Revenue Recognition for Operating Real Estate Entities

Updated on: June 6, 2018

With the 2018 effective date for the new revenue recognition standard issued by FASB quickly approaching, SC&H Group has pulled together a comprehensive series of industry specific resources. The following blog post summarizes revenue recognition concepts specific to real estate entities that must be considered to ensure their accounting policies are aligned with the FASB’s new standard.

The new revenue standard affects how operating real estate entities must account for sales of real estate to service arrangements with customers. The revenue standard replaces Accounting Standards Codification 360-20, with a principles-based approach for sales of real estate. Entities will apply ASC 606 to account for sales of real estate (that do not meet the definition of a business) to customers and ASC 610 to account for sales of real estate (that do not meet the definition of a business) to non-customers. Although leases are not within the scope of the new revenue recognition standard, operating real estate entities are required to apply its provisions to account for certain non-lease components.

The following post shares key factors to consider as real estate entities progress through the 5 step revenue recognition model.

Identify the contract with the customer

A contract must create enforceable rights and obligations to fall within the scope of the new standard. Contracts can be written, oral or implied by an entity’s ordinary business practices. Real estate entities should consider any history of entering into amendments, side agreements or modifications to contracts, whether verbal or written, as these all have specific implications for revenue recognition. Additionally, contract modifications are considered a new contract separate from the original contract if the modification adds distinct goods or services at a price that reflects standalone selling prices of those goods or services, i.e. property management.

Identify the contract’s separate performance obligations

Many operating real estate entities provide property management services to customers. Property management contracts are generally composed of multiple underlying activities, as such, significant judgment may be required when applying the new standard. Entities need to first determine which services within the contract are distinct and therefore could represent separate performance obligations. The identification of performance obligations may affect when revenue is ultimately recognized.

Determine the transaction price

The transaction price is calculated as the amount of consideration the entity expects to be entitled to for providing the promised goods or services to a customer. The transaction price should include an estimate to account for any variable components i.e. concessions.

Allocate the transaction price to the separate performance obligations

Under the new standard, management must allocate the transaction price to each distinct separate performance obligation based on the relative standalone selling price of each distinct good or service promised. In a contract where property management services are included within the terms of the lease, generally, those services must be separately estimated on a standalone basis.  The best evidence of a standalone selling price is the price management would charge for the product or services when the entity sells it separately.

Recognize revenue when or as the entity satisfies a performance obligation

Revenue is recognized when (or as) the performance obligations are satisfied. The revenue standard provides guidance to help determine if a performance obligation is satisfied at a point in time or over time. When a performance obligation is satisfied over time, the related revenue is also recognized over time.

Non-lease components

The current guidance in ASC 840, Leases, requires non-lease elements in a contract to be separated from the lease element at inception. Reimbursements the lessor receives for lease related executory costs (i.e. insurance, maintenance, and taxes) are considered part of the lease element.

The new lease standard, ASC 842, Leases, will require lessors to account for the services in a lease contract that are transferred separately from the right to use the underlying asset as non-lease components. Although this is similar to the guidance in ASC 840, leases executed after the adoption of ASC 842 will require that common area maintenance (CAM) services be considered a non-lease component rather than part of the lease.

Disclosure Requirements – What do Financial Statement Users Need to Know about Performance Obligations?

FASB’s new model includes a variety of disclosure requirements, one of which relates specifically to performance obligations. The goal of the expanded disclosures is to eliminate “boilerplate” language and instead provide a more meaningful description of revenue recognition policies and how they are applied to contracts with customers.

While the standard does not specify the level of detail required, operating real estate companies should consider the level of disaggregation of revenue streams and provide additional detail to depict the revenue streams both quantitatively and qualitatively. Below are examples of common revenue streams of operating real estate companies. Companies must evaluate the streams to determine if separate performance obligations exist:

  • Revenues from rental properties – base rent, above and below market rent adjustments, lease termination fee income
  • Reimbursement income – generally reimbursement of CAM costs, real estate taxes and other operating expenses
  • Management and other fee income – property management fees, property acquisition and disposition fees, construction management fees, leasing fees and asset management fees

Nonpublic entities are required to adopt the new standard for annual reporting periods beginning after December 15, 2018 (December 31, 2017 for public entities).  Implementation is to be done on a retrospective basis, so organizations should understand and account for revenue under the new standard at least a year in advance.

As a result of these standards entities need to reassess their current revenue accounting and determine whether changes are necessary. SC&H Group is here to help as you are navigating the best next steps to pursue. If you have any questions about revenue recognition specific to the real estate industry please Contact Us.

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