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All industry specific revenue recognition guidance has been superseded with Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606). There will be more judgment required when evaluating real estate sales and other real estate related contracts. The previous “bright-line” tests for real estate sales are no longer available and the new guidance is expected to significantly impact real estate industry participants. Below are some considerations homebuilders, developers, management and real estate service companies as well as real estate own-and-operate entities my want to consider when evaluating their contracts and the impact ASC 606 will have on their company.
Gains and losses on real estate sales will be recognized when title transfers to the customer. If seller financing is provided, the sale may not meet the criteria for revenue recognition depending on the terms of the financing. You will need to consider if there is an enforceable contract as defined under ASC 606 and the agreement will not meet these criteria if collection is not probable.
Costs incurred for model units, advertising and sales overhead are unlikely to qualify for capitalization under ASC 340-40, Other Assets and Deferred Costs—Contracts with Customers. Often these costs will not be considered incremental costs of obtaining a contract under the new guidance. However, costs of furniture and equipment used in sales offices and model units may qualify for capitalization under ASC 360, "Property, Plant, and Equipment."
Management will need to determine if warranties provided in conjunction with home or residential unit sales are assurance or service-type warranties. Service-type warranties would be evaluated as a separate performance obligation.
Most developer fees from third parties or investees will be recognized over a period of time due to the fact that (i) the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced and (ii) the asset under construction has no alternative use and the developer has an enforceable right (throughout the contract) to payment from the customer for performance completed to date. Management will need to determine the appropriate measure of progress that will be used to recognize revenue over time (e.g., input method based on development costs incurred).
Land developers often earn a profit on future home sales (e.g., lots sold to a homebuilder subject to a profit participation clause). Incentives and bonuses included in developer agreements are variable consideration and should be included in the estimated transaction price using either the ‘most likely’ or ‘expected value’ approach. However, Developers will need to consider any constraints on such variable consideration and make determinations if the variable consideration is subject to a risk of significant revenue reversal. It is expected that the constraint will often not result in the variable considerations being reduced to zero. It is not reasonable to default to a conclusion that the variable consideration is fully constrained until the uncertainty is resolved.
Land developers will need to consider if there is more than one performance obligation at lot sale (e.g., two performance obligations, one being the lot sale and two being the performance of construction or development services.)
Property Management Fees
Many property management agreements will be accounting for under the ‘series’ guidance as (i) the services are for a period of time and (ii) considered a single performance obligation composed of a series of distinct services that are substantially the same and that have the same pattern of transfer to the customer. However, management will need to consider if there are other performance obligations such as leasing and tenant improvement services separate from the day-to-date management services that need to be considered as a separate performance obligation.
Own and operate Real Estate Entities
Management will need to carefully evaluate all lease contracts to identify substantial services that are within the scope of ASC 606. Contract consideration will need to be separated between the lease (scoped out) and other performance obligations (within the scope of ASC 606).
Selling real estate for some own-and-operate real estate entity will be within the scope of ASC 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets, which was amended with the new revenue recognition standard.
Many participants in the real estate industry will see changes in how revenue is recognized and will need to modify the revenue recognition processes in their organization. Moreover, other processes and controls may need changes including internal controls, IT controls and operational and business processes.
To learn how HCVT can help you understand the impact of ASC 606 on your company, contact us at firstname.lastname@example.org.
About Jessica Saugstad
Jessica has over twelve years of public accounting experience and serves clients primarily in the real estate and financial services industries. Her real estate clients include developers, homebuilders, management and real estate service companies and real estate own-and-operate entities. Jessica also has experience providing audit and accounting services to financial service organizations such as investment advisors, loan originators and investors in performing and nonperforming loans. She received a bachelor’s of arts degree in economics with an emphasis in accounting from the University of California, Santa Barbara and began her career at Deloitte. Jessica is a member of the American Institute of Certified Public Accountants. To learn more about Jessica and HCVT, see www.hcvt.com.
Founded in 1991, HCVT provides tax, audit and assurance, business management and mergers & acquisition services to private companies, closely-held businesses, public companies and high net worth individuals and family offices. Our over 585 members, including over 100 partners and principals, work from eight offices in Southern California with additional offices in Walnut Creek, California, Fort Worth, Texas and Park City, Utah.
The real estate industry represents one of the firm’s largest lines of business. We serve owners, developers, and investors across the full spectrum of the industry and have deep experience with all property types including residential, multi-family, commercial and industrial. We understand that the tax and audit issues associated with this industry sector are complex. Beyond compliance requirements, we help you to identify cost savings, identify risks and improve operations by providing recommendations to help you achieve your business goals.