Current value reporting for real estate: an industry perspective.

Current value reporting provides users with information about financial resources that may be available to an entity either through their use or sale. In addition, it reflects changes in those amounts from one reporting period to another. Current value reporting has been discussed by the accounting profession many times over the years, usually in the context of changes in general price levels. Recently, there has been a growing interest by companies that invest in and operate real estate properties in presenting supplementary current value information. This information, along with historical cost financial statements, would give users (such as investors and lenders) more useful information for decision making.

Real estate assets traditionally have tended to fluctuate widely in value. Since inflation is currently under control, the increased interest in current value reporting is not due to changes in general price levels. Instead this interest reflects a perceived need for better information about a real estate entity's assets and liabilities as well as the capacity of these assets to benefit the entity economically.

RECENT INITIATIVES

Over the years, the accounting profession has tried to deal with changing values in financial statements by using various methods to account for the effects of inflation (see sidebar on page 71). Supporters of supplementary current value reporting for real estate companies believe it is time for the profession to take a look at the issues outside the context of inflation. They recognize that information based on historical cost generally is more reliable and objective than current value information. However, they point out that even staunch supporters of historical cost information admit the recorded amounts of nonmonetary assets (for example, buildings and property) in real estate companies' historical cost financial statements generally do not provide relevant information about the values of these assets. Therefore, they suggest that historical cost financial statements alone are not a sufficiently informative basis on which to make sound management and investment decisions.

Supplementary reporting about the current values of assets and liabilities can provide this necessary financial information. The American Institute of CPAs real estate committee has established a task force to develop guidance for the real estate industry on the presentation of supplementary current value information. This initiative is a follow-up to the AICPA report Guidance for an Experiment on Reporting Current Value Information for Real Estate issued in 1984.

In addition, an issues paper titled The Changing Significance of Financial Statements--The Relative Disparity Between Content and Need, developed by the AICPA future issues committee, explores the committee's view that "financial statements are of decreasing relative importance within the context of the total range of information available" and calls on the AICPA to take a leadership role in addressing this problem. The accounting standards executive committee agreed to create a task force to deal with the quality of financial reporting issues. Current value reporting most likely will be one of the issues considered by the task force.

CHARACTERISTICS OF ASSETS

As stated in Financial Accounting Standards Board Financial Accounting Concepts Statement no. 6, Elements of Financial Statements, one of the characteristics of an asset is that "it embodies a probable future benefit that involves a capacity, singly or in coordination with other assets, to contribute directly or indirectly to future net cash inflows." Historical cost financial statements do not provide users with the most relevant information about the possible economic benefits of assets because real estate assets have unique characteristics. First, the values of well-maintained properties usually appreciate rather than depreciate. Because depreciation does not approximate changes in value of income-producing real estate, the amounts of depreciated assets on the balance sheet are meaningless for users who need to estimate the value of those assets or evaluate a real estate entity's capacity to generate financial resources. Further, because depreciation is deducted in computing net income, information about a real estate entity's historical cost-based operating performance does not reflect its economic performance.

Proponents of current value reporting argue that under the historical cost model, the amounts at which real estate assets are reported (acquisition cost less depreciation) do not fully inform users about the probable future benefit of those assets to the entity for the following reasons:

* Changes in the reported amounts of assets, which generally are carried at acquisition cost, are not reported until confirmed by a transaction (for example, a disposal of the property).

* Depreciation reduces the reported amounts of assets by systematically allocating their acquisition costs to accounting periods as the assets are "consumed" through use. As a result, a real estate company's assets are reported as if they are wasting assets. Instead, information about changes (both decreases and increases) in their revenue-generating capacity is more relevant to users.

* The depreciated amounts of real estate assets do not fully inform users about the potential economic benefits of the assets in terms of cash flows that may be generated through their futurea use or sale.

SUPPORT FOR CURRENT VALUE REPORTING

The concept of current value reporting for income-producing assets was

supported by FASB members David Mosso, Robert Sprouse and Ralph Walters in their dissent on the adoption of FASB Statement no. 41, Financial Reporting and Changing Prices: Specialized Assets--Income-Producing Real Estate. This statement, whose requirements were subsequently eliminated, established specific reporting requirements for real estate entities. The three board members dissented because of their concern about "the relevance of deducting current cost depreciation to measure income from a property that is being maintained to last indefinitely and that is continuing to appreciate in value. Because income-producing real estate is generally held as an investment rather than as an operating capability involving continuous disposals and replacements of components, the effect of changing specific prices on depreciation is not a significant concern. Cash flows and value changes are the critical factors just as they are with other kinds of marketable investments."

They said further that "estimated fair values and changes in fair values are the most relevant information that can be provided about the effects of changing prices on income-producing real estate: those estimates are sufficiently reliable to be required as supplementary information."

ATTEMPTS TO DEAL WITH PROBLEM

Proponents of current value reporting believe that if value changes are not recognized, the relevance of financial information is diminished because both appreciation and impairment of value are disregarded. Presenting both of these changes is particularly important for users of a real estate company's financial statements because its assets are subject to fluctuation. The value of assets such buildings, for example, generally is influenced more by the capacity to generate revenues than the value of assets held by other kinds of business enterprises. Those who support reporting value changes in the financial statements note that when cash flows generated by real estate assets are capitalized, the resulting amounts often approximate the market values of those assets and generally exceed their historical cost amounts.

Appreciation. Proponents believe that the usefulness of a real estate company's historical cost financial statements, which ignore appreciation, is limited because the reported asset amounts do not reflect their economic values to the entity. The Rouse Company, a large publicly held real estate company, tries to deal with that limitation by disclosing an amount for shareholders' equity per share based on the information in its current value financial statements. That amount more closely approximates the price at which its common stock is traded than an amount based on the historical cost financial statements.

Impairment. Historical cost figures also do not clearly indicate when the impairment of long-lived assets should be recognized and how impairment should be measured. Because of a lack of guidance, certain real estate companies, particularly those affected by the recent downturn in the real estate market, continue to report properties at historical carrying amounts that may exceed their recoverable amounts. Consequently, those financial statements do not informs users about a loss in the economic benefit of those assets.

In an attempt to provide guidance, in late 1988 the FASB added to its agenda a project on impairment of long-lived assets for all entities. This was in response to the 1980 AICPA issues paper, Accounting for the Inability to Fully Recover the Carrying Amounts of Long-Lived Assets. Rather than reporting only permanent declines in value, the issues paper recommended that a probability test similar to that in FASB Statement no. 5, Accounting for Contingencies, be used to report impairments in the value of assets. The issues paper also recommended that reporting a recovery of an asset's value should be permitted up to the amount at which the asset was reported before the writedown.

Under a current value reporting model, impairment would not ne an issue because real estate companies would report assets, albeit in the form of supplementary data, at their current values.

ACCOUNTING AND PRESENTATION ISSUES

Many accounting and presentation issues as well as audit and reporting issues must be considered in developing a methodology for measuring and presenting current value information. The following are a few of the major accounting and presentation issues:

Measurement. What methods are acceptable for measuring the current value of a real estate company's nonmonetary assets? Three methods have been suggested: entry value, exit value and value in use (see sidebar above). Should they be used as alternatives, or is one method more suitable than another for measuring a particular type of asset? For example, exit value may be more suitable for measuring the current value of real estate properties under development, while value in use may be more appropriate for measuring the current value of income-producing properties.

Comprehensive vs. piecemeal presentations. Is it necessary to revalue all the assets and liabilities on the balance sheet, or is it permissible to revalue only selected assets and liabilities? Should the company disclose current value information about all or just selected assets and liabilities in the notes to the financial statements?

Stand-alone or side-by-side. Should supplementary current value financial statements be presented only side-by-side with historical cost financial statements, or can they be presented alone?

Complete set of financial statements. Should supplementary current value financial statements be presented only as part of a complete set of current value financial statements, including a balance sheet, an income statement and a reconciliation to historical cost equity, or is it permissible to issue a balance sheet alone?

Individual assets and liabilities or the entire entity. Should supplementary current value information represent the amounts of individual assets and liabilities, or should it represent the value of the entity as a whole?

AUDIT AND REPORTING ISSUES

The following audit and reporting issues also must be considered:

Appraisals. Should external appraisals always be required to support current values?

Auditor association. Should auditors be associated with current value financial statements if they have not been associated with the historical cost financial statements?

Audit procedures. What procedures should auditors performs to ensure that current value information is fair?

Wording of the report. How should the audit or review report on current value financial statements be worded?

A CALL FOR ACTION

Since there is increased interest in the presentation of supplementary current value information by real estate companies, the accounting profession should explore how to provide uniform accounting and auditing guidance. This article presents some of the issues that must be addressed while the AICPA real estate committee works on developing this guidance.

D. GERALD SEARFOSS, CPA, a partner of Deloitte & Touche, Wilton, Connecticut, is a former member of the American Institute of CPAs accounting standards executive committee. JUDITH FELLNER WEISS, CPA, a senior manager in Deloitte & Touche's Wilton, Connecticut, office, is a member of the AICPA and the New York State CPA Society's real estate committee.