A New Definition of a “Business” – How the Clarification in the New Accounting Standards Affects Your Next Real Estate Acquisition
The next time a real estate company acquires an operating property – for example, an apartment complex, industrial property or office building – the accounting for that acquisition could be different from the previous transactions. The Financial Accounting Standards Board (FASB) has clarified its more than a decade-old definition of a “business.” The clarification is included in Accounting Standards Update (ASU) 2017-01, which was meant to assist companies in applying the broadly interpreted FASB Statement No. 141(R), Business Combinations (codified in ASC 805). This clarification will probably result in more real estate acquisition transactions being accounted for as asset acquisitions rather than business combinations.
Prior to the clarification, when a real estate deal was made the buyer would pay a price for the operating real estate and an additional amount for the services required to close the transaction (think broker and attorney fees). Those fees and associated closing costs, which could add up to approximately 5 percent of the acquisition price or more, leave buyers of a $100 million real estate purchase with an automatic $5 million acquisition expense on their books at the date they close the transaction.
With the FASB’s new clarification, the full $105 million the buyer just spent could be capitalized as an asset, if the acquired assets were not considered a business in accordance with the clarified guidance. This is good news for anyone who has ever said: “I just spent $105 million to acquire the property; I want a $105 million asset on my balance sheet!”
But while the FASB brings some clarity, the guidance isn’t necessarily black and white, so there are gray areas that should be analyzed. If the transaction was accounted for as an asset acquisition, the acquisition costs would be capitalized and allocated to the assets acquired on a relative fair value basis and no goodwill will be recognized.
The clarification takes effect for public companies for fiscal years beginning after Dec. 15, 2017, and all other entities for fiscal years beginning after Dec. 15, 2018. Many companies have been early-implementing this new guidance due to its benefits for financial reporting purposes and financial ratios.
There are many variables to consider, and this update might not apply to some real estate acquisitions. The application of the clarified definition of a business needs special consideration, and the results will be different for certain types of real estate acquisitions. With such a sweeping change to these critical accounting functions, it is imperative to consult your CPA when structuring your next real estate transaction.
Paul Louis, CPA is an Audit Principal at Haskell & White LLP, one of the largest independent middle-market CPA firms in Southern California. He can be reached at firstname.lastname@example.org or (949) 450-6200.