INFocus: New accounting rules for real estate and joint investments

Date: July, 2014 Joint Investments

This article was originally published in the inFocus Summer ’14 Issue.

Real estate traditionally lends itself to joint investment with various investors. Real estate deals are constantly evolving, mirroring the developments occurring in economics, markets, and investors. With the change in the structure of these arrangements, the accounting for them has become complex and at times inconsistent. This has resulted in joint investment accounting not being faithfully represented.

Like investors’ confidence, which reflect the true nature of real estate deals, accounting standards also need to evolve alongside this economic reality. Currently, Canadian private investors have multiple accounting options for these investments.

The International Financial Reporting Standard for joint arrangements was recently revised and is applicable to publicly listed entities.

At the heart of this standard is the understanding of the concept of joint control – what investors actually own and owe.

The Canadian Accounting Standards Board has also undertaken the task to review this concept and a revised standard (s.3056, Joint Arrangements) is expected later in 2014.

This revised standard will apply to entities that report under Accounting Standards for Private Enterprises effective for fiscal periods starting on or after January 1, 2016. This revised standard considers the concept of joint control and investors’ rights to individual assets or net assets with the objective of making the accounting treatment user friendly.

What is s. 3056 about?

Under the new standard, the classification of the investment determines the accounting treatment. Some real estate deals involve two or more investors bound by a contractual arrangement, which establishes the rights and obligations of each investor. The question to ask: are there two or more investors who jointly control the arrangement? Joint control allows investors to share power when determining strategic operating, investing and financing policies. Simply, they act together to run the business. But joint control need not be shared by all investors.

As every arrangement is structured uniquely, the assessment can only be made after careful review of the terms of the contractual arrangement. Control is not limited to the form and/or structure of the arrangement, such as partnership, co-tenancy, corporation, joint venture or undivided interest. If joint control exists then these investors follow s.3056 and elect to record all such investments using either the cost* or the equity** method of accounting. This is a simplification over the current standard of three choices.

(Note: If joint control doesn’t exist, then the investor should assess if it is a passive portfolio investment or if there is significant influence, and record the investment accordingly.)

The investors do have the option of undertaking further analysis of what they own and owe in the joint arrangement, to see if they are required to apply the third method of accounting. The third method is the recording of the investor’s interest in individual assets and liabilities for which they have rights and obligations. Alternatively, if the investor has the right only to the net assets of the arrangement, then this option is not available and the equity method will have to be used.

So what’s next?

Assessing whether joint control exists in a real estate investment is not always a straightforward task. Further, this determination will direct the accounting choices available. The accounting choice affects the investors’ financial statements significantly. For example, one-line equity accounting versus cost versus a proportionate consolidation style accounting. Each choice has its place and purpose and needs to be evaluated on an individual basis.

Please consult your Crowe Soberman advisor for further clarification on the choices available and to determine which would be most suitable for your situation.

*Under the cost method, the investment is initially recorded at cost; earnings from these joint arrangements are recognized only to the extent received.

**Under the equity method, the investment is initially recorded at cost and the carrying value is adjusted thereafter to include the investor’s pro rata share of earnings of the joint arrangement.

Connect with the Author

Soo-Ling Huang, CPA, CA, CFP, Director – Professional Practice Group

Soo-Ling Huang is the director of Crowe Soberman’s Professional Practice Group. She assists in the monitoring of accounting and assurance standards, as well as standards regarding professional conduct and quality control.

Connect with Soo-Ling at: 416.963.7136 or s.huang@crowesoberman.com http://ca.linkedin.com/in/soolinghuang

Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article.

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