Accounting for real estate syndication income and foreclosed assets.

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies statements of position (SOPs) as sources of established GAAP This month's column summarizes American Institute of CPAs SOPs no. 92-1, Accounting for Real Estate Syndication Income, and no. 92-3, Accounting for Foreclosed Assets.

Both SOPs are available as sepa| rate pamphlets (SOP no. 92-1, product no. 014853; SOP 92-3, product no. 014855) and also are included in the AICPA Technical Practice Aids loose-leaf service. To obtain these publications, contact the AICPA order department, P.O. Box 1003, New York, New York 10108-1003. Telephone: [phone] [(800) 2480445 in New York State].

SOP NO. 92-1

On February 6, 1992, the AICPA accounting standards division released SOP no. 92-1, which is an established source of GAAP for income recognition from syndication activities--efforts to directly or indirectly sponsor the formation of limited partnerships, trusts, joint ventures or entities acquiring interests in real estate by raising funds from investors. If the initial closing with investors occurred after March 15, 1992, the SOP is effective. Earlier application is encouraged for financial statements not previously issued.

The FASB's emerging issues task force (EITF) identified the need for guidance on real estate syndications in Issue no. 85-37, Recognition of Notes Received for Real Estate Syndication Activities. The EITF was unable to reach a consensus and referred the issue to the AICPA real estate committee. The resulting SOP concludes the following:

a. Applicability of FASB Statement no. 66, Accounting for Sales of Real Estate, to syndication activities. Statement no. 66 applies to the recognition of profit from real estate sales by syndicators to partnerships, although it does not apply to the recognition of fees excluded from sales value. SOP no. 92-1 concludes that the guidance in Statement no. 66 should be applied to profit recognition for all real estate syndication transactions, even when the syndicators never had ownership interests in the properties acquired by the real estate partnerships.

b. Determining sales value of property and fee income. In applying Statement no. 66, all fees charged by syndicators should be included in determining sales value, except fees for which future services must be performed (which should be recognized at the time they're performed) and syndication fees.

c. Syndication fees. Syndicalors should not recognize syndicalion fees until the earnings process is complete and collectibility is reasonably assured. If a syndicator receives or retains a partnership interest as compensation for syndicating a deal, the amount of profit that may be recognized as syndication fee should not exceed the proportionate cost of the partnership interest, using partial sale accounting, as described in Statement no. 66.

d. Exposure to losses or costs from syndicator involvement and collectibility risk. Material involvement with the properties, partnerships or partners or uncertainties regarding the collectibility of partnership notes may expose syndicators to future losses or costs. If so, they should defer income recognition on syndication fees and fees for future services until the losses or costs can be estimated reasonably.

e. Allocating cash payments. In determining whether buyers' initial and continuing investments satisfy the requirements for full profit recognition, cash received by syndicators should be allocated to unpaid syndication fees before being allocated to initial and continuing investment. After the syndication fee is fully paid, additional cash received should be allocated to unpaid fees for future services (to the extent those services have been performed by the time the cash is received) before being allocated to sales value.

f. Recognition of partnership interests received or retained. SOP no. 92-1 amends paragraph 32 of SOP no. 78-9, Accounting for Investments in Real Estate Ventures, to exempt syndicators that receive or retain partnership interests in a syndication transaction. Such syndicators otherwise would have been precluded from recognizing fee income on services performed for the partnerships; rather, the syndicators would have been required to allocate the costs of performing the services to the carrying amounts of their partnership interests. SOP NO. 92-3 On April 28, 1992, the AICPA accounting standards division released SOP no. 92-3, which addresses the balance sheet treatment of foreclosed assets and in-substance foreclosed assets after foreclosure. It applies to all assets obtained through foreclosure or repossession, except for inventories, marketable equity securities and real estate previously owned by the lender and accounted for under Statement no. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects. The SOP is effective for foreclosed assets and in-substance foreclosed assets in annual financial statements for those periods ending on or ending after December 15, 1992.

Accounting for foreclosed assets after foreclosure has been diverse for many years:. Some enterprises report foreclosed assets at amounts no greater than net realizable value; some factor in interest costs to carry the asset, and some don't; others report foreclosed assets at the lower of cost or fair value.

Although the methods and issues have been debated for over a decade, certain developments (the savings and loan crisis, depressed real estate markets, regulatory pressure, new legislation and increased bank competitiveness) underscored the urgency of reducing diverse accounting practices for foreclosed assets.

The SOP applies to all enterprises except those valuing their assets at fair value (such as investment companies). It is a major step toward eliminating inconsistencies and diversity in accounting for foreclosed assets and leveling the playing field for all holders of foreclosed assets.

The SOP presumes foreclosed assets are held for sale and requires such assets be carried at the lower of cost or fair value minus estimated costs to sell. Foreclosed assets held for the production of income should be treated the same as if the assets had been acquired in a manner other than through foreclosure. The SOP essentially limits the amount at which a foreclosed asset held for sale may be reported to its fair value minus estimated cost to sell.

On the adoption date, (a) the carrying amount and (b) fair value minus estimated costs to sell for each foreclosed asset held for sale and insubstance foreclosed asset should be compared. To the extent that the amount of (b) exceeds the amount of (a), income from continuing operations for the adoption period should be charged and the carrying amount of the assets should be adjusted through a valuation allowance. The carrying amount of assets would not be adjusted upward as a result of adopting the SOP. Valuation allowances that are related to foreclosed assets held for sale and in-substance foreclosed assets existing at the adoption date may be retained. However, the SOP does not have an effect on any previous decisions to charge off portions of assets.

The accounting standards division has another project under way on accounting for the results of operations of foreclosed assets held for sale. An exposure draft is expected to be issued late in 1992.

By CLIFFORD H. SCHWARTZ ,. CPA, senior technical manager, and DIONNE McNAMEE, technical manager, of the AICPA accounting standards division. Edited by LINDA A. VOLKER T, CPA, technical manager. of the AICPA technical information division.

EXECUTIVE SUMMARY

* STATEMENT on Auditing Standards no. 69 identifies statements of position (SOPs) as sources of established GAAP.

* SOP 92-1 addresses income recognition from syndication activities-efforts to directly or indirectly sponsor the formation of limited partnerships, trusts, joint ventures or other entities that acquire interests in real estate by raising funds from investors. It applies to all entities that perform such activities, not just those whose primary business is real estate syndication.

* SOP 92-3 addresses balance sheet treatment of foreclosed assets and in-substance foreclosed assets after foreclosure. It applies to most assets obtained through foreclosure or repossession and to all enterprises except for those valuing their assets at fair value.