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Real estate financial reporting and accounting
Article Type: Guest editorial From: Journal of Property Investment & Finance, Volume 28, Issue 5
Corporate real estate portfolios are generally shaped by the requirements of a corporate to provide accommodation for the production of economic profit, be it retail outlets as a route to market, factories for manufacturing or offices for staff. The financial statements reflect the cost of the real estate portfolio, whether owned or leased, as well as any assets and liabilities that arise. Invariably real estate forms a significant part of the balance sheet and total occupancy costs contribute to a major part of the overall cost base in the profit and loss account. Inherently, key ratios, such as return on capital employed are affected by the make up of real estate portfolios.
Decision making relating to a real estate portfolio can be driven by strategic and operational considerations. However the economic implications are fundamental to the end decision. Accounting and financial reporting add a further layer of complexity as the accounting standards do not always align to the economic facts and a divergence occurs.
These distortions have been plain to see, for both owned and leased real estate. Owned assets have often been overvalued in the balance sheet leaving significant issues to resolve on vacation or disposal of premises when the book value bears no resemblance to the market value. Some companies have taken advantage of the off balance sheet treatment of operating leases to use sale and leaseback programmes as nothing more than off balance sheet financing structures.
The recent proposals from the IASB and FASB are addressed in this special issue and identify the significant improvement on the existing framework for lease accounting. The changes will dramatically affect the way corporates account for leased real estate and serve to align the substance of leased transactions with the economic form. As a result, off balance sheet financing arrangement will become a thing of the past and real estate transactions will be less focused on manipulating accounting implications. The shape of corporates’ balance sheets, will change significantly as the changes come into affect and while this will adversely affect some key ratios, there is a general acceptance behind the principals that have driven the new proposed framework.
Fair value is another issue raised in this special issue as the account standard setters grapple with accounting convergence and highlighting the need for improved collaboration between those setting standards and those measuring the values.
It is in the interests of all corporates to analyse the overall impact that its property has on their financial statements: what is their own versus leasehold split, what is book value versus market value versus “value in use”, assessing whether deprecation policies are still appropriate, and understanding their total lease liability obligations both active and onerous.
Understanding this information, as well as the wider market perspective on corporate properties particularly in terms of their attraction either as a property investment or source of finance will enable more strategic financial decisions to be taken. The Barclays case study illustrates the results that can be achieved.
The academic papers in this special issue demonstrate the importance of understanding the accounting standards that relate to real estate, the flaws within the existing framework, proposed changes to align economics and accounting and the need for further reform of the guidelines that corporate follow. Additionally they provide a pointer to the way that real estate can be used to achieve wider economic and strategic objectives.
Michael Evans, Richard PorterCorporate Capital Markets, Jones Lang LaSalle, London, UK