476 Costs Same as Schedule A 1,270 1,270 1,270 1,270 1,270 Total projected profit $ 100 $ 100 $ 125 $ 205 $ 206

(a) Two-thirds of projected revenue during periods of support of operations; this can also be calculated as projected rental expenses plus projected debt service less projected deficit cash flow.

(b) Actual rental revenue. (c) Actual rental revenue excluding amounts not needed to meet cash flow requirements of the property. (d) Because the property has attained a level of occupancy in excess of the original adjusted projection, and there is no reason to

believe that such occupancy level cannot be sustained, the projected 19X4 rental revenue should be adjusted to 19X3 actual rental revenue.

Profit to be recognized: Cost to date x projected profit Total costs

Profit recognized in period of sale: $ 237,000 x $ 100,000 = $ 18,661 1,270,000

Total profit to date $ 18,661 Less profit previously reported – Current profit recognition $ 18,661

Profit recognized in period of construction: $ 838,000 x $ 100,000 = $ 65,984 1,270,000

Total profit to date $ 65,984 Less profit previously reported 18,661 Current profit recognition $ 47,323



Profit recognized during support period (19X2): $ 968,000 x $ 125,000 = $ 95,276 1,270,000

Total profit to date $ 95,276 Less profit previously reported 65,984 Current profit recognition $ 29,292 Profit recognized during support period (19X3): $1,119,000 x $ 205,000 = $ 180,626 1,270,000

Total profit to date $ 180,626 Less profit previously reported 95,276 Current profit recognition $ 85,350 Profit recognized during support period (19X4): $ 1,270,000 x $ 206,000 = $ 206,000 1,270,000

Total profit to date $ 206,000 Less profit previously reported 180,626 Current profit recognition $ 25,374

Schedule C is included at section 5.9.3.

5.9.5 Application of the performance-of-services method when arrangement includes support versus a guarantee The use of the performance-of-services method may be required when a seller guarantees a return on a buyer’s investment for a limited period (ASC 360-20-40-41 — see section 5.8) or when a seller agrees to support (or is presumed to support) the operations of a property for a limited period (ASC 360-20-40-42 — see section 5.9). However, the timing of profit recognition under the performance-of-services method may be different if an arrangement includes a support obligation for a limited period than if the arrangement includes a guaranteed return on the buyer’s investment for a limited period because the threshold for recognizing profit is not the same. When a seller guarantees a return on the buyer’s investment for a limited period, the deposit method must be applied until actual operations of the property cover all operating expenses, debt service, and contractual payments. If a seller provides support for a limited period, the seller is permitted to begin recognizing profit when there is a reasonable assurance that future rent receipts will cover operating expenses, debt service, and contractual payments.

Because of the higher threshold for recognizing profit when a seller has guaranteed a return on the buyer’s investment for a limited period, the seller will not recognize any profit at the date of sale unless the amount of such guarantee is contractually limited in accordance with ASC 360-20-40-37 (see section 5.5) or the property sold is already operating (i.e., current operations of the property already cover current operating expenses and project debt service and contractual payments). Alternatively, if the seller only agrees to support the operations of the property for a limited period of time, it may be possible for the seller to recognize profit before the property begins operations if there is reasonable assurance that future rent receipts will cover future expenses.



Illustration 5-7: Guaranteed return on buyer’s investment

Facts:

On 31 December 20X0, Company A sells a newly constructed apartment building (including the land on which the building is located) with a cost of $1,200,000 to Company B for $2,000,000. There is no debt on the property. Company A guarantees that Company B will earn a profit of 10-percent per year for the next three years. The sale meets all of the other criteria for recognizing profit under the full accrual method and the seller has no other continuing involvement in the property.

Actual results of the property for the first two years (20X1 and 20X2) are as follows:

20X1 20X2

Revenue $ 180,000 $ 300,000

Operating expenses and debt service (200,000) (260,000)

Profit (deficit) (20,000) 40,000

Guaranteed profit (10%) 18,000 30,000

Difference $ (38,000) $ 10,000

Results for the third year of operations are projected to be at least as favorable as in 20X2.

Analysis:

Total profit on the transaction is calculated as follows:

Revenues Sales value $ 2,000,000 Operating revenue

20X1 180,000 20X2 290,000* 20X3 290,000*

2,760,000 Costs

Cost of property 1,200,000 Operating expenses, debt service, and guaranteed return

20X1 218,000 20X2 290,000 20X3 290,000 1,998,000

Total projected profit $ 762,000

* Excludes amounts not needed to meet guarantee requirements.

Because Company A has guaranteed a return on Company B’s investment, the deposit method should be applied to this transaction until 20X2 when operations of the property cover all operating expenses, debt service, and contractual payments. At that time, profit should be recognized using the performance-of-services method. In 20X2, Company A may recognize $651,400 in profit ($1,708,000 costs to-date/$1,998,000 projected costs X $762,000 projected profit). In 20X3, Company A would recognize the remaining deferred profit of $110,600.



Illustration 5-8: Support obligation

Facts:

Assume the same facts as in Illustration 5-7, except that instead of guaranteeing that Company B will earn profit of 10 percent for the first three years of operations, Company A guarantees the cash flows of the property will be sufficient to meet all operating needs of the property for the first three years of operations.

Company A has completed an extensive market research and feasibility study analyzing its cost estimates, the rent-up incubation period, and subsequent rent levels. Based on this market analysis, the projected results are as follows (except for 20X1 rental revenue, which is based on actual signed leases):

20X1 20X2 20X3

Rental revenue $ 180,000 $ 300,000 $ 300,000

Operating expenses and debt service (200,000) (260,000) (260,000)

Anticipated net surplus (deficit) in cash flow $ (20,000) $ 40,000 $ 40,000

Initial cost estimates by Company A on previous projects have never varied from final costs by more than one-half of one percent of total costs.

Actual results equal unadjusted projected results (i.e., before the safety factor adjustment) in all three years.

Analysis:

Company A’s extensive market research and feasibility study provides reasonable assurance that rent revenue from the project will be sufficient to cover operating expenses and debt service over the life of the project. Therefore, Company A may begin recognizing profit in accordance with the performance-of-services method at the date of sale. In calculating the profit to recognize each period, Company A must estimate the amount of support that will be required over the support period by comparing projected rental revenue to projected operating expenses and debt service. The projected rental revenue must be reduced by a safety factor of one-third unless that amount is less than actual signed leases. The calculation of the anticipated net deficit over the three-year support period is as follows:

20X1 20X2 20X3

Operating expenses and debt service $ 200,000 $ 260,000 $ 260,000

Rental revenue (180,000) (300,000) (300,000)

Anticipated net deficit (surplus) in cash flow 20,000 (40,000) (40,000)

Safety factor of 1/3 of rental revenue N/A* 100,000 100,000

Adjusted anticipated net deficit (surplus) $ 20,000 $ 60,000 $ 60,000

* $180,000 equals rents to be received from signed leases. As such, no safety factor is needed.



Company A’s total profit on the transaction as of the date of sale is calculated as follows:

Revenues Sales value $ 2,000,000 Projected operating revenue

20X1 180,000 20X2 200,000* 20X3 200,000*

2,580,000 Costs

Cost of property 1,200,000 Operating expenses, debt service, and guaranteed return

20X1 200,000 20X2 260,000 20X3 260,000 1,920,000


* Projected revenue of $300,000 less $100,000 safety factor.

At the date of sale, Company A may recognize $412,500 in profit ($1,200,000 costs to-date/$1,920,000 projected costs X $660,000 projected profit). In 20X1, Company A would recognize $68,750 in profit ($200,000 current costs/$1,920,000 projected costs X $660,000 projected profit).

In 20X2 and 20X3, because the actual results were equal to the unadjusted projected results, and not the projected results less a safety factor, Company A must recalculate total profit as follows:

Revenues Sales value $ 2,000,000 Operating revenue

20X1 180,000 20X2 260,000* 20X3 260,000*

2,700,000

* Actual rental revenue excluding amounts not needed to meet cash flow requirements of the property.

Costs Cost of property 1,200,000 Operating expenses and debt service

20X1 200,000 20X2 260,000 20X3 260,000 1,920,000


The cumulative profit to be recognized through the end of 20X2 would be $674,375 ($1,660,000 costs to-date/$1,920,000 projected costs X $780,000 projected profit). Because $481,250 was recognized in 20X1, $193,125 would be recognized in 20X2. In 20X3, Company A would recognize the remaining deferred profit of $105,625.



5.10 Requirement to provide management services without compensation or at compensation less than market rates A seller may agree to provide management services to a buyer for no additional charge or at a rate that is less than the prevailing market rate. Pursuant to ASC 360-20-40-43(d), in such situations, the seller should impute compensation for the services to be performed and recognize that amount over the term of the management contract (see section 5.9). The seller should exclude the amount allocated to management services from the sales value and the initial and continuing investments when performing the initial and continuing investment tests. ASC 360-20-40-8 indicates that the net present value of services that the seller commits to perform without compensation or the net present value of the services in excess of the compensation that will be received must be subtracted from the stated sales price in calculating the sales value of a transaction (see section 2.3). Therefore, if the management services fee is included in the buyer’s initial investment, the seller should consider the need to discount the amount deferred and accrete the discount as interest over the service period. However, in practice, most companies do not discount the amount deferred because they analogize to the accounting for prepaid service contracts and leases. By not discounting the services more profit is deferred at the time of sale and recognized as the management services are performed.

Illustration 5-9: Accounting for an obligation to provide services

Facts:

Hotel Company sells a hotel with a carrying amount of $1,500,000 for $2,000,000. Hotel Company agrees to manage the property for three years at no cost to the buyer. The prevailing rate for such services is $100,000 per year and the market rate of interest is 10 percent. Cash flows from the property are currently sufficient to service all indebtedness on the property.

Analysis:

Hotel Company should impute compensation for the management services to be performed and recognize that amount over the term of the management contract. The present value of $100,000 per year for three years, discounted at 10 percent, is $248,695. If all other criteria for recognizing profit under the full accrual method are satisfied, Hotel Company may recognize profit of $251,315 ($2,000,000 sales price — $1,500,000 carrying amount — $248,695 discounted management fee) at the time of sale.

In assessing whether the minimum initial investment test has been satisfied, the amount allocated to management services should be excluded from the sales value. Therefore, the minimum initial investment would be $262,697 (($2,000,000 sales price — $248,695 discounted management fee) X 15 percent minimum investment percentage required for other income-producing properties when cash flows are currently sufficient to service all indebtedness- see section 3.4.1). In order to satisfy the initial and continuing investment tests, either the initial down payment must be at least $511,392 ($262,697 minimum initial investment plus $248,695 for prepaid management fees) or the initial down payment must be at least $262,697 and the periodic payments received in the first three years must be sufficient to cover both the level annual payment required under the continuing investment test and fees allocated to the management services.

As discussed in section 5.9.1, if a seller agrees to manage property for a buyer on terms that are not usual for the services being rendered (e.g., the seller will not be paid for any management services unless profitability reaches a certain threshold) and the agreement cannot be terminated by either the seller or the buyer, the transaction includes implied support and should be accounted for in accordance with ASC 360-20-40-43 (see section 5.9).



5.11 Transaction is merely an option to purchase Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-45 The transaction may be merely an option to purchase the property. For example, undeveloped land may be sold under terms that call for a very small initial investment by the buyer (substantially less than the percentages specified in paragraph 360-20-55-2) and postponement of additional payments until the buyer obtains zoning changes or building permits or other contingencies specified in the sales agreement are satisfactorily resolved. Proceeds from the issuance of the option by a property owner shall be accounted for as a deposit (see paragraphs 360-20-55-17 through 55-20). Profit shall not be recognized until the option either expires or is exercised. When an option to purchase real estate is sold by an option holder, the seller of the option shall recognize income by the cost recovery method (see paragraphs 360-20-55-13 through 55-15) to the extent nonrefundable cash proceeds exceed the seller’s cost of the option if the buyer’s initial and continuing investments are not adequate for profit recognition by the full accrual method (see paragraphs 360-20-40-8 through 40-24). When an option to purchase real estate is sold by an option holder, the sales value includes the exercise price of the option and the sales price of the option. For example, if the option is sold for $150,000 ($50,000 cash and a $100,000 note) and the exercise price is $500,000, the sales value is $650,000.

If a property owner enters into an arrangement to sell an option in the property, the arrangement should be treated as a deposit until the option expires or is exercised. Sale or profit recognition on such a transaction is not appropriate, even if the payment received from the buyer satisfies the initial investment test. Additionally, even if a transaction meets the legal definition of a sale, the buyer’s initial investment may be so low that the transaction is, in substance, the sale of an option. For example, if a buyer makes a 3 percent down payment to purchase land that requires a minimum initial investment of 25 percent (see section 3.4.1 for minimum investment table), the transaction may be in substance the sale of an option. Such a payment should be accounted for as a deposit. In the future, if the buyer makes sufficient additional payments to demonstrate that the transaction is the sale of property and not just the sale of an option, it may be appropriate for the seller to account for the transaction using the installment or cost recovery method at that time (see section 3.4 for additional information).

5.11.1 Sale of an option by an option holder The sale of an option by an option holder that is not the owner of the property is a sale of an interest in real estate and the seller should recognize profit under the full accrual method if all of the criteria for recognizing profit under the full accrual method have been satisfied. As discussed in section 2.3.7, the seller must consider both the sales price and the exercise price of the option in determining the sales value used in the initial and continuing investment tests (i.e., the buyer’s initial and continuing investments, to the extent applicable, should be based on the total amount that must be paid to acquire the property). If the initial and continuing investment tests are not satisfied, to the extent nonrefundable cash proceeds exceed the seller’s cost of the option, the seller may recognize income using the cost recovery method.



Illustration 5-10: Sale of an option by an option holder

Facts:

Company A paid $25,000 for a transferable option to purchase land held for commercial development for an additional $500,000 from Company X. Company X is the owner of the land. Company A sells its option to Company B for $100,000 ($50,000 cash and a note for $50,000). Development of the land is not expected to commence for more than two years.

Analysis:

Company A may recognize profit on the sale of the option to Company B if all of the criteria for recognizing profit under the full accrual method are satisfied. The sales value used to calculate the adequacy of the initial and continuing investments is the sales price of the option ($100,000) plus the exercise price of the option ($500,000), or $600,000. Because the minimum initial investment is 20 percent of the sales value (see section 3.4 for initial investment requirement) and the initial investment is only 8.3 percent of the sales value ($50,000 down payment/$600,000 sales value), the initial investment test is not satisfied. However, because the cash proceeds received ($50,000) exceed Company A’s cost of the option ($25,000), Company A may recognize profit of $25,000 under the cost recovery method.

5.12 Partial sales of real estate Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-46 A sale is a partial sale if the seller retains an equity interest in the property or has an equity interest in the buyer. Profit (the difference between the sales value and the proportionate cost of the partial interest sold) shall be recognized at the date of sale if all of the following conditions are met:

a. The buyer is independent of the seller.

b. Collection of the sales price is reasonably assured (see paragraph 360-20-40-4).

c. The seller will not be required to support the operations of the property or its related obligations to an extent greater than its proportionate interest.

360-20-40-47 If the buyer is not independent of the seller, for example, if the seller holds or acquires an equity interest in the buyer, the seller shall recognize the part of the profit proportionate to the outside interests in the buyer at the date of sale. If the seller controls the buyer, no profit on the sale shall be recognized until it is realized from transactions with outside parties through sale or operations of the property.

360-20-40-48 If collection of the sales price is not reasonably assured, the cost recovery or installment method of recognizing profit shall be used.



360-20-40-49 If the seller is required to support the operations of the property after the sale, the accounting shall be based on the nature of the support obligation. For example, the seller may retain an interest in the property sold and the buyer may receive preferences as to profits, cash flows, return on investment, and so forth. If the transaction is in substance a sale, the seller shall recognize profit to the extent that proceeds from the sale, including receivables from the buyer, exceed all of the seller’s costs related to the entire property. Other examples of support obligations are described in paragraphs 360-20-40-42 through 40-43.

A seller has made a partial sale of real estate if the seller retains an equity interest in the property or has an equity interest in the buyer. Because the seller retains an interest in the property either directly or indirectly through its interest in the buyer, partial sales of real estate by their nature, involve continuing involvement by the seller (in this case, continued ownership interest in the property). If all other requirements for recognizing profit under the full accrual method have been satisfied (see section 2.1) and no other forms of continuing involvement are present, a seller may recognize profit on the partial sale of real estate at the date of a sale if the following conditions are met:

• The buyer is independent of the seller

• The seller will not be required to support the operations of the property or its related obligations to an extent greater than the seller’s proportionate retained interest

Buyer independent of seller

If the buyer is not independent of the seller, which will always be the case if the seller has an equity interest in the buyer, the seller may recognize profit proportionate to the outside interest in the buyer, unless the seller controls the buyer. If the seller controls (i.e., consolidates) the buyer, no profit should be recognized at the date of sale. Instead, profit will be realized by the seller either when the property is sold to a third party or though the operations of the property. A seller is deemed to control a buyer if the seller consolidates the buyer in accordance with the requirements of ASC 810, Consolidation.

Obligation to support

If a transaction gives a buyer preference as to profits or cash flows, the seller should only recognize profit to the extent that proceeds from the sale, including receivables from the buyer, exceed all of the seller’s costs related to the entire property, not just the cost associated with the portion sold. The preference given to a buyer may relate to the timing (e.g., buyer receives first 10 percent of profits, but over the life of the venture it is expected that distributions will be equal) or amount (e.g., buyer receives 75 percent and seller receives 25 percent in a 50/50 venture) of profits or cash flows. We believe the requirement to include the costs related to the entire property in the profit calculation applies regardless of the significance or nature (i.e., timing or amount) of the preference given to the buyer.

Illustration 5-11: Sale of interest in subsidiary

Facts:

Company A sells an 80 percent interest in a wholly owned subsidiary that holds one hotel with a carrying amount of $1,000,000 to Company B for $2,400,000 in cash. Company B is independent of Company A and each company will share in the costs and profits of the subsidiary based on its proportionate interest. Except for Company A’s continuing involvement in the property, all other criteria for recognizing revenue under the full accrual method have been satisfied.



Analysis:

Company A may recognize $1,600,000 ($2,400,000 sales price—80 percent of the total cost, or $800,000) in profit at the time of sale. Company A would record the following journal entry to account for this transaction:

Cash $ 2,400,000 Equity Investment 200,000

Land $ 1,000,000 Gain on Sale 1,600,000

Illustration 5-12: Seller consolidates buyer

Facts:

Company A contributes land to a venture with a fair value of $2,000,000 (cost basis $900,000). Company B contributes cash in the amount of $1,000,000, which is immediately withdrawn by Company A. Each investor has a 50 percent interest in the venture and shares equally in the profits and losses of the venture. Company A is independent of Company B. Except for Company A’s continuing ownership interest in the property, all other criteria for recognizing revenue under the full accrual method have been satisfied. Company A consolidates the venture under ASC 810 for reasons not specified in this example for simplicity purposes.

Analysis:

Because Company A controls the buyer of the property, no profit should be recognized by Company A at the date of sale. Company A will realize profit associated with this transaction when the property is sold to an outside party or through the operations of the property.

Illustration 5-13: Seller has noncontrolling interest in buyer

Facts:

Assume the same facts as in Illustration 5-12, except that Company A does not control the venture.

Analysis:

Because Company A does not control the venture and is independent of Company B, Company A should recognize the portion of the profit that relates to Company B’s interest in the buyer at the date of sale. That is, Company A has sold a 50 percent interest in the property for $1,000,000 and should recognize profit of $550,000 ($1,000,000 selling price — $450,000 cost). Company A will realize profit associated with its retained interest in the property when the property is sold to an outside party or through the operations of the property. Company A would record the following journal entry to account for this transaction:

Cash $ 1,000,000

Equity Investment 450,000

Land $ 900,000

Gain on Sale 550,000



Illustration 5-14: Seller retains interest in property with disproportionate sharing of costs and profit

Facts:

Assume the same facts as in Illustration 5-13 above, except that Company B will receive a priority return until achieving a 16 percent internal rate of return. Company A will then receive a priority return until it also achieves a cumulative 16 percent return, after which Company A and Company B will share equally in all future returns.

Analysis:

Company A may only recognize profit to the extent that the sales price ($1,000,000) exceeds its cost in the entire property ($900,000). Therefore, Company A may only recognize $100,000 in profit at the time of sale. Any additional profit will be recognized when the property is sold to an outside party or through the operations of the property. Company A would record the following journal entry to account for this transaction:

Cash $ 1,000,000

Equity investment 0

Land $ 900,000

Gain on sale 100,000

However, if Company A received only $800,000 in proceeds from the sale, such proceeds from the sale do not exceed all of Company A’s cost related to the entire property. Company A would record the following journal entry to account for this transaction:

Cash $ 800,000

Equity investment 100,000

Land $ 900,000

The entries in the illustrative examples above represent acceptable methods to account for each scenario involving a partial sale of real estate with disproportionate sharing of costs and profits.

5.13 Condominium sales Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales


360-20-15-9 The guidance in paragraphs 360-20-40-50 through 40-55 applies only to individual units in a condominium project or time-sharing interests being sold separately.



Derecognition

360-20-40-50 The following guidance through paragraph 360-20-40-55 is limited to the sale of individual units in a condominium project. A condominium project may be a building, a group of buildings, or a complete project. If individual units in condominium projects or time-sharing interests are being sold separately and all the following criteria are met, profit shall be recognized by the percentage-of-completion method on the sale of individual units or interests:

a. Construction is beyond a preliminary stage. Construction is not beyond a preliminary stage if engineering and design work, execution of construction contracts, site clearance and preparation, excavation, and completion of the building foundation are incomplete.

b. The buyer is committed to the extent of being unable to require a refund except for nondelivery of the unit or interest. The buyer may be able to require a refund, for example, if a minimum status of completion of the project is required by state law and that status has not been attained; if state law requires that a declaration of condominium be filed and it has not been filed, except that in some states the filing of the declaration is a routine matter and the lack of such filing may not make the sales contract voidable; if the sales contract provides that permanent financing at an acceptable cost must be available to the buyer at the time of closing and it is not available; or if the condominium units must be registered with either the Office of Interstate Land Sales Registration of the Department of Housing and Urban Development or the Securities and Exchange Commission (SEC), and they are not so registered.

c. Sufficient units have already been sold to assure that the entire property will not revert to rental property. In determining whether this condition has been met, the seller shall consider the requirements of state laws, the condominium or time-sharing contract, and the terms of the financing agreements.

d. Sales prices are collectible (see paragraph 360-20-40-4).

e. Aggregate sales proceeds and costs can be reasonably estimated. Consideration shall be given to sales volume, trends of unit prices, demand for the units including seasonal factors, developer’s experience, geographical location, and environmental factors.

360-20-40-51 In assessing the collectibility of the sales price pursuant to paragraph 360-20-40-50(d), an entity should evaluate the adequacy of the buyer’s initial and continuing investment to conclude that the sales price is collectible.

360-20-40-52 Consistent with the requirements for sales of other types of real estate, the buyer’s initial and continuing investments shall be in any of the forms specified in paragraph 360-20-40-10 and shall consider only the nonrefundable portion of such investments.

360-20-40-53 An entity can meet the continuing investment criterion in paragraphs 360-20-40-19 through 40-20 by requiring the buyer to do either of the following:

a. Make additional payments during the construction term at least equal to the level annual payments that would be required to fund principal and interest on an amortizing customary mortgage for the remaining purchase price of the property (excess of the purchase price over the initial investment by the buyer).

b. Increase the minimum initial investment by an equivalent aggregate amount.



The remaining purchase price should be determined based on the sales price of the property. The test shall be performed using a hypothetical loan between the seller and the buyer for the amount of the purchase price less the buyer’s initial investment.

360-20-40-54 If an entity is unable to meet the criteria in paragraph 360-20-40-50, including an assessment of collectibility using the initial and continuing investment tests described in paragraphs 360-20-40-9 through 40-20, then the entity should apply the deposit method as described in paragraphs 360-20-55-17 through 55-20 until the criteria in paragraph 360-20-40-50 are met.

360-20-40-55 On a reassessment date, an entity should reassess all of the criteria in paragraph 360-20-40-50 to determine whether profit should be recognized under the percentage-of-completion method. In reassessing the collectibility of the sales price, the initial and continuing investment tests should be applied prospectively from the reassessment date (as if the deposit was received on the reassessment date).

A condominium sale is considered a partial sale of real estate, in that the seller is conveying to the buyer a portion (i.e., the condominium interest) of the real estate (i.e., the condominium project). Partial sales of real estate by their nature include continuing involvement by the seller. Despite the seller’s continuing involvement, ASC 360-20-40-50 requires recognition of profit by the percentage-of-completion method if certain conditions are met. The use of the percentage-of-completion method for long-term construction projects is not an accounting policy election. That is, the use of this method is required when the criteria in ASC 360-20-40-50 are met.

ASC 360-20-40-50 notes that a condominium project may be a building, a group of buildings, or a complete project. The AICPA Audit and Accounting Guide, Common Interest Realty Associations, defines a condominium as a legal form of ownership in which each owner has title to a defined interior space within a building or combination of buildings and an undivided ownership interest in common property within a development, such as the grounds, recreational facilities, and exteriors of buildings shared in common with all other owners. The definition of a condominium may vary by locality and in some cases may include both attached and detached units.

Additionally, a condominium project may include the renovation of a preexisting structure (i.e., a hotel) for subsequent sale as condominium interests. In some cases, only a portion of the structure is converted to condominiums (i.e., a portion of a hotel converted to condominiums and the remainder continues to function as a hotel). The sale of these converted condominium interests are also subject to ASC 360-20-40-50.

If a sale of a condominium interest does not satisfy all of the conditions in ASC 360-20-40-50, the seller should apply the deposit method until such time as all of the criteria are satisfied. These criteria may not always be satisfied on the closing of individual condominium units. For example, if only a small number of units have been sold, the seller may not have sold a sufficient number of units to assure the entire property will not revert to rental property. In these situations, the seller should not recognize profit on the sale of an individual unit (i.e., the seller should continue to apply the deposit method), even if the unit has closed and all of the proceeds due from the buyer of the unit have been received.

5.13.1 Construction is beyond a preliminary stage Construction is beyond a preliminary stage after all of the following have been completed:

• Engineering and design work

• Execution of construction contracts



• Site clearance and preparation

• Excavation

• Building foundation

Any payments received prior to the completion of all of the above items should be accounted for as deposits.

5.13.2 Refund requirement If a buyer’s investment is refundable, the seller should not recognize any profit on the transaction, unless the refund right only applies if the seller does not deliver the unit. A seller should analyze the sales contract, the terms of any seller financing, and applicable state and/or federal laws to determine whether a buyer has the ability to require a refund. Indicators that a buyer has the ability to require a refund from the seller may include, but are not limited to, the following:

• A state requirement that a minimum status of completion on the project be met.

• A state requirement that a “declaration of condominium” be filed. (Although, in some states the filing of the declaration is routine and the lack of such filing may not make the contract voidable.)

• A provision in the sales contract requiring that permanent financing at an acceptable cost be available to the buyer at the time of closing.

• A requirement to register the condominium unit with either the Office of Interstate Land Sales Registration of the Department of Housing and Urban Development or the Securities and Exchange Commission.

5.13.3 Reversion to rental property A seller of condominium interests should not recognize any profit on a condominium project until sufficient units have been sold to assure the entire property will not revert to rental property. The seller should consider its historic experience with similar projects and the current economic environment in determining how many units must be sold to assure the property will not revert to rental property. The seller should also analyze the sales contract, the terms of any seller financing, and applicable state and/or federal laws. For example, if the provisions of the sales contract specify that under no condition may the property revert to a rental property, it may be possible to recognize profit on the first unit sold using the percentage-of-completion method.

5.13.4 Collectibility The reference to the adequacy of the buyer’s initial and continuing investment in paragraph ASC 360-20-40-5 (see section 2.1) is in the context of post-sale seller financing (e.g., a seller finances a first mortgage for a condominium buyer through its mortgage subsidiary). However, ASC 360-20-40-50 also requires the seller to assess collectibility during the construction period. ASC 360-20-40-51 to 40-53 provide guidance on assessing collectibility and applying the initial and continuing investment tests to condominium sales during the construction period (see Chapter 3 for additional guidance on applying the initial and continuing investment tests and section 5.13 for excerpts of referenced paragraphs).

A buyer’s continuing investment is considered adequate when the buyer is contractually required to make payments each year that are at least equal to the level annual payments necessary to repay the total debt and interest on the property over no more than the customary amortization term of a first mortgage loan by an independent established lending institution. Because condominium buyers generally are required to pay the balance due on a condominium on closing, contracts entered into within one year



of closing will often satisfy the continuing investment test (i.e., the buyer must at least make payments of principal and interest on a customary mortgage during the year, but instead is contractually required to pay the entire balance due). ASC 360-20-40-24 states that the tests of the buyer’s initial and continuing investment should be applied cumulatively when the sale is consummated and annually afterward (see section 3.7). However, ASC 360-20-40-55 states that a seller should reassess all criteria prospectively from the reassessment date, as if the deposit was received on the reassessment date (see section 5.13). This requirement leads to a difference in the accounting for condominium sales and all other real estate sales, in that performing the assessment prospectively results in a condominium sale often meeting the continuing investment test solely through the passage of time. Because condominium buyers are generally required to pay the balance due on a condominium on closing, when the reassessment is performed prospectively, contracts will automatically satisfy the continuing investment test when there is less than one year until closing.

Illustration 5-15: Project expected to be completed within one year

Facts:

A condominium project commences on 1 March 20X6 and is expected to be completed on 15 January 20X7. The condominium developer has a history of meeting the expected completion date. One of the condominiums is sold on 20 April 20X6, and the buyer, who will be using the property as a primary residence, makes a non-refundable five percent down payment.

Analysis:

The initial and continuing investment criteria are met by the non-refundable down payment. The down payment is the minimum percentage required in ASC 360-20-55-2 (see section 3.4.1), and no additional payment is required under the continuing investment test because the non-refundable down payment was made within one year of the completion of the condominium. Presuming all other criteria in ASC 360-20-40-5 and ASC 360-20-40-50 are met, the developer should recognize the condominium profit based on the percentage-of-completion method.

Illustration 5-16: Project expected to take more than one year to complete

Facts:

Assume the same facts as in Illustration 5-15, except the condominium project is expected to be completed by the end of June 20X9.

Analysis:

The initial investment criterion is met by the down payment. Absent the buyer paying an additional non-refundable amount equal to the level annual payment to fund principal and interest on or before 20 April of each of the subsequent years, the continuing investment criterion is not met, and as a result, the seller is unable to support collectibility on 20 April 20X6. Despite meeting all other criteria of ASC 360-20-40-5 and ASC 360-20-40-50, until the buyer meets the continuing investment criterion, the developer should apply the deposit method and not the percentage-of-completion method to the sale of the condominium. The developer should reassess the buyer’s continuing investment prospectively, as if the deposit was received on the reassessment date. Therefore, in July 20X8, the continuing investment test is satisfied because the transaction will close and the balance due will be paid in full within one year. At that time, the developer should begin recognizing the condominium profit based on the percentage-of-completion method, assuming market conditions are such that the buyer is expected to close and all amounts are collectible.



The continuing investment test also may be met solely through a non-refundable down payment, if the size of the non-refundable down payment is sufficient to cover the initial investment test and the level annual payments to fund principal and interest.

Illustration 5-17: Initial investment is in excess of minimum requirement

Facts:

Assume the same facts as in Illustration 5-15, except the condominium project is expected to be completed at the end of June 20X9 and the buyer makes a non-refundable down payment of $70,000. The sales value of this condominium is $300,000. The required level annual payment, as described in ASC 360-20-40-19 (see section 3.5), is approximately $16,000 (principal and interest based on a 30-year amortization).

Analysis:

Both the initial investment and the continuing investment criteria are met by the non-refundable down payment. The down payment exceeds the minimum of 5 percent required in ASC 360-20-55-2 (see section 3.4.1). The amount of the non-refundable down payment that remains after the initial investment criterion is met, $55,000 ($70,000 less the minimum required 5 percent initial investment of $15,000), exceeds the level annual payments, $16,000, that must be made on or before 20 April of each of the subsequent three years. That is, the $55,000 available exceeds the continuing investment requirement of $48,000.

Illustration 5-18: Excess initial investment is not adequate to cover continuing investment on

date of sale

Facts:

Assume the same facts as in Illustration 5-17, except the down payment was only $60,000.

Analysis:

The continuing investment test would not be satisfied as of the date of sale. However, as ASC 360-20-40-53 requires prospective reassessment of the continuing investment, the continuing investment test would be satisfied in July 20X6 because only two level payments of $16,000 would be required before the balance would be paid in full.

ASC 360-20-40-50 presumes that the requirements for recognizing a sale in accordance with the full accrual method (see section 2.1) will be met at closing after construction is complete. If a seller provides or anticipates providing post-closing financing to the buyer of a condominium unit, the seller must assess such financing for compliance with the initial and continuing investment requirements in ASC 360-20-40-9 through 40-24 (see Chapter 3). If the post-closing financing does not meet the initial and continuing investment requirements, the seller should apply the deposit method until closing. After closing, the seller may recognize profit in accordance with the installment, cost recovery, or reduced-profit method, assuming all other criteria for recognizing profit under the full accrual method are satisfied (see section 5.2.1 for guidance on determining which method to apply).

The qualitative factors described in ASC 360-20-40-4 (e.g., credit standing of buyer and adequacy of cash flow from the property) should be reassessed throughout the construction process (see section 2.1). If the percentage-of-completion method is being applied and circumstances change that would indicate that the collectibility of the sales price is not reasonably assured, the percentage-of-completion method should be discontinued and any previously recognized profit should be evaluated for realizability based on an evaluation of collectibility and impairment of the project.



5.13.5 Aggregate proceeds and costs can be reasonably estimated A seller should not recognize any profit under the percentage-of-completion method until the aggregate sales proceeds and costs of the entire condominium project can be reasonably estimated. The seller’s history of developing and selling condominium projects within the same geographic area, the sales volume of condominiums within the condominium project, and the sales trends of those condominiums, as well as other factors that may affect an individual unit’s sales price should all be considered in determining whether the seller has the ability to reasonably estimate the aggregate sales proceeds and costs of a condominium project.

Condominiums within the same condominium project are often not considered homogeneous. That is, some units may be more desirable than other units (i.e., certain units may be larger and/or better placed within the condominium project, resulting in different selling prices, often disproportionate to costs). In determining the aggregate sales proceeds of a condominium project, a seller should consider the discount or premium for each unit. If a seller is required to discount units that are sold later in a project, any change in the estimated sales proceeds may affect the percentage-of-completion calculation and the seller’s ability to reasonably estimate the sales proceeds.

A seller must also have the ability to reasonably estimate the costs of a condominium project to apply the percentage-of-completion method. Developer incentives, including upgrades and payment of condominium association dues and assessments, are considered costs of a condominium project and must be reasonably estimable before the percentage-of-completion method may be applied.

A seller should assess its ability to estimate sales proceeds and costs throughout a condominium project, even after the criteria in ASC 360-20-40-50 (see section 5.13) have been initially satisfied. The fact that estimates may require revisions does not necessarily indicate that aggregate sales proceeds and costs cannot be reasonably estimated. However, if changes, such as a rapid decline in the market, indicate that a seller is no longer able to estimate the sales proceeds or costs of a condominium project (e.g., additional incentives will be required, the amount of which cannot be estimated), the developer should no longer apply the percentage-of-completion method and any previously recognized profit should be evaluated for realizability based on an evaluation of collectibility and impairment of the project.

5.13.6 Application of the percentage-of-completion method to a condominium project If individual units in condominium projects are being sold separately (versus a sale of the entire project to one buyer) and all the criteria in ASC 360-20-40-5 (see section 2.1) and ASC 360-20-40-50 (see section 5.13) are met, profit should be recognized using the percentage-of-completion method. Each unit in the project must be separately evaluated to determine whether the sale of the unit meets the criteria for recognizing profit using the percentage-of-completion method. Differences in sales terms (e.g., the required down payment), the buyers’ intended use of the unit (i.e., primary versus secondary residence), or the buyers’ credit status may result in a seller applying the percentage-of-completion method to some units and the deposit method to other units within the same project.

Although it may not be appropriate to apply the percentage-of-completion method to each unit in a condominium project, it is necessary for a seller to consider the costs and selling price of the entire condominium project in determining the appropriate profit to allocate to each unit. The Real Estate Project Costs Subsections of ASC 970, provide guidance on allocating capitalized costs to the components of a real estate project as follows:



Excerpt from Accounting Standards Codification Real Estate — General — Property, Plant, and Equipment

Initial Measurement

970-360-30-1 The capitalized costs of real estate projects shall be assigned to individual components of the project based on specific identification. If specific identification is not practicable, capitalized costs shall be allocated as follows:

a. Land cost and all other common costs including the costs of amenities to be allocated as common costs per paragraphs 970-340-25-9 through 25-11 (before construction), shall be allocated to each land parcel benefited. Allocation shall be based on the relative fair value before construction.

b. Construction costs shall be allocated to individual units in the phase on the basis of relative sales value of each unit.

If allocation based on relative value also is impracticable, capitalized costs shall be allocated based on area methods (for example, square footage) or other value methods as appropriate under the circumstances.

Illustration 5-19: Percentage of completion method applied to a condominium project

Facts:

A condominium developer is in the process of developing a condominium building with nine units, eight regular units and a penthouse. The sales price for the regular units is $100,000 each and the sales price for the penthouse is $200,000. As of 28 February 20X6, construction is beyond a preliminary stage, sufficient units have already been sold to assure the entire property will not revert to rental property, and the aggregate sales proceeds and costs of the project can be reasonably estimated.

On 1 March 20X6, the condominium developer enters into two separate arrangements to sell one regular unit and the penthouse. The buyers’ down payments are non-refundable, the receivables from the buyers are not subject to future subordination, and except for the lack of a certificate of occupancy, the sales are considered to be consummated. The down payment received for the regular unit is sufficient to meet the initial and continuing investment requirements. The down payment for the penthouse is 7 percent of the selling price, which is not sufficient to meet the initial investment requirement, because the buyer plans to use the unit as a secondary residence.

Specific identification of costs associated with each condominium unit is not practicable. Construction costs are estimated to be $600,000 for the entire project. For simplicity purposes, assume there are no land or common costs associated with the project. As of 31 March 20X6, the entire project is estimated to be 50 percent complete.

Costs are allocated to the individual condominium units based on the relative sales value of each unit. The penthouse represents 20 percent of the total sales value of the project and all other units represent 10 percent of the sales value. Therefore, $120,000 ($600,000 total costs X 20 percent) is allocated to the penthouse and $60,000 ($600,000 total cost X 10 percent) is allocated to all other units. Profit on the penthouse is $80,000 ($200,000 selling price — $120,000 allocated costs) and profit on all other units is $40,000 ($100,000 selling price — $60,000 allocated costs).



Analysis:

On 31 March 20X6, the condominium developer should recognize $20,000 in profit associated with the sale of the regular condominium unit ($40,000 total profit X 50 percent complete). Because the initial investment test has not been satisfied for the penthouse, no sale should be recorded and any funds received from the buyer should be accounted for as deposits until all of the criteria in ASC 360-20-40-50 are met.

5.13.7 Applicability of the percentage-of-completion method to condominium sales When all the criteria in ASC 360-20-40-50 are satisfied, ASC 360-20-40-50 indicates that the percentage-of-completion method of profit recognition should be applied (see section 5.13). However, the criteria for recognizing profit under the full accrual method in ASC 360-20-40-5 (see Chapter 2) must also be satisfied. Because ASC 360-20-40-28 notes that “because of the length of construction period of office buildings, apartments, condominiums, shopping centers, and similar structures, such sales and the related income may be recognized during the process of construction…” (see section 2.2.2 and section 5.1), some believe the application of the percentage-of-completion method is not required, but is an election.

While we believe it is preferable to apply the percentage-of-completion method to all sales of condominiums that meet the applicable requirements, we would not object to a company that consistently applies the deposit method and subsequent sale accounting upon closing (the closing method) to projects that are started and completed in a short period of time (i.e., a period formally defined by the seller and consistently applied not to exceed one year). For all long-term condominium projects (e.g., with a construction period greater than twelve months), we believe the percentage-of-completion method is required. This requirement was confirmed through a technical inquiry of the FASB staff.

5.14 Seller sells property improvements and leases the underlying land to the buyer Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-56 If the seller sells property improvements (including integral improvements) and leases the underlying land to the buyer of the improvements, the transactions are interdependent and it is impracticable to distinguish between profits on the sale of the improvements and profits under the related lease (for guidance on leases, see Topic 840). The transaction shall be accounted for as a lease of both the land and improvements if the term of the land lease to the buyer from the seller of the improvements either:

a. Does not cover substantially all of the economic life of the property improvements, thus strongly implying that the transaction is in substance a lease of both land and improvements

b. Is not for a substantial period, for example, 20 years.

360-20-40-57 If the land lease described in the preceding paragraph covers substantially all of the economic life of the improvements and extends for at least 20 years, the profit to be recognized on the sale of the improvements at the time of sale shall be the present value of the rental payments not in excess of the seller’s cost of the land plus the sales value of the improvements minus the carrying value of the improvements and the land.



360-20-40-58 The present value of the specified rental payments is the present value of the lease payments specified in the lease over the term of the primary indebtedness, if any, on the improvements, or over the customary amortization term of primary debt instruments on the type of improvements involved. The present value is computed at an interest rate appropriate for either:

a. Primary debt if the lease is not subordinated

b. Secondary debt if the lease is subordinated to loans with prior liens.

360-20-40-59 Profit on either of the following shall be recognized when the land is sold or the rents in excess of the seller’s cost of the land are accrued under the lease:

a. The buyer’s rental payments on the land in excess of the seller’s cost of the land

b. The rent to be received on the land after the maturity of the primary indebtedness on the improvements or other customary amortization term.

Calculations of profit in those circumstances are illustrated in Example 1, Cases C and D (see paragraphs 360-20-55-33 through 55-43).

Improvements, such as warehouses and office buildings, may be sold to a buyer with a concurrent lease of the land on which the improvements are located. The seller generally owns or leases the land and executes a lease or sublease with the buyer of the improvements. However, in some situations a buyer may assume a lease from a third-party lessor. As discussed in section 2.3.4, in situations where improvements are sold subject to an underlying land lease (whether or not the seller remains as the lessor), the sales value used to evaluate the adequacy of the buyer’s initial and continuing investments should include the present value of the lease payments for the land because the land lease is another form of buyer financing that must be considered in determining whether the buyer is committed to pay for the property.

When an underlying land lease is assumed by a buyer from a third-party lessor and the seller of the improvements has no obligation related to the lease, there are no limitations on the profit that may be recognized by the seller of the improvements (assuming all criteria for recognizing profit under the full accrual method have been satisfied), because the seller has no continuing involvement in the property. However, when a seller of improvements remains involved in the property by executing a lease or sublease with the buyer of the improvements for the underlying land, the sale of the improvements and lease of land are interdependent and must be evaluated together. Any losses on the sublease of the land must be recognized with any gain on the sale of the improvements.

If the term of a land lease does not cover substantially all of the economic life of the property improvements or is not for a substantial period (i.e., at least 20 years), the transaction should be accounted for as a lease of the land and improvements, and no sale should be recorded (refer to our FRD, Lease Accounting—Accounting Standards Codification 840, Leases, before the adoption of the new leases standard (ASC 842)). The land lease must meet both conditions (20 years and cover the economic life of the improvements) to qualify as a sale of the improvements. If the transaction qualifies as a sale of improvements, and not a lease, profit recognized at the time of sale should be calculated as follows: A + B — C, where:

• A = the present value of the rental payments (over the period of primary indebtedness) not in excess of the seller’s cost of the land

• B = the sales value of the improvements

• C = the carrying amount of the improvements and the land

https://www.ey.com/ul/en/accountinglink/frd-bb1793-lease-accounting




The present value of rental payments should be calculated using an interest rate that is appropriate for primary debt if the lease is not subordinated, or secondary debt if the lease is subordinated. The period used to calculate the present value of rental payments should be equal to the term of the primary indebtedness, if any, on the improvements. If there is no debt on the improvements, the seller should use a customary amortization period on primary debt for the type of improvements being sold.

This method of calculating profit limits the amount of profit the seller may recognize at the time of sale, because no consideration is given to any rental payments that are in excess of the cost of the land or that are to be made after the term of the primary indebtedness on the improvements. Therefore, profit recognized at the time of sale will never be more than the sales price of the improvements less the cost of the improvements, and will generally be less than that amount, unless the present value of the rental payments on the land over the appropriate term at least equals the cost of the land. Any profit on rental payments that are in excess of the cost of the land or that will be made after the term of the primary indebtedness will be recognized by the seller when the land is sold or as rental income in excess of the seller’s cost of the land is accrued under the lease.

ASC 360-20 provides several examples of the sale of improvements with a concurrent lease of the underlying land and the calculation of the sales value, minimum initial investment, and profit to be recognized in the period of sale. The first example, Case A, included in ASC 360-20-55-26 through 55-27, only includes a calculation of the sales value and the minimum initial investment and is included at section 2.3.4. The example in Case B below demonstrates the sale of improvements when the seller is not also the lessor of the underlying land and the examples in Cases C and D below demonstrate the sale of improvements when the seller is also the lessor of the underlying land.



360-20-55-23 Land improvements may be sold and concurrently the land under the improvements may be leased to the buyer of the improvements.

360-20-55-24 This Example illustrates the effect of loans issued in connection with long-term land leases on evaluations of the adequacy of a buyer’s initial investment if improvements on the land are sold separately. In addition, it demonstrates the limit that a lease places on profit recognition if the leased land is owned by the seller of the improvements, making the lease of land and sale of improvements interdependent transactions.

360-20-55-25 The calculations are illustrated in the following Cases:

a. Primary land lease—land owned by third party lessor—nonqualifying (Case A)

b. Primary land lease—land owned by third party lessor—qualifying (Case B)

c. Subordinated land lease—land owned by seller—qualifying (Case C)

d. Subordinated land lease—land owned by seller—nonqualifying (Case D).

[Note: Case A is included at section 2.3.4]



Case B: Primary Land Lease—Land Owned by Third Party Lessor—Qualifying

360-20-55-28 This Case has the following assumptions:

Sales price of improvements $ 875,000 Represented by proceeds of:

Cash down payment $ 165,000 Loan by insurance company: lien on leasehold improvements, 28-year term, 8 1/2%, payable in equal monthly installments of principal and interest

657,000

Note received by seller from buyer: 12-year term, 9 1/2%, payable in equal monthly installments of principal and interest

53,000

$ 875,000 Land lease for 99 years @ $17,880/year, net, payable monthly in advance



Computations:

Present value of 336 monthly payments on land lease of $1,490 discounted at 8 1/2% (interest rate on loan from insurance company): $1,490 + ($1,490 x 127.9071) $ 192,000 Loan from insurance company 657,000 Equivalent primary debt 849,000

Note receivable from buyer 53,000 Total debt or equivalent 902,000

Down payment 165,000 Sales value $ 1,067,000

360-20-55-29 Because 15% of the sales value of the improvements is $160,050, the initial investment of $165,000 (15% of the sales value) is adequate to recognize profit on the sale of improvements. However, the second test must also be applied.

360-20-55-30 The initial investment required by the second test is as follows.

Sales value $ 1,067,000 115% of $849,000 (loan from primary lender) 976,350 $ 90,650

360-20-55-31 The initial investment of $165,000 exceeds the amount required, so recognition of profit on sale of improvements is appropriate. The second test may alternatively be applied as the ratio of total debt or equivalent to the equivalent primary debt: $902,000/$849,000 = 106%. Because 106% is less than 115%, the initial investment exceeds the difference between the sales value of the property and 115% of the equivalent primary debt.



360-20-55-32 The following table illustrates profit recognition.

Sales price of improvements $ 875,000 Less: Cost of improvements 750,000

Profit recognized at time of sale $ 125,000

Case C: Subordinated Land Lease- Land Owned by Seller—Qualifying

360-20-55-33 This Case has the following assumptions.


Cash down payment $ 154,000 Loan by insurance company: first lien on the fee or on subordinated leasehold, 28-year term, 8 1/4%, payable in equal monthly installments of principal and interest

760,000

$ 914,000

Land lease for 99 years @ $11,580/year, net, payable monthly in advance, and 5% of gross rents

Cost of land—$200,000



Computations:

Present value of 336 monthly payments on land lease at $965 discounted at 12% (imputed interest for a second lien receivable): $965 + ($965 x 96.432696) $ 94,000 Loan from insurance company (primary debt) 760,000

Total debt or equivalent 854,000 Down payment 154,000

Sales value $ 1,008,000

The initial investment ($154,000) is more than 15% of the sales value. (15% x $1,008,000 = $151,200).

The initial investment is also larger than the excess of the sales value over 115% of the primary debt.

Sales value $ 1,008,000 115% of $760,000 874,000

Excess of sales value over 115% of debt $ 134,000

360-20-55-34 Therefore, the initial investment of $154,000 is adequate, and recognizing profit on the sale of the improvements is appropriate.

360-20-55-35 Profit recognition is as follows.

Sales value $ 1,008,000 Less: Cost of improvements $ 750,000 Cost of land 200,000 950,000

Profit recognized at time of sale $ 58,000



360-20-55-36 The effect of including the present value of the lease is to reduce profit recognized by $106,000: $94,000 (present value of the land lease)—$200,000 (cost of land).

Case D: Subordinated Land Lease- Land Owned by Seller—Nonqualifying

360-20-55-37 This Case has the following assumptions:


Cash down payment $ 132,000 Loan by insurance company: first lien on the fee or on subordinated leasehold, 28-year term, 8 1/4%, payable in equal monthly installments of principal and interest

743,000

$ 875,000 Land lease for 99 years @ $19,332/year, net, payable monthly in advance

Cost of land—$200,000

Cost of improvements—$750,000


Computations:

Present value of 336 monthly payments on land lease of $1,611 discounted at 12% (imputed interest for a second lien receivable): $1,611 + ($1,611 x 96.432696) $ 157,000 Loan from insurance company (primary debt) 743,000

Total debt or equivalent 900,000 Down payment 132,000

Sales value $ 1,032,000 360-20-55-38 The initial investment ($132,000) is less than 15% of the sales value (15% x $1,032,000 = $154,800), and therefore is inadequate to recognize profit on sale of improvements. Profit recognized at time of sale should not exceed that recognizable under the installment method as if the subordinated lease were an installment receivable.

360-20-55-39 Profit recognition on installment method is as follows.

Sales value $ 1,032,000 Less: Cost of improvements $ 750,000 Cost of land 200,000 950,000

Anticipated profit on sale of improvements $ 82,000 360-20-55-40 Cash received or to be received by the seller, other than the proceeds of the primary loan, is as follows.

Down payment $ 132,000 Present value of land lease payments 157,000 $ 289,000



360-20-55-41 The percentage of profit in each collection is therefore as follows.

The percentage of profit in each collection is therefore:

$ 82,000 = 28.37% $ 289,000

360-20-55-42 Profit recognizable in the period of sale is 28.37% of the down payment of $132,000, or $37,450. The remaining profit of $44,550 will be recognized at the rate of 28.37% of the portion of each lease payment that is equivalent to a reduction of principal on a loan of $157,000 for 28 years at 12%.

360-20-55-43 The effect of including the present value of the lease in the sales value of the improvements is to reduce the profit recognized on the improvements by $43,000: $157,000 (present value of the land lease) — $200,000 (cost of the land).

5.15 Sale-leaseback transactions Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-60 The sale of the property may be accompanied by a leaseback to the seller of all or any part of the property for all or part of its remaining economic life. Real estate sale-leaseback transactions shall be accounted for in accordance with Subtopic 840-40.

ASC 840-40, Leases — Sale-Leaseback Transactions, applies to all sale-leaseback transactions involving real estate and integral equipment, even those that involve the leaseback of only a portion of the real estate sold. Sale-leaseback accounting described in ASC 840-40 requires a seller-lessee to record a sale, remove the property from the balance sheet, and recognize profit in accordance with the provisions of ASC 840-40.

ASC 840-40 provides that a seller-lessee may only apply sale-leaseback accounting to a transaction involving real estate if the transaction first qualifies as a sale under ASC 360-20. If the transaction does not qualify as a sale, the seller must account for the transaction as a financing transaction or by using the deposit method, depending on which criteria in ASC 360-20 have not been satisfied. For example, if the initial investment test is not met, the deposit method should be applied (see section 3.4). Alternatively, if a transaction does not qualify as a sale under ASC 360-20 (e.g., it includes an option to repurchase the property), it may be appropriate to account for the transaction as a financing transaction (see section 5.6). ASC 840-40 also expands the definition of prohibited continuing involvement from ASC 360-20 and provides that if a seller-lessee has any continuing involvement with the property, other than a normal leaseback, the seller is precluded from accounting for the transaction as a sale. Therefore, a transaction in which the seller has continuing involvement, such as a support obligation for a limited period (see section 5.9) or a right to participate in future profits (see section 5.17), may qualify as a sale under ASC 360-20, but would not qualify to be accounted for as a sale-leaseback transaction under ASC 840-40 (i.e., both would be accounted for as financing arrangements).



Refer to our FRD, Lease Accounting—Accounting Standards Codification 840, Leases, for detailed guidance on accounting for sale-leaseback transactions before the adoption of the new leases standard (ASC 842).

In February 2016, the FASB issued ASC 842, Leases. This guidance will supersede the guidance for sale-leaseback transactions.

ASC 842 will be effective for annual periods beginning after 15 December 2018 (i.e., 1 January 2019 for a calendar-year public entity), and interim periods within those years, for public business entities and both of the following:

• Not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on an exchange or an over-the-counter market

• Employee benefit plans that file or furnish financial statements with or to the SEC

For all other entities, ASC 842 will be effective for annual periods beginning after 15 December 2019 (i.e., 1 January 2020 for a calendar-year entity), and interim periods beginning after 15 December 2020 (i.e., 1 January 2021 for a calendar-year entity). Early adoption is permitted for all entities.

5.15.1 Sale of property subject to the seller’s preexisting lease ASC 840-40-55-37 through 55-41 addresses the sale of property when an entity owns an interest in the property and also is a lessee under an operating lease for all or a portion of the same property (see section 5.14). This owner-lessee relationship can occur when the entity has an investment in a partnership that owns the leased property. If the entity sells its interest in the partnership or the partnership sells the property to an independent third party and the entity continues to lease the property under the preexisting operating lease, the result is a sale of property subject to the seller’s preexisting lease.

Such transactions should generally be accounted for as sale-leaseback transactions in accordance with ASC 840-40. Refer to our FRD, Lease Accounting—Accounting Standards Codification 840, Leases, for additional guidance before the adoption of ASC 842.

5.16 Sales contract requires seller to develop property Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-61 The sales contract or an accompanying agreement may require the seller to develop the property in the future, to construct facilities on the land, or to provide off-site improvements or amenities. The seller is involved with future development or construction work if the buyer is unable to pay amounts due for that work or has the right under the terms of the arrangement to defer payment until the work is done. If future costs of development can be reasonably estimated at the time of sale, profit allocable to the following shall be recognized when the sale of the land meets the criteria in paragraph 360-20-40-5:

a. Performance before the sale of the land

b. The sale of the land.

360-20-40-62 Profit allocable to performance after the sale shall be recognized by the percentage-of-completion method as development and construction proceed, provided that cost and profit can be reasonably estimated from the seller’s previous experience.





360-20-40-63 The profit shall be allocated to the sale of the land and the later development or construction work on the basis of estimated costs of each activity; the same rate of profit shall be attributed to each activity. No profit shall be recognized at the time of sale if future costs of development cannot be reasonably estimated at that time.

A seller of real estate may make a commitment to develop the property sold in the future, construct facilities on the land, or provide improvements or amenities, such as roads, sewer lines, or parks. Frequently, the buyer may be permitted to defer payment of the arrangement consideration associated with the property development until the work is complete or to make payments as the work progresses. In such situations, ASC 360-20 allows a seller to recognize profit using the percentage-of-completion method if the seller can reliably estimate the future costs of development and the total profit that will be realized in the arrangement, and all other criteria for recognizing profit under the full accrual method have been satisfied (see section 2.1). Payments made (or to be made) by the buyer for improvements should be included in the sales value (see section 2.3) and the calculation of the initial and continuing investment tests (see Chapter 3), even if the payments are not due until the improvements are complete.

If a seller applies the percentage-of-completion method to such an arrangement, the seller may recognize profit for work that was performed prior to the sale of the land and the sale of the land at the time of sale. However, the same rate of profit must be applied to each activity (pre and post-sale) regardless of the amount of cash received from the buyer.

If a seller cannot reasonably estimate the future costs of development, no profit should be recognized until costs can be reliably estimated or until development is complete (i.e., the seller has no continuing involvement).

Illustration 5-20: Sale of land with development contract

Facts:

On 2 January 20X5, XYZ Development sells land with a carrying amount of $400,000 to Homebuilder for $1,000,000. The two companies enter into a separate development agreement on the same day. XYZ Development agrees to build access roads and develop a recreation facility on the land for $500,000. The estimated cost to complete this development is $400,000, which is based on XYZ Development’s historic experience and is considered reliable. All other criteria for recognizing revenue under the full accrual method have been satisfied. XYZ Development incurs $160,000 in development costs in 20X5 and $240,000 in costs in 20X6.

Analysis:

Although commitment to complete development of the property is included in a separate development agreement, ASC 360-20-40-61 indicates that an accompanying agreement that requires the seller to develop the property in the future constitutes continuing involvement and should be accounted for with the sale of the land. XYZ Development should account for the arrangement using the percentage-of-completion method as follows:

Projected profit: Sales Value Land $1,000,000 Development 500,000 1,500,000 Costs Land 400,000 Development 400,000 800,000 Total projected profit $ 700,000



Profit recognized in period of sale:

($400,000 costs incurred/$800,000 total costs) x $700,000 projected profit = $350,000

Profit recognized in 20X5:


Profit recognized in 20X6:


If future costs of development can be reasonably estimated (i.e., the transaction qualifies to be accounted for using the percentage-of-completion method) but the transaction is required to be accounted for using the installment, cost recovery, or reduced-profit method because the initial and/or continuing investment tests have not been satisfied, both the percentage-of-completion method and the other applicable reduced profit method should be considered in determining the amount of profit to recognize. We do not believe it is appropriate for a seller to recognize profit using the percentage-of-completion method without taking into consideration the profit that would be recognized under the installment, reduced-profit, or cost recovery method. Likewise, when the initial and/or continuing investments are not adequate and continuing involvement exists, we do not believe it is appropriate for a seller to recognize profit using the installment or cost recovery method without taking into consideration the profit that would be recognized under the percentage-of-completion method (e.g., a failure to meet the initial investment test should not result in the seller recognizing more profit than the amount that would have been recognized had the initial investment test been adequate). ASC 360-20 does not provide guidance on the appropriate accounting method to apply when a transaction fails more than one of the criteria for recognizing profit under the full accrual method in ASC 360-20-40-5 (see Chapter 2). We believe in such situations, the seller would apply both methods to the transaction (e.g., the profit that would otherwise be recognized in accordance with the percentage-of-completion method would be reduced based on cash received in accordance with the installment method). It should be noted that the decision to apply both methods to a transaction only applies when both methods would result in the seller recording a sale (e.g., the installment and financing method cannot both be applied to the same transaction). When one of the methods does not result in a sale, the least favorable method (financing in the above example) should be applied.

The following example illustrates the application of the installment and percentage-of-completion methods to a transaction that includes a development contract when the initial investment test is not satisfied:

Illustration 5-21: Sale of land with development contract when initial investment test is not met

Facts:

Assume the same facts as in Illustration 5-20, except the initial investment test is not met. The required initial investment is 20 percent of the sales value, or $300,000, but the down payment is only $225,000 (15 percent of the sales value). Principal payments of approximately $30,000 per year will be made during the development period and the continuing investment test is met.



Analysis:

Because the initial investment is not adequate, XYZ Development should apply the cost recovery or installment method to this transaction. Under the cost recovery method, no profit would be recognized during the development period because total costs ($800,000) exceed cash received ($225,000 down payment plus $30,000 in principal each year). Under the installment method, XYZ Development would first calculate the profit that would be recognized under the percentage-of-completion method (see Illustration 5-20 above) and then apply the installment method as follows:

Profit recognized in period of sale: Payments received to-date $ 225,000 Total sales price 1,500,000 Percentage of sales price received to-date 15% Profit under percentage-of-completion method (see Illustration 5-20) 350,000 Profit recognized in period of sale $ 52,500

Profit recognized in 20X5: Payments received to-date ($225,000 down + $30,000 principal) $ 255,000 Total sales price 1,500,000 Percentage of sales price received to-date 17%

Profit under percentage-of-completion method (see Illustration 5-20) 490,000 Profit to be recognized to-date 83,300 Profit recognized in period of sale (52,500) Profit recognized in 20X5 $ 30,800 Profit recognized in 20X6: Payments received to-date ($225,000 down + $60,000 principal) $ 285,000 Total sales price 1,500,000 Percentage of sales price received to-date 19%

Profit under percentage-of-completion method (see Illustration 5-20) 700,000 Profit to be recognized to-date 133,000 Profit recognized through 20X5 (83,300) Profit recognized in 20X6 $ 49,700

Profit would continue to be recognized using the installment method until the initial investment test is satisfied or until XYZ Development receives all cash to which it is entitled without retaining any risk related to any buyer financing.

If a seller’s commitment to develop property in the future relates to an operating property, such as an apartment building or shopping center, the arrangement may also include a support obligation (see section 5.9). ASC 360-20-55-44 through 55-48 provide an example of a transaction that includes a commitment to develop property and an obligation to support the operations of the property for a limited period of time. This example is included in section 5.9.4.



5.16.1 Percentage-of-completion and home sales Excerpt from Accounting Standards Codification Real Estate- General — Property, Plant, and Equipment


970-360-55-4 In the following transaction, a homebuilder enters into a contract for the construction of a single-family home on the homebuilder’s lot. Although the transaction includes both a lot sale and construction of a house, the contract does not distinguish between those two elements. The homebuilder does not relinquish title to the lot until closing.

970-360-55-5 The accounting guidance for this transaction is provided in Subtopic 360-20, that is, profit recognition is not appropriate until the conditions in paragraph 360-20-40-5 are met. Until that time, deposit accounting should be used for the construction activity and the land.

Homebuilders often enter into arrangements to construct single-family homes on the homebuilder’s lot. Such arrangements include two elements: 1) the sale of a lot and 2) the construction of a single-family residence. The contract generally does not distinguish between the sale of the lot and the construction of the residence and the lot title generally does not transfer to the buyer until closing, which takes place after construction is complete. In such situations, profit should not be recognized (i.e., the percentage-of-completion method should not be applied) because the seller has not met all of the conditions in ASC 360-20-40-5 (see section 2.1) (i.e., all conditions precedent to closing have not been met and a sale of the lot has not been consummated until title transfers to the buyer).

As discussed in section 5.1.1, ASC 360-20-40-28 (see section 5.1) provides an exception to the requirement that all conditions precedent to closing be met for sales of condominiums, shopping centers, office buildings, and similar structures that involve long construction periods. Sellers of such real estate may recognize profit using the percentage-of-completion method even though a certificate of occupancy has not been obtained. However, the construction of single-family homes does not fall under this exception.

Therefore, no profit should be recognized during construction. Instead, homebuilders should apply the deposit method to such transactions.

5.17 Seller participates in future profits from the property without risk of loss Excerpt from Accounting Standards Codification Property, Plant, and Equipment — Real Estate Sales

Derecognition

360-20-40-64 If the seller will participate in future profit from the property without risk of loss (such as participation in operating profits or residual values without further obligation) and if the transaction otherwise qualifies for recognition of profit by the full accrual method, the transfer of risks and rewards of ownership and absence of continuing involvement criterion shall be considered met. The contingent future profits shall be recognized when they are realized. Paragraphs 450-30-25-1 and 450-30-50-1 address accounting for gain contingencies. All the costs of the sale shall be recognized at the time of sale; none shall be deferred to periods when the contingent profits are recognized.



ASC 360-20-40-5 states that profit should only be recognized in accordance with the full accrual method if a seller has transferred the usual risks and rewards of ownership to the buyer and does not have substantial continuing involvement with the property (see section 2.1). However, ASC 360-20-40-64 allows for an exception to this requirement if the only continuing involvement with the property is the participation in future profits without risk of loss (i.e., some rewards of ownership have been retained). If all other criteria for recognizing revenue under the full accrual method have been satisfied (see section 2.1), profit, excluding contingent future profits, may be recognized on the date of sale. It is not appropriate for a seller to defer any costs (or a corresponding loss) associated with such a sale, even if the receipt of future profits is probable and was taken into consideration when determining the sales price of the property.

Financial Reporting Developments Real estate sales | A-1

A Other recognition methods

A real estate transaction must meet all of the criteria in ASC 360-20-40-5 (see section 2.1) to be accounted for using the full accrual method (i.e., to recognize all profit at the time of sale). If one or more of the criteria in ASC 360-20-40-5 are not satisfied, one of the other recognition methods described in ASC 360-20 must be applied. This appendix describes and provides examples of the application of those other recognition methods.

If a buyer’s initial investment is not adequate (see section 3.4), and recovery of the cost of the property is not reasonably assured (see section 5.2.1), the seller should apply the cost recovery method or the deposit method (see section 5.2.1.1 for guidance on determining which method to apply). If recovery of the cost of the property is reasonably assured and the risks and rewards of property ownership have been transferred to the buyer, then the seller should apply the installment method or the cost recovery method (see section 5.2.1.2 for guidance on determining which method to apply).

If the initial investment test is satisfied but the continuing investment test is not (see section 3.5), the reduced-profit method may be applied in certain circumstances (see section 5.3 for criteria for recognizing profit under the reduced-profit method and guidance on the application of that method). If the requirements for applying the reduced-profit method are not satisfied, the seller should recognize profit under the installment or cost recovery method.

If a seller has continuing involvement in a property without transferring substantially all of the risks and rewards of ownership, the seller’s accounting for the transaction depends on the nature and extent of the seller’s involvement. Transactions that include continuing seller involvement will generally be accounted for as financing, leasing, or profit-sharing arrangements or using the percentage-of-completion or performance-of-services method (see Chapter 5 for additional information on continuing involvement and the application of the percentage-of-completion and performance-of-services methods).

A.1 Installment method When the installment method is applied to a transaction, the seller recognizes a sale of real estate. However, profit is recognized on a reduced basis. This method is described in ASC 360-20 as follows:


Installment Method

The installment method apportions each cash receipt and principal payment by the buyer on debt assumed between cost recovered and profit. The apportionment is in the same ratio as total cost and total profit bear to the sales value.



360-20-55-7 As defined, the installment method apportions each cash receipt and principal payment by the buyer on debt assumed between cost recovered and profit. The apportionment is in the same ratio as total cost and total profit bear to the sales value. The calculation is illustrated in Example 3 (see paragraph 360-20-55-51).



360-20-55-8 If the stated interest rate is equal to or less than an appropriate interest rate, it is acceptable not to reduce the receivable to its present value. This ordinarily results in reducing profit recognized in the earlier years.

360-20-55-9 Under the installment method, the receivable less profits not recognized does not exceed what the property value would have been if the property had not been sold.

360-20-55-10 The income statement, or related footnotes, for the period including the date of sale presents the sales value, the gross profit that has not yet been recognized, and the total cost of the sale. Revenue and cost of sales (or gross profit) are presented as separate items on the income statement or are disclosed in the footnotes when profit is recognized as earned. This presentation is illustrated in Example 2, Schedule A (see paragraph 976-605-55-13).

360-20-55-11 Paragraph 976-605-30-3 describes accounting for obligations for future improvement costs under the percentage-of-completion method. That description applies as well to accounting for those obligations under the installment method.

360-20-55-12 If after adoption of the installment method the transaction meets the requirements for the full accrual method (specified in paragraphs 360-20-40-3 through 40-26) of recognizing profit for real estate sales other than retail land sales, the seller may then change to the full accrual method. The remaining profit that was not recognized is recognized in income at that time.

Under the installment method, the amount of profit recognized is limited by the amount of cash paid by the buyer. Each payment of principal made by the buyer (including payments from the buyer to the seller and payments made by the buyer on debt assumed from the seller) is apportioned between recovery of the cost of the property and profit. This apportionment should be based on the ratio of total cost and total profit to the sales value.

In reporting a transaction accounted for in accordance with the installment method, a seller should report the total sales value, the total cost of the sale, and deferred profit as separate line items on the income statement or in the notes to the financial statements in the period of sale. The seller should also record a receivable from the buyer and derecognize any debt assumed by the buyer. Any deferred profit on the transaction should be netted against the receivable from the buyer in the balance sheet and the net receivable should not exceed what the carrying amount of the property would have been had it not been sold. The netting of any deferred profit against the receivable from the buyer is consistent with the example included in ASC 976-605-55-14. Although this example relates to retail land sales, we believe the balance sheet presentation should be similar for retail land sales and all other sales of real estate accounted for under the installment method.

A transaction may initially be required to be accounted for using the installment method because the initial and/or continuing investment tests are not satisfied (see Chapter 3 for additional information on initial and continuing investment requirements). However, the terms of the transaction may be structured in such a manner that both the initial and continuing investment tests are satisfied at some point in the future. For example, if the continuing investment test is not satisfied because a ten-year loan includes interest-only terms for the first five years, the cumulative payments received will eventually exceed those required under the continuing investment test, if the term of the loan is for a shorter period



than the customary amortization term. At the time the initial and continuing investment tests are both satisfied, any profit deferred under the installment method may be recognized in full under the full accrual method, assuming all other criteria for recognizing profit under the full accrual method have been satisfied. Although ASC 360-20 does not require a seller to change from the installment method to the full accrual method when all criteria for recognizing profit under the full accrual method are satisfied, we believe such a change is preferable. If a seller chooses to continue to account for a transaction using the installment method at the time all criteria for recognizing profit under the full accrual method are met, the seller must continue to account for the transaction under the installment method for the remainder of the financing term (i.e., the seller cannot choose to recognize profit in full at some later date). Additionally, this policy should be clearly documented, applied on a consistent basis, and disclosed in the seller’s financial statements.

Illustration A-1: Application of the installment method

Facts:

Company A sells land with a carrying amount of $600,000 to Homebuilder B for $1,000,000. Homebuilder B does not plan to commence development of the land for more than two years. Consideration consists of $150,000 in cash paid at closing, a first mortgage from the seller for $500,000 (20-year amortization of principal plus interest), and a second mortgage from the seller for $350,000 (10-year amortization of principal plus interest), both at a market rate of interest. The terms of the seller financing call for the buyer to make set principal payments of $25,000 and $35,000, respectively on the first and second mortgages plus interest each year. Company A does not have any continuing involvement with the property.

Analysis:

Because the required minimum initial investment is $250,000 (25 percent on land held for residential development to commence more than two years after sale), the buyer’s initial investment is not adequate. Therefore, Company A should account for the transaction under the installment, cost recovery, or deposit method. Assuming the transaction meets the requirements for applying the installment method (i.e., recovery of the cost of the property is reasonably assured—see section 5.2.1), Company A should recognize profit of $60,000 ($150,000 down payment X $400,000 total profit/$1,000,000 sales value) at the date of sale.

Company A should separately present sales of $1,000,000, cost of sales of $600,000, and deferred profit of $340,000 ($400,000 total profit — $60,000 recognized) in its income statement or footnotes. Company A’s balance sheet should include a net receivable of $510,000 ($850,000 receivable — $340,000 deferred profit).

As principal payments of $60,000 ($25,000 on the first mortgage + $35,000 on the second mortgage) are made in the first year, Company A should recognize additional profit of $24,000 ($60,000 principal X $400,000 total profit/$1,000,000 sales value). Additionally, Company A should recognize interest income as it is received (as both financings are at market rates). The net receivable presented on Company A’s balance sheet after one year would be reduced to $474,000 ($790,000 receivable — $316,000 deferred profit).

Based on the terms of the seller financing (i.e., the first mortgage is being amortized over 20 years and the second mortgage over 10 years), at some point in the future, both the initial and continuing investment tests will be satisfied. At that time, Company A may recognize all of the remaining deferred profit under the full accrual method, assuming all other criteria for recognizing profit under the full accrual method continue to be satisfied.



Application of the installment method when a transaction includes third-party financing

As discussed in section 3.2.2, debt incurred that is secured by the property sold, including debt for which the seller is not contingently liable, should not be included in the calculation of profit under the installment, cost recovery, or reduced-profit method unless the profit deferred exceeds the outstanding amount for which the seller is at risk (i.e., the outstanding amount of seller financing and the buyer’s debt secured by the property for which the seller is contingently liable). When the profit deferred exceeds the financing for which the seller is at risk, the seller should recognize the excess as profit.

Following is an example of the application of the installment method when the buyer’s financing includes an assumption of the seller’s debt:



Example 3: Profit Recognition—Installment Method, with Debt Assumed by Buyer

360-20-55-51 This Example illustrates the guidance in paragraph 360-20-55-7. This Example has the following assumptions.

Cash down payment $ 150,000 Second mortgage payable by buyer to seller (10-year amortization of principal plus interest) 350,000 Total cash to be received by seller 500,000 First mortgage assumed by buyer (20-year amortization of principal plus interest) 500,000 Total sales price and sales value 1,000,000 Cost 600,000 Total profit $ 400,000

360-20-55-52 The initial investment is assumed to be inadequate for full profit recognition, and the installment method of accounting is assumed to be appropriate. It is also assumed that, after the down payment, the buyer pays $25,000 of principal on the first mortgage and $35,000 of principal on the second mortgage.

360-20-55-53 Under the installment method, profit recognition attributable to the down payment is $60,000, representing 40% ($400,000/$1,000,000) of $150,000.

360-20-55-54 Profit recognition attributable to the principal payments by the buyer on the first and second mortgages is $24,000, representing 40% of $60,000 ($25,000 + $35,000).

The amount of profit to be recognized in the above example is the same as the amount to be recognized in the example in the previous section in which all financing is provided by the seller. Although not specifically noted, it appears the seller remains contingently liable for the first mortgage assumed by the buyer in the above example (i.e., the outstanding amount for which the seller is at risk is the same in both examples). Because the outstanding amount for which the seller is at risk is the same in both examples, there is no difference in the amount of profit to be recognized. However, because the installment method calls for the seller to remove any debt assumed by the buyer from its balance sheet at the time of sale, there would be a difference in the seller’s balance sheet depending on whether the financing is provided by the seller or a third party. In the above example the seller’s balance sheet would include a net receivable of



$10,000 ($350,000 receivable — $340,000 deferred profit) at the date of sale. As principal payments of $60,000 ($25,000 on the first mortgage + $35,000 on the second mortgage) are made in the first year, the seller’s receivable is reduced to $315,000 ($350,000 initial balance — $35,000 principal payment on seller financing) and the deferred profit balance is reduced to $316,000 ($340,000 initial balance — $24,000 profit recognized). Because the profit deferred ($316,000) exceeds the outstanding receivable ($315,000), a net liability of $1,000 would be presented in the seller’s balance sheet.

If the seller does not remain contingently liable for the first mortgage assumed by the buyer, the initial calculation of profit to be recognized under the installment method does not change. However, the seller would recognize additional profit if the profit to be deferred exceeds the outstanding amount for which the seller is at risk. In the above example, if the seller was not contingently liable for the debt assumed by the buyer, at the end of the first year when the deferred profit of $316,000 ($340,000 initial balance — $24,000 profit recognizable under installment method) exceeds the outstanding amount for which the seller is at risk of $315,000 ($350,000 initial balance — $35,000 principal payment), the seller would recognize an additional $1,000 in profit, or $25,000 in total during the year.

Application of the installment method when a transaction includes a below market rate of interest

If a seller accounts for a transaction using the installment method and the transaction is financed through seller financing with a below market rate of interest, ASC 360-20-55-8 indicates that the seller need not reduce its receivable from the buyer to its present value. This treatment is allowed because it will generally result in reducing the amount of income recognized in earlier years. Because the installment method allows a seller to recognize all interest received by the buyer and only a portion of the principal payments made by the buyer, discounting a receivable to achieve a higher interest rate would generally result in the seller recognizing more income in earlier years, albeit interest income. If a seller chooses to not discount its below market receivable from a buyer to its present value when a transaction is accounted for using the installment method, this policy should be clearly documented, applied on a consistent basis, and disclosed in the seller’s financial statements as appropriate.

Although ASC 360-20-55-8 indicates that it is not necessary for a seller to reduce its receivable from a buyer to its present value when the installment method is applied, we do not believe a failure to discount should occur if discounting the receivable would result in a loss on the sale. That is, if discounting the receivable would result in a loss on the sale, we believe the receivable should be discounted notwithstanding the provisions of ASC 360-20-55-8. As discussed in section 2.3.3, a seller should discount notes receivable on a net present value basis to determine the sales value used in the initial and continuing investment tests. An inadequate initial or continuing investment should not result in an inappropriate deferral of a loss on a transaction.

Obligations for future improvement costs

If there are obligations for future improvement costs under the installment method, the following guidance should be applied:

Excerpt from Accounting Standards Codification Real Estate — Retail Land — Revenue Recognition

Initial Measurement

976-605-30-3 If there is an obligation for future improvement costs that is recognized under the percentage-of-completion method:

a. Estimates are based on costs generally expected in the construction industry locally.



b. Unrecoverable costs of off-site improvements, utilities, and amenities shall be provided for. In determining the amount of unrecoverable costs, estimates of amounts to be recovered from future sale of the improvements, utilities, and amenities shall be discounted to present value as of the date the net unrecoverable costs are recognized.

Subsequent Measurement

976-605-35-1 Estimates of future improvement costs shall be reviewed at least annually. Changes in those estimates shall not lead to adjustment of revenue applicable to future improvements that has been previously recorded unless the adjusted total estimated cost exceeds the applicable revenue. When cost estimates are revised, the relationship of the two elements included in the revenue not yet recognized — costs and profit — shall be recalculated on a cumulative basis to determine future income recognition as performance takes place. If the adjusted total estimated cost exceeds the applicable revenue previously recognized, the total anticipated loss is charged to income when it meets the criteria in paragraph 450-20-25-2. When anticipated losses on lots sold are recognized, the entity also shall consider recognizing a loss on land and improvements not yet sold.

Refer to section 5.16 for example of the application of the installment method when an obligation for future improvements exists.

A.2 Cost recovery method When the cost recovery method is applied to a transaction, the seller recognizes a sale of real estate. However, profit is recognized on a deferred basis. The cost recovery method is described in ASC 360-20 as follows:


Cost Recovery Method

Under the cost recovery method, no profit is recognized until cash payments by the buyer, including principal and interest on debt due to the seller and on existing debt assumed by the buyer, exceed the seller’s cost of the property sold.



360-20-55-13 As defined, under the cost recovery method, no profit is recognized until cash payments by the buyer, including principal and interest on debt due to the seller and on existing debt assumed by the buyer, exceed the seller’s cost of the property sold. The receivable less profits not recognized, if any, does not exceed what the depreciated property value would have been if the property had not been sold. For an all-inclusive or wrap-around receivable held by the seller, interest collected is recognized as income to the extent of, and as an appropriate offset to, interest expense on prior-lien financing for which the seller remains responsible.

360-20-55-14 The income statement for the period including the date of sale presents the sales value, the gross profit that has not yet been recognized, and the total cost of the sale. Gross profit not yet recognized is offset against the related receivable on the balance sheet. Principal collections reduce the related receivable, and interest collections on such receivables increase the unrecognized gross profit on the balance sheet. Gross profit is presented as a separate item of revenue on the income statement when it is recognized as earned.



360-20-55-15 If, after the adoption of the cost recovery method, the transaction meets the requirements for the full accrual method (specified in paragraphs 360-20-40-3 through 40-26), the seller may then change to the full accrual method. The remaining profit that was not recognized is recognized in income at that time.

Under the cost recovery method, no profit may be recognized until cash payments by the buyer, including principal and interest payments on debt assumed by the buyer, exceed the seller’s cost of the property. The seller should record the full sales value and the total cost of the sale at the time of the sale, offset by any deferred profit. The seller should record a receivable from the buyer and derecognize any debt assumed by the buyer in the balance sheet. Any deferred profit on the transaction should be netted against the receivable from the buyer in the balance sheet and the net receivable should not exceed what the carrying amount of the property would have been had it not been sold.

A transaction may initially be required to be accounted for using the cost recovery method because the initial and/or continuing investment tests are not satisfied (refer to Chapter 3 for additional information on initial and continuing investment requirements). However, the terms of the transaction may be structured in such a manner that both the initial and continuing investment tests are satisfied at some point in the future. At the time the initial and continuing investment tests are both satisfied, any profit deferred under the cost recovery method may be recognized in full under the full accrual method, assuming all other criteria for recognizing profit under the full accrual method have been satisfied. Although ASC 360-20 does not require a seller to change from the cost recovery method to the full accrual method when all criteria for recognizing profit under the full accrual method are satisfied, we believe such a change is preferable. If a seller chooses to continue to account for a transaction using the cost recovery method at the time all criteria for recognizing profit under the full accrual method are met, the seller must continue to account for the transaction under the cost recovery method for the remainder of the financing term (i.e., the seller cannot choose to recognize profit in full at some later date). Additionally, this policy should be clearly documented, applied on a consistent basis, and disclosed in the seller’s financial statements as appropriate.

Illustration A-2: Application of the cost recovery method

Facts:

Company A sells land with a carrying amount of $350,000 to Homebuilder B for $1,000,000. Homebuilder B does not plan to commence development of the land for more than two years. Consideration consists of a down payment of $250,000 and a 25-year non-subordinated note from the seller for $750,000 at a market rate of interest, which will result in the buyer making annual payments of $82,000 (approximately $75,000 in interest and $7,000 in principal during the first two years). Company A does not have any continuing involvement with the property.

Analysis:

Because the terms of the note require the note to be repaid in 25 years and not within the maximum term of 20 years (see section 3.5), the buyer’s continuing investment is not adequate. There is no excess down payment to apply to the continuing investment shortfall, because the buyer’s initial investment equals the minimum required investment (25 percent on land held for residential development to commence more than two years after sale). The transaction should be accounted for under the reduced-profit, installment, or cost recovery method.



Assuming Company A determines the most appropriate method to apply to this transaction is the costs recovery method, Company A may not recognize any profit at the date of sale because the buyer’s payment of $250,000 is less than the $350,000 cost of the property. Company A should separately present sales of $1,000,000, cost of sales of $350,000, and deferred profit of $650,000 in its income statement or footnotes. Company A’s balance sheet should include a net receivable of $100,000 ($750,000 receivable — $650,000 deferred profit).

In the first year, total payments made by the buyer are $332,000 ($250,000 down payment + $82,000 annual principal and interest payment). Because the buyer’s payments do not exceed the cost of the property ($332,000 in total payments versus $350,000 cost of property), no profit should be recognized. Principal collections of $7,000 would reduce the related receivable balance to $743,000 and interest collections of $75,000 would increase the deferred profit balance to $725,000. Company A’s balance sheet should include a net receivable of $18,000 ($743,000 receivable — $725,000 deferred profit).

In the second year, payments of $82,000 would result in total cash payments of $414,000. Therefore, Company A should recognize $64,000 in profit ($414,000 buyer payments — $350,000 cost of property). The receivable and deferred profit balance are both $736,000, resulting in a net receivable balance of zero on Company A’s balance sheet. Because the buyer’s total payments are in excess of the cost of the property, all future payments should be recognized when received by Company A.

Application of the cost recovery method when transaction includes third-party financing

As discussed in section 3.2.2, debt incurred that is secured by the property sold, including debt for which the seller is not contingently liable, should not be included in the calculation of profit under the installment, cost recovery, or reduced-profit method unless the profit deferred exceeds the outstanding amount for which the seller is at risk (i.e., the outstanding amount of seller financing and the buyer’s debt secured by the property for which the seller is contingently liable). In such situations, the seller should recognize the difference between the profit deferred and the outstanding amount for which the seller is at risk as profit.

Illustration A-3: Cost recovery method with third party financing

Facts:

Company A sells land with a carrying amount of $350,000 to a homebuilder for $1,000,000. The homebuilder does not plan to commence development of the land for more than two years. Consideration consists of a down payment of $250,000, a 25-year first mortgage assumed by the buyer for $500,000, and a 25-year second mortgage from the seller for $250,000, both at a market rate of interest. Company A does not retain any risk related to the first mortgage assumed by the buyer, its receivable is not subject to future subordination, and it does not have any continuing involvement with the property.

Analysis:

Because the terms of the notes require them to be repaid in 25 years, and not within the maximum term of 20 years (see section 3.5), the buyer’s continuing investment is not adequate. There is no excess down payment to apply to the continuing investment shortfall because the buyer’s initial investment equals the minimum required investment (25 percent on land held for residential development to commence more than two years after sale). Therefore, this transaction should be accounted for under the reduced-profit, installment, or cost recovery method.



Assuming Company A determines the most appropriate method to apply to this transaction is the cost recovery method, although the buyer’s payment of $250,000 is less than the $350,000 cost of the property, the seller may recognize profit for the difference between the calculation of deferred profit under the cost recovery method ($650,000) and the outstanding amount to which the seller is at risk ($250,000). Therefore, Company A may recognize profit of $400,000 at the time of sale.

Company A should separately present sales of $1,000,000, cost of sales of $350,000, and deferred profit of $250,000 in its income statement or footnotes. Company A’s balance sheet would include a net receivable of $0 ($250,000 receivable — $250,000 deferred profit). The remaining $250,000 of deferred profit would be recognized as the seller financing is repaid.

A.3 Deposit method When the deposit method is applied to a transaction, the seller does not recognize a sale of real estate. This method is described in ASC 360-20 as follows:

Excerpt from Accounting Standards Codification Deposit Method

Under the deposit method, the seller does not recognize any profit, does not record notes receivable, continues to report in its financial statements the property and the related existing debt even if it has been assumed by the buyer, and discloses that those items are subject to a sales contract.



360-20-55-17 As defined, under the deposit method, the seller does not recognize any profit, does not record notes receivable, continues to report in its financial statements the property and the related existing debt even if it has been assumed by the buyer, and discloses that those items are subject to a sales contract. The seller continues to charge depreciation to expense as a period cost for the property for which deposits have been received unless the property has been classified as held for sale in accordance with paragraphs 360-10-45-9 through 45-10. Cash received from the buyer, including the initial investment and subsequent collections of principal and interest, is reported as a deposit on the contract except that, for sales that are not retail land sales, portions of cash received that are designated by the contract as interest and are not subject to refund offset carrying charges (property taxes and interest on existing debt) on the property. Interest collected that is subject to refund and is included in the deposit account before a sale is consummated is accounted for as part of the buyer’s initial investment (see paragraph 360-20-40-8) at the time the sale is consummated.

360-20-55-18 See the Real Estate Project Costs Subsection of Section 970–360–55 for guidance concerning use of the deposit method in the accounting for the sale of a lot and construction of a home by a homebuilder.

360-20-55-19 When a contract is canceled without a refund, deposits forfeited are recognized as income. When deposits on retail land sales are ultimately recognized as sales, the interest portion is recognized as interest income.

360-20-55-20 The seller’s balance sheet presents nonrecourse debt assumed by the buyer among the liabilities; the debt assumed is not offset against the related property. The seller reports the buyer’s principal payments on mortgage debt assumed as additional deposits with corresponding reductions of the carrying amount of the mortgage debt.




Under the deposit method, no profit or sale is recognized. The seller does not recognize a receivable and the property and any related debt remain on the seller’s balance sheet, even if the existing debt has been assumed by the buyer. Any cash received from the buyer should be recorded as a deposit, except that interest payments on seller financing that are not subject to refund may offset carrying charges (property taxes and interest on existing debt) on the property. Refundable interest payments or interest payments that are not subject to refund that are in excess of carrying charges should be recorded as a deposit. The seller should record any principal payments made by the buyer on debt assumed from the seller as additional deposits and reduce the carrying amount of the debt on its balance sheet. The seller should continue to recognize depreciation expense on the property, unless the property has been classified as held for sale. The property continues to be subject to the accounting guidance for the impairment and disposal of long-lived assets (ASC 360-10) and should be tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.

As discussed in section 2.2.1, if a property owner enters into an arrangement to sell an option in the property, the arrangement should be treated as a deposit until the option expires or is exercised. Recognition of a sale or profit on such a transaction is not appropriate, regardless of the amount of the payment received from the buyer.

A transaction may initially be required to be accounted for using the deposit method because the initial investment test is not met (see section 3.4). However, the terms of the transaction may be structured in such a manner that the initial investment test is satisfied at some point in the future. The seller’s calculation of the sales value and the required initial investment should include any interest that has been included in the deposit account (i.e., interest that is subject to refund or that is in excess of the carrying charges on the property). At the time the initial investment test is satisfied, the seller may recognize profit under the full accrual method, assuming all other criteria for recognizing profit under the full accrual method have been satisfied. If the continuing investment test is not satisfied, the seller may recognize a sale and record profit using the installment, cost recovery, or reduced-profit method.

Illustration A-4: Application of the deposit method

Facts:

Company A consummates a sale and sells land with a carrying amount of $600,000 to Company B for $1,000,000. Consideration consists of $50,000 in cash paid at closing and a 10-year amortization first mortgage from the seller for $950,000 at a market rate of interest of 10 percent. Company B plans to commence development of the land within two years. Company A does not have any continuing involvement with the property and the receivable is not subject to future subordination. For simplicity purposes, assume there are no carrying charges on the property and the interest is not subject to refund.

Analysis:

The buyer’s initial investment is not adequate, because the required minimum initial investment is $200,000 (20 percent on land held for commercial development to commence within two years after sale). Therefore, Company A should account for the transaction under the installment, cost recovery, or deposit method. Assuming the transaction is accounted for using the deposit method, Company A should recognize a $50,000 deposit from the buyer at the time the cash is received.

In year 1, the seller receives payments of $150,000 from the buyer ($58,000 in principal and $92,000 in interest). The new sales value is $1,092,000 ($1,000,000 sales value + $92,000 interest) and the required initial investment is $218,400 ($1,092,000 X 20 percent). Because the buyer has only made payments of $200,000 ($50,000 down payment + $150,000 principal and interest payments), the initial investment test has not been satisfied and the $150,000 in payments received during the year should be recorded as an additional deposit (as there are no carrying charges on the property).



In year 2, the seller receives payments of $150,000 from the buyer ($64,000 in principal and $86,000 in interest). The new sales value is $1,178,000 ($1,092,000 year 1 sales value + $86,000 interest) and the required initial investment is $235,600 ($1,178,000 X 20 percent). Because the buyer has made payments of $350,000 ($50,000 down payment + $300,000 principal and interest payments), the initial investment test has been satisfied. In this situation, the continuing investment test is also satisfied.

Therefore, Company A may recognize a sale and profit under the full accrual method, assuming all other criteria for recognizing profit under the full accrual method have been satisfied.

Company A should record a sale of $1,178,000 (original sales value plus interest in excess of carrying charges during deposit period) and $600,000 in cost of sales, resulting in profit of $578,000. Company A should record a receivable of $828,000 ($950,000 original receivable — $58,000 principal in year 1 — $64,000 principal in year 2).

A.4 Financing method The application of the financing method does not result in a sale of real estate for accounting purposes. That is, the real estate remains on the seller’s books.

When a transaction includes certain forms of continuing involvement, ASC 360-20 indicates that the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement (see sections 5.6 — 5.9). The financing method is generally applied in situations where the buyer effectively receives a return of its investment plus interest (e.g., an obligation to repurchase property at a price higher than the sales price after five years or a 20-percent guaranteed return on the buyer’s investment for six years—refer to section 5.6 and section 5.8).

ASC 360-20 does not provide any guidance on how to apply the financing method to a real estate transaction. We believe it would generally be appropriate for a seller to apply the following guidelines when accounting for a transaction using the financing method:

• No profit or sale should be recognized, the seller should not recognize a receivable, and the property and any related existing debt assumed by the buyer should remain on the seller’s balance sheet.

• The seller should continue to depreciate the property and the property should be tested for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable in accordance with ASC 360-10.

• The seller should record any cash received from the buyer as a liability and accrue interest on the liability over the financing period.

• Principal payments on debt assumed by the buyer should be reflected by reducing the debt and increasing the liability to the buyer.

• Because the property remains on the seller’s balance sheet, the seller should record the operating results of the property in its income statement. Any benefit (income) generated by the property, exclusive of depreciation, that the seller is not entitled to receive should be reflected as interest expense. Similarly, if the seller is not exposed to operating losses of the property, any losses generated by the property, exclusive of depreciation, should be reflected as a reduction in interest expense. This treatment is consistent with ASC 470-30, Debt — Participating Mortgage Loans.



Illustration A-5: Obligation to repurchase a property at a price higher than the selling price

Facts: Company A sells a hotel with a carrying amount of $600,000 to Company B for $1,000,000 in cash. Company A has an obligation to repurchase the property from Company B after five years for $1,500,000. Annual depreciation on the property is $15,000. In the first year after the sale the property generates revenue of $100,000 and incurs cash expenses (i.e., excluding depreciation) of $50,000.

Analysis:

Because Company A has an obligation to repurchase the hotel from Company B, this transaction should be accounted for as a financing, leasing, or profit-sharing arrangement. Because the repurchase price is higher than the sales price, we believe this transaction is most appropriately accounted for as a financing transaction (see section 5.6). When cash of $1,000,000 is received from Company B, Company A should record a financing liability of $1,000,000.

Company A should recognize depreciation expense of $15,000 each year and interest expense necessary to accrete the $1,000,000 liability to $1,500,000 at the end of five years (8.1 percent per year compounded annually). Additionally, Company A should recognize the operating results of the property in its income statement. Because Company A is not entitled to receive any benefit from the results of the operations of the property, additional interest expense must be recorded, which would result in total interest expense of $131,000 ($81,000 accrued interest on the liability plus $50,000 net operating income of the property, excluding depreciation). During the first year, Company A should record the following journal entry:

Interest expense $ 131,000 Operating expenses 50,000 Depreciation 15,000

Revenue $ 100,000 Financing liability 81,000 Accumulated depreciation 15,000

After five years, the liability balance will equal the cash payment of $1,500,000 needed to repurchase the property from Company B.

Illustration A-6: Obligation to repurchase a property at fair value

Facts:

Assume the same facts as in Illustration A-5, except Company A has an obligation to repurchase the property from Company B at fair value after five years. On the date of sale the estimated fair value of the property is $1,500,000. After one year, the estimated fair value of the property has increased to $1,600,000.

Analysis:

Because Company A has an obligation to repurchase the property sold, this transaction should be accounted for as a financing, leasing, or profit-sharing arrangement. Because the repurchase price is an indeterminate price, we believe this transaction is most appropriately accounted for as a financing transaction (see section 5.6). During the first year after the sale, because the estimated fair value of the property is the same as the set repurchase price in Illustration A-5 ($1,500,000), Company A would account for this transaction in the same manner as in Illustration A-5 above. However, when the estimated fair value of the property increases after the first year, Company A must adjust interest expense prospectively so that a liability of $1,600,000 is accrued at the end of the five-year term.



Illustration A-7: Guaranteed return for an extended period

Facts:

Company A sells a hotel with a carrying amount of $600,000 to Company B for $1,000,000 in cash. Company A guarantees that Company B will receive a return of 20 percent per year for the next 6 years. Annual depreciation on the property is $40,000. Company A’s normal borrowing rate is 14 percent.

Analysis:

Because Company A has guaranteed a return of and on Company B’s investment (20 percent per year X 6 years = 120 percent), this transaction should be accounted for as a financing, leasing, or profit-sharing arrangement (see section 5.8). Assuming Company A determines it is most appropriate to account for the transaction as a financing arrangement, when cash of $1,000,000 is received from Company B, Company A should record the following journal entry:

Cash $ 1,000,000

Financing liability $ 1,000,000

The property would remain on Company A’s balance sheet and Company A would continue to record depreciation and the operating results of the property. The financing liability should be amortized using an interest rate of 14 percent with annual payments equal to the guaranteed return of $200,000. In the first year after the sale, the following journal entry should be recorded:

Interest expense $ 140,000

Financing liability 60,000

Payable to Company B $ 200,000

The liability balance should never be less than the carrying amount of the property (i.e., Company A should not have a loss on the property at the end of the guarantee period). At an interest rate of 14 percent, the liability balance at the end of six years will be $488,000 and the carrying amount of the property will be $360,000 ($600,000 initial balance — $40,000 per year in depreciation). Therefore, an interest rate of 14 percent is appropriate. If this was not the case, Company A would have needed to adjust the interest rate so that the liability was not less than the carrying amount of the property at the end of the six years.

The actual payments made by Company A to Company B over the 6-year guarantee period will depend on the operations of the property. The accounting for the guarantee obligation and the operations of the property (excluding depreciation) for several different scenarios is described below:

Property operates at breakeven level (excluding depreciation)

If the property generates $200,000 in revenue and $200,000 in cash expenses, because Company A guaranteed that Company B would receive a return of 20 percent on its investment each year, Company A would be required to make a payment of $200,000 to Company B. Company A would record the following journal entries to record the operations of the property:

Operating expenses $ 200,000

Revenue $ 200,000

Because a liability of $200,000 was recorded above, no additional journal entries are required to account for the amount due to Company B.



Property operates at loss (excluding depreciation expense)

If the property generates $100,000 in revenue and $200,000 in cash expenses, because Company A guaranteed that Company B would receive a return of $200,000, Company A would be required to make a payment of $300,000 to Company B. Company A would record the following journal entry to record the operations of the property and record the additional $100,000 due to Company B ($200,000 previously recorded above):

Operating expenses $ 200,000

Payable to Company B $ 100,000

Revenue 100,000

Property generates less profit than guaranteed return (excluding depreciation expense)

If the property generates $300,000 in revenue and $200,000 in cash expenses, because Company A guaranteed that Company B would receive a return of $200,000, Company A would be required to make a payment of $100,000 to Company B. Company A would record the following journal entry to record the operations of the property and reduce the payable to Company B by $100,000 ($200,000 previously recorded above):

Operating expenses $ 200,000 Payable to Company B 100,000

Revenue $ 300,000

Property generates more profit than guaranteed return (excluding depreciation expense)

If the property generates $500,000 in revenue and $200,000 in cash expenses, because Company A guaranteed that Company B would receive a return of $200,000, Company A would not be required to make any payments to Company B. Company A effectively paid Company B an additional $100,000 through the operations of the property that should be recorded as interest expense. Company A would record the following journal entry to record the operations of the property and remove the $200,000 payable previously recorded:

Operating expenses $ 200,000 Payable to Company B 200,000 Interest expense 100,000

Revenue $ 500,000

Completion of guarantee period

At the end of the six year guarantee period, Company A will no longer have any continuing involvement with the property and should record the sale of the property (assuming all other criteria for recognizing profit under the full accrual method are satisfied upon the elimination of the continuing involvement), which would result in a gain of $128,000 ($488,000 financing liability — $360,000 carrying amount of property). This gain is not affected by the results of operations during the guarantee period.



A.5 Leasing method The application of the leasing method does not result in a sale of real estate for accounting purposes. That is, the real estate remains on the seller’s books.

When a transaction includes certain forms of continuing involvement, ASC 360-20 indicates that the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement (see sections 5.6 — 5.9). The leasing method is generally applied to transactions in which the seller has an obligation or an option it is expected to exercise to repurchase a property at a price that is less than the selling price (see section 5.6).

ASC 360-20 does not provide any guidance on how to apply the leasing method to a real estate transaction. We believe it would generally be appropriate for a seller to apply the following guidelines when accounting for a transaction using the leasing method:

• No profit or sale should initially be recognized, the seller should not recognize a receivable, and the property and any related existing debt assumed by the buyer should remain on the seller’s balance sheet.


• Any cash received from the buyer equal to the purchase price should be recorded as a liability. The difference between the cash received from the buyer and the seller’s repurchase price represents deferred rental income that should be recognized ratably over the rental period. Because this type of transaction may also include a financing element, we believe the seller may record the repurchase liability at its stated amount or at a discount. If the repurchase liability is recorded at a discount, interest expense and additional rental income are recognized during the financing/rental period.

• If it is possible that the seller will not repurchase the property (e.g., the buyer has an option to put the property back to the seller), the carrying amount of the property should not exceed the repurchase liability recorded by the seller (i.e., there should be no loss on the sale of the property if the option expires unexercised). Instead, the seller should adjust the rental income so that the repurchase liability is equal to the carrying amount at the end of the option period.

• Unlike the financing and profit-sharing methods, because the buyer is paying for the right to use the property for a period of time, the operating results of the property should not be recorded by the seller.

The following example illustrates the leasing method:

Illustration A-8: Application of the leasing method

Facts:

Company A sells a hotel with a carrying amount of $600,000 to Company B for $1,000,000 in cash. Company A has an obligation to repurchase the property from Company B after five years for $800,000. Annual depreciation on the property is $15,000. Company A’s normal borrowing rate is 11 percent.

Analysis:

Because Company A has an obligation to repurchase the hotel from Company B, this transaction should be accounted for as a financing, leasing, or profit-sharing arrangement. Because the repurchase price is less than the sales price, we believe this transaction is most appropriately accounted for as a leasing transaction (see section 5.6).



If Company A determines it is appropriate to discount the liability to Company B, when cash of $1,000,000 is received from Company B, Company A should record a financing liability of $475,000 (based on Company A’s normal borrowing rate of 11 percent) and deferred rental income of $525,000. During the first year, Company A should recognize $15,000 in depreciation, $105,000 in rental income ($525,000 deferred income/5 years), and $52,000 in interest expense. At the end of five years, Company A will have recognized $525,000 in rental income and $325,000 in interest expense and the liability will equal the repurchase price of $800,000.

If Company A does not discount the liability to Company B, when cash of $1,000,000 is received from Company B, Company A should record a financing liability of $800,000 and deferred rental income of $200,000. During the first year, Company A should recognize $15,000 in depreciation and $40,000 in rental income ($200,000 deferred income/5 years). At the end of five years, Company A will have recognized $200,000 in rental income.

A.6 Profit-sharing method The application of the profit-sharing method does not result in a sale of real estate for accounting purposes. That is, the real estate remains on the seller’s books.

When a transaction includes certain forms of continuing involvement, ASC 360-20 indicates that the transaction should be accounted for as a financing, leasing, or profit-sharing arrangement (see sections 5.6 — 5.9). The profit-sharing method is generally applied when a seller is a general partner in a limited partnership that acquires an interest in the property sold and holds a receivable from the buyer for a significant part of the sales price (see section 5.7). The profit-sharing method may also be applied when there is an obligation or option to repurchase a property (see section 5.6), a guaranteed return on or of a buyer’s investment (see section 5.8), or an obligation to support the operations of a property (see section 5.9). The profit-sharing method is often the most appropriate method to apply in partial sales of real estate with continuing involvement.

ASC 360-20 does not provide any guidance on how to apply the profit-sharing method to a real estate transaction. We believe it would generally be appropriate for a seller to apply the following guidelines when accounting for a transaction using the profit-sharing method:

• No profit or sale should be recognized, the seller should not recognize a receivable, and any existing debt related to the property assumed by the buyer should remain on the seller’s balance sheet.


• The property should be reclassified to an investment account and any cash received from the buyer should be credited to the investment account. Depreciation on the property should also be recorded to this account. As noted above, the seller is still required to assess the property for impairment, so the seller must also separately track the net carrying amount of the property. Depending on the terms of the transaction, the balance in this account may be a debit or a credit. If all consideration to which the seller is entitled has been received, the account balance should be a credit (i.e., the carrying amount of the property is less than the cash received from the buyer). If the balance is a debit, the property is likely impaired. Because the seller must continue to track the net carrying amount of the property for impairment evaluation purposes, as an alternative, a seller may choose not to reclassify the property to an investment account and instead record a liability for cash received from the buyer similar to the financing method discussed above.



• The operating results of the property (excluding depreciation) should initially be recorded by the seller as a reduction (operating loss) or increase (operating income) in the investment account. Any benefit (income) generated by the property that the seller is not entitled to receive should be reflected as profit-sharing expense. Similarly, if the seller is not exposed to losses on the property, such as when the only continuing involvement is an obligation to repurchase the property at a price equal to the sales price (see section 5.6), profit-sharing income (or a reduction in profit-sharing expense) should be recorded when the property operates at a loss.

• Principal payments on debt assumed by the buyer should be reflected as a credit to the investment account.

• Any support payments made by the seller should be recorded as an increase in the investment account because any loss from operations has already been recorded.

• Any guaranteed return payments should be recorded as an increase in the investment account.

Illustration A-9: Support obligation for an extended period

Facts:

Company A sells a hotel with a carrying amount of $600,000 to Company B for $1,000,000 in cash. Company A has committed to support the operations of the hotel up to a breakeven level for six years. Annual depreciation on the property is $40,000.

Analysis:

Because Company A has an obligation to support the operations of the property sold for an extended period (six years), this transaction should be accounted for as a financing, leasing, or profit-sharing arrangement (see section 5.9). Assuming Company A determines it is most appropriate to account for this transaction as a profit-sharing arrangement, when cash of $1,000,000 is received from Company B, Company A should record the following journal entries:

Cash $ 1,000,000 Investment $ 1,000,000

Investment $ 600,000 Building $ 600,000

The above entries result in a net credit balance of $400,000 in the investment account. Company A should record depreciation expense of $40,000 each year by crediting the investment account.

The accounting for the operations of the property (excluding depreciation) and the support obligation for various scenarios is summarized below:

Property operates at breakeven level (excluding depreciation)

If the property generates $200,000 in revenue and $200,000 in cash expenses, because Company A is only obligated to support the operations of the property up to a breakeven level, Company A would not be required to make any payments to Company B. Company A would record the following journal entry to record the operations of the property:

Operating expenses $ 200,000 Revenue $ 200,000

Property generates profit (excluding depreciation)



If the property generates $300,000 in revenue and $200,000 in cash expenses, because Company A is only obligated to support the operations of the property up to a breakeven level, Company A would not be required to make any payments to Company B. Company A would record the following journal entry to record the operations of the property:

Operating expenses $ 200,000 Investment 100,000

Revenue $ 300,000

Because Company A is not entitled to receive any of the benefit from the operations of the property, the $100,000 operating profit (excluding depreciation) effectively represents a profit-sharing payment made to Company B and should result in the following journal entry:

Profit-sharing expense $ 100,000 Investment $ 100,000

Property operates at loss (excluding depreciation)

If the property generates $50,000 in revenue and $200,000 in cash expenses, because Company A is obligated to support the operations of the property up to a breakeven level, Company A would be required to make a payment of $150,000 to Company B. Company A would record the following journal entries to record the operations of the property and the support obligation:

Operating expenses $ 200,000 Investment $ 150,000 Revenue 50,000

Investment $ 150,000 Payable to Company B $ 150,000

Completion of support period

At the end of the six-year support period, Company A will no longer have any continuing involvement with the property and should record a sale by eliminating any remaining balance in the investment account as a gain on sale.

Illustration A-10: Guaranteed return for an extended period

Facts:

Assume the same facts as in Illustration A-9, except Company A guarantees that Company B will receive a 10 percent return on its investment for the first six years.

Analysis:

Assuming Company A determines it is most appropriate to account for this transaction as a profit-sharing arrangement (see section 5.8), the only difference between the accounting for this transaction and the accounting for the transaction described in Illustration A-9, would be in the breakeven and loss scenarios. Because Company A has guaranteed that Company B will receive a return of at least $100,000, Company A would record the following additional journal entry to account for the guarantee in these scenarios:

Investment $ 100,000 Payable to Company B $ 100,000



Additionally, a similar journal entry would be required if the net operating income generated by the property, excluding depreciation, was less than the guaranteed return (e.g., if the net operating income, excluding depreciation, was only $30,000, the above entry would be for $70,000 instead of $100,000).

In the above scenarios, because there is a net increase in the investment account (a debit of $100,000 or $70,000 for the guaranteed return and a credit of $40,000 for depreciation), it may be necessary for Company A to recognize profit-sharing expense during the year. If Company A believes there will be a net debit balance in the investment account at the end of the guarantee period, Company A should recognize profit-sharing expense instead of a debit to the investment account so that a loss would not be incurred at the future point of sale.

Illustration A-11: Obligation to repurchase property

Facts:

Assume the same facts as in Illustration A-9, except instead of a support obligation, Company B could at its option require Company A to repurchase the property after six years for $1,000,000.

Analysis:

Assuming Company A determines it is most appropriate to account for this transaction as a profit-sharing arrangement (see section 5.6), the only difference between the accounting for this transaction during the six-year period it is accounted for under the profit-sharing method and the accounting for the transaction described in Illustration A-9, would be that Company B would bear operating losses under the profit-sharing arrangement (excluding depreciation). Because the property remains on Company A’s balance sheet (i.e., a failed sale accounted for under the profit-sharing method), Company A must record the operating results of the property in its income statement. However, because the arrangement does not include a guarantee or support obligation, Company A is not exposed to losses from the operations of the property. The assumption of the loss under the profit-sharing arrangement by Company B is recorded as profit-sharing income by Company A to offset the operating losses reflected in its income statement. Company A would record the following journal entries to record the operations of the property and the loss assumed by Company B (Company A would also record depreciation expense of $40,000 each year by crediting the investment account):

Operating expenses $ 200,000 Investment $ 150,000

Revenue 50,000

Investment $ 150,000

Profit-sharing income $ 150,000

Although Company A is not responsible for any losses on the property, an operating loss could be an indicator of impairment that should be evaluated in accordance with ASC 360-10.

At the end of six years if Company B does not require Company A to repurchase the property, Company A will no longer have any continuing involvement with the property and should record a sale by eliminating any remaining balance in the investment account as a gain on sale.

If Company B requires Company A to repurchase the property, the net book value of the asset of $360,000 ($600,000 original book value less $240,000 in deprecation over six years assuming no intervening impairment under ASC 360-10 should be reclassified to fixed assets and the remaining credit balance in the investment account would be the $1,000,000 payment due to Company B. There would be no gain or loss on the transaction.

Financial Reporting Developments Real estate sales | B-1

B Sales of real estate (other than retail land sales) decision tree

3.

Deposit method

¶ 28

5.

Recovery of cost of property assured?

¶31

6. Deposit (or

cost recovery) method

¶ 31

1.

Consummation of sale? ¶ 7

4.

Initial investment adequate? ¶9-10, 13

18,21

Start

7. Continuing investment adequate? ¶19-20, 22-24

12.

Subject to future subordination?

¶25

16.

Full accrual method

¶5

13.

Cost recovery method

¶ 36

15.

Transfer risks & rewards? ¶ 26, 64

A

A

8. Annual

paymts. > int. & prin. on 1st mtge. & int. on excess?

¶33

14. Installment (or cost recovery)

method ¶31

No

No

No

No

No

Yes

No

Yes

Yes

Yes

Yes

Yes

Yes

Yes Yes

10.

Reduced profit method

¶33


method ¶33

2. Construction of condos, office buildings, etc.?

¶28

9.

Transfer risks & rewards? ¶26, 64

No No

No

Note: All paragraph references are within ASC 360-20-40



24.

Performance of services method

¶41

A

17.

Obligation or option to repurchase?

¶33

18.

General ptnr. in partnership & holds

receivable? ¶40

20.

Guarantee for extended period?

¶41

21.

Initiate/support for extended period?

¶42-44

22.

Guarantee for limited period?

¶41

26. Initiate/support for limited time or until level of operations

reached? ¶42-44

28.

Transaction is sale of an option?

¶45

B

19.

Financing, leasing, or profit

sharing ¶38, 40-44

23.

Operations cover expenses?

¶41

25.

Deposit method

¶41

27. Performance of services method

¶42-44

29.

Option sold by prop. owner or by

option holder? ¶45

30.

Deposit, until expires or is

exercised ¶45

32.

Full accrual method

¶45

33.

Cost recovery method

¶45

31.

Init. & cont. investment test

met? ¶45

No

No

No

No

No

No

No

Yes

Yes

Yes

Yes

Yes

Yes

Yes

By property owner

Yes

By option holder

Yes

No

No



43. Percentage-of-

completion method

¶50

B

34. Partial sale? ¶46

37. Collection assured?

¶48

41. Sale of

indiv. units in condo?

¶50

46. Sale of

improvements, lease of land?

¶56

47. Lease for

substantial period? ¶56-59

C

36. Proportionate

profit or no profit recognized

¶47

42. Constr. begun,

buyer committed, no reversion, sales

known? ¶50

50. Sale and

leaseback? ¶60

54. Allocate profit to

land and development: % of completion

¶61-62

55. No profit

recognized ¶63

52. Seller required to develop further?

¶61-62

35. Buyer

independent? ¶47


method ¶48

39. Support

obligations? ¶49

40. If sale recorded, profit limited to

excess of proceeds over costs

¶49

53. Cost of

development estimable?

¶61-62

51. Refer to

Subtopics 840-10 & 840-40

¶60

45.

Deposit method ¶50

48. PV of rent &

sales value of improvements less carrying

value ¶57-59

44. Full accrual

method ¶46

49. As a lease of both land &

improvements ¶56

No

Yes No

Yes

No

Yes

Yes

Yes

No

No

Yes

Yes Yes

No

Yes

Yes Yes

No

No No

No

No



C

56. Seller only

participates in future profit?

¶64

58. Some other form of

continuing involvement?

¶37

57. Future profit

recognized when realized

¶64

No

Yes

59. According to

nature of involvement

¶37

Yes

Financial Reporting Developments Real estate sales | C-1

C Abbreviations used in this publication

Abbreviation FASB Accounting Standards Codification ASC 310-20 FASB ASC Subtopic 310-20, Receivables — Nonrefundable Fees and Other Costs ASC 320 FASB ASC Topic 320, Investments — Debt and Equity Securities ASC 360-10 FASB ASC Subtopic 360-10, Property, Plant, and Equipment — Overall ASC 360-20 FASB ASC Subtopic 360-20, Property, Plant, and Equipment — Real Estate Sales ASC 450 FASB ASC Topic 450, Contingencies ASC 470-30 FASB ASC Subtopic 470-30, Debt — Participating Mortgage Loans ASC 810 FASB ASC Topic 810, Consolidation ASC 825 FASB ASC Topic 825, Financial Instruments ASC 835-30 FASB ASC Subtopic 835-30, Interest — Imputation of Interest ASC 840-40 FASB ASC Subtopic 840-40, Leases — Sale-Leaseback Transactions ASC 845 FASB ASC Topic 845, Nonmonetary Transactions ASC 860 FASB ASC Topic 860, Transfers and Servicing ASC 970 FASB ASC Topic 970, Real Estate — General ASC 970-323 FASB ASC Subtopic 970-323, Real Estate — General — Investments — Equity

Method and Joint Ventures ASC 970-605 FASB ASC Subtopic 970-605, Real Estate — General — Revenue Recognition ASC 976 FASB ASC Topic 976, Real Estate — Retail Land ASC 976-605 FASB ASC Subtopic 976-605, Real Estate — Retail Land — Revenue Recognition Statement 66 FASB Statement No. 66, Accounting for Sales of Real Estate

Financial Reporting Developments Real estate sales | D-1

D Index of ASC references in this publication

ASC Paragraph Chapter/Section 360-20-15-1 1 Scope 360-20-15-2 1 Scope 360-20-15-3 1 Scope 360-20-15-4 1.3 Integral equipment 360-20-15-5 1.3 Integral equipment 360-20-15-6 1.3 Integral equipment 360-20-15-7 1.3 Integral equipment 360-20-15-8 1.3 Integral equipment 360-20-15-9 5.13 Condominium sales 360-20-15-10 1.4 Transactions excluded from the scope of ASC 360-20 360-20-40-1 5 Recognition of profit when the full accrual method is not appropriate 360-20-40-3 2.1 Recognition of profit by the full accrual method 360-20-40-4 2.1 Recognition of profit by the full accrual method 360-20-40-5 2.1 Recognition of profit by the full accrual method 360-20-40-7 2.2 Consummation of a sale 360-20-40-8 2.3 Sales value 360-20-40-9 3.1 Buyer’s initial investment 360-20-40-10 3.2 Composition of buyer’s initial investment 360-20-40-11 3.2.1 Irrevocable letters of credit 360-20-40-12 3.2.1 Irrevocable letters of credit 360-20-40-13 3.3 Items excluded from buyer’s initial investment 360-20-40-14 3.2.2 Applicability of the initial and continuing investment tests and the

effects of various forms of financing 360-20-40-15 3.2.2 Applicability of the initial and continuing investment tests and the



effects of various forms of financing 360-20-40-18 3.4 Size of buyer’s initial investment 360-20-40-19 3.5 Buyer’s continuing investment 360-20-40-20 3.5 Buyer’s continuing investment 360-20-40-21 3.6 Release provisions 360-20-40-22 3.6 Release provisions 360-20-40-23 3.6 Release provisions 360-20-40-24 3.7 Cumulative application of initial and continuing investment tests



ASC Paragraph Chapter/Section 360-20-40-25 4.1 Receivable subject to future subordination 360-20-40-26 4.2 Continuing involvement 360-20-40-27 5 Recognition of profit when the full accrual method is not appropriate 360-20-40-28 5.1 Sale not consummated 360-20-40-29 5.1 Sale not consummated 360-20-40-30 5.1 Sale not consummated 360-20-40-31 5.2 Buyer’s initial investment is not adequate 360-20-40-32 3.2.2 Applicability of the initial and continuing investment tests and the

effects of various forms of financing 360-20-40-32 5.2 Buyer’s initial investment is not adequate 360-20-40-33 5.3 Buyer’s continuing investment is not adequate 360-20-40-34 5.3 Buyer’s continuing investment is not adequate 360-20-40-35 3.5.1 Customary amortization term 360-20-40-36 5.4 Receivable subject to future subordination 360-20-40-37 5.5 Continuing involvement without transfer of risks and rewards 360-20-40-38 5.6 Obligation or option to repurchase 360-20-40-39 5.6.1 Antispeculation clauses in real estate sales contracts 360-20-40-40 5.7 General partner holds a significant receivable from the buyer 360-20-40-41 5.8 Guarantee of the return of the buyer’s investment or a return on

the buyer’s investment 360-20-40-42 5.9 Requirement to initiate or support operations 360-20-40-43 5.9 Requirement to initiate or support operations 360-20-40-44 5.9 Requirement to initiate or support operations 360-20-40-45 5.11 Transaction is merely an option to purchase 360-20-40-46 5.12 Partial sales of real estate 360-20-40-47 5.12 Partial sales of real estate 360-20-40-48 5.12 Partial sales of real estate 360-20-40-49 5.12 Partial sales of real estate 360-20-40-50 5.13 Condominium sales 360-20-40-51 5.13 Condominium sales 360-20-40-52 5.13 Condominium sales 360-20-40-53 5.13 Condominium sales 360-20-40-54 5.13 Condominium sales 360-20-40-55 5.13 Condominium sales 360-20-40-56 5.14 Seller sells property improvements and leases the underlying land

to the buyer 360-20-40-57 5.14 Seller sells property improvements and leases the underlying land



to the buyer 360-20-40-60 5.15 Sale-leaseback transactions



ASC Paragraph Chapter/Section 360-20-40-61 5.16 Sales contract requires seller to develop property 360-20-40-62 5.16 Sales contract requires seller to develop property 360-20-40-63 5.16 Sales contract requires seller to develop property 360-20-40-64 5.17 Seller participates in future profits from the property without risk

of loss 360-20-55-1 3.4.1 Minimum initial investment requirements 360-20-55-2 3.4.1 Minimum initial investment requirements 360-20-55-3 3.2.1 Irrevocable letters of credit 360-20-55-4 3.2.1 Irrevocable letters of credit 360-20-55-5 3.2.1 Irrevocable letters of credit 360-20-55-7 1.3 Integral equipment 360-20-55-7 A.1 Installment method 360-20-55-8 A.1 Installment method 360-20-55-9 A.1 Installment method 360-20-55-10 A.1 Installment method 360-20-55-11 A.1 Installment method 360-20-55-12 A.1 Installment method 360-20-55-13 A.2 Cost recovery method 360-20-55-14 A.2 Cost recovery method 360-20-55-15 A.2 Cost recovery method 360-20-55-16 5.3 Buyer’s continuing investment is not adequate 360-20-55-17 A.3 Deposit method 360-20-55-18 A.3 Deposit method 360-20-55-19 A.3 Deposit method 360-20-55-20 A.3 Deposit method 360-20-55-21 B Sales of real estate (other than retail land sales) decision tree 360-20-55-21A 5.6.2 Buy-sell clauses 360-20-55-23 5.14 Seller sells property improvements and leases the underlying land



to the buyer 360-20-55-26 2.3.4 Calculating the sales value of improvements subject to a land lease 360-20-55-27 2.3.4 Calculating the sales value of improvements subject to a land lease 360-20-55-28 5.14 Seller sells property improvements and leases the underlying land




to the buyer



ASC Paragraph Chapter/Section 360-20-55-32 5.14 Seller sells property improvements and leases the underlying land












to the buyer 360-20-55-44 5.9.4 Profit recognition on performance of services 360-20-55-45 5.9.4 Profit recognition on performance of services 360-20-55-46 5.9.4 Profit recognition on performance of services 360-20-55-47 5.9.4 Profit recognition on performance of services 360-20-55-48 5.9.4 Profit recognition on performance of services 360-20-55-49 5.9.3 Estimating future rent receipts 360-20-55-50 5.9.3 Estimating future rent receipts 360-20-55-51 A.1 Installment method 360-20-55-52 A.1 Installment method 360-20-55-53 A.1 Installment method 360-20-55-54 A.1 Installment method 360-20-55-55 3.2.2 Applicability of the initial and continuing investment tests and the


effects of various forms of financing 360-20-55-57 1.3 Integral equipment 360-20-55-58 1.3 Integral equipment 360-20-55-59 1.3 Integral equipment 360-20-55-60 5.3 Buyer’s continuing investment is not adequate 360-20-55-61 5.3 Buyer’s continuing investment is not adequate



ASC Paragraph Chapter/Section 360-20-55-62 5.3 Buyer’s continuing investment is not adequate 360-20-55-63 5.3 Buyer’s continuing investment is not adequate 360-20-55-64 5.3 Buyer’s continuing investment is not adequate 360-20-55-65 3.2.3 Transfer of ownership interests as part of down payment 360-20-55-66 3.2.3 Transfer of ownership interests as part of down payment 360-20-55-67 3.2.3 Transfer of ownership interests as part of down payment 825-10-55-1 3.5.2.2 Nontraditional financing terms 845-10-15-15 1.6.1 Nonmonetary transactions involving boot 845-10-15-16 1.6.1 Nonmonetary transactions involving boot 845-10-15-17 1.6.1 Nonmonetary transactions involving boot 845-10-25-6 1.6.1 Nonmonetary transactions involving boot 845-10-25-7 1.6.1 Nonmonetary transactions involving boot 845-10-25-8 1.6.1 Nonmonetary transactions involving boot 845-10-30-16 1.6 Nonmonetary exchanges 845-10-30-23 1.6.1 Nonmonetary transactions involving boot 970-360-30-1 5.13.6 Application of the percentage-of-completion method to a

condominium project 970-605-25-5 1.7 Accounting for real estate syndication income 970-360-55-4 5.16.1 Percentage-of-completion and home sales 976-605-30-3 A.1 Installment method 976-605-35-1 A.1 Installment method

Financial Reporting Developments Real estate sales | E-1

E Summary of important changes

The following highlights the topics for which substantive updates have been made in recent editions of this publication. Other non-substantive or clarifying changes are not listed.

• There have been no significant changes.

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