Real estate is a major asset class for businesses, whether a company is in the commercial real estate industry or owns headquarters, remote offices, warehouses, factories, and other properties. There are implications for cash flow, the balance sheet, tax planning, and other financial aspects.
Deloitte recently issued a short paper on some of the considerations, which will appear in this three-part series. This first article addresses real estate reevaluation and accounting for changes in use.
Corporate real estate use saw jarring changes during the pandemic. Many retail locations significantly changed operations, many even closing temporarily or permanently. Others, like grocery stores and pharmacies, became even more critical and valuable. E-commerce drove enormous demand for industrial properties, especially for last-mile and infill service. Offices closed and millions of people started working at home, which raised the question of how much work would be done in common buildings going forward.
C-suite executives have had to consider how business strategies might change. CFOs and their teams have been contemplating how to balance real estate portfolios for the present and future. Potential chances include leaving leased properties before the scheduled date, negotiating lease changes, obtaining more space of certain types, or looking at sale-and-leaseback arrangements.
Each approach has implications for an organization’s accounting. For example, there may be implications under Financial Accounting Standards Board’s Accounting Standards Codification Topic 360, or ASC 360. As global investment bank and advisory firm Stout has noted, “Specifically, ASC 360 requires that a company recognize an impairment loss if, and only if, the carrying amount of a long-lived asset (asset group) is not recoverable from the sum of the undiscounted cash flows expected to result from the use and eventual disposal of the asset (the “Recoverable Amount”) and if the carrying amount exceeds the asset’s Fair Value.”
Deloitte wrote, “Since right-of-use (ROU) assets were first recognized with ASC 842 (i.e., operating leases), the ASC 360 guidance is relatively new in this area, and many lessees are finding the related accounting requirements challenging.”
Under ASC 360, “long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities,” as Deloitte recounted.
That definition creates many complications. A right-of-use asset, or ROU, may see accelerated depreciation, but it depends on when abandonment occurred—when there was absolutely no use for business purpose and without any ability to sublease. And the analysis of an ROU might show that it can’t be considered by itself in a vacuum but within a relevant asset group.
“Determining when to revisit the asset group or the identified lease components is important, as these decisions will have a direct impact on the underlying accounting and related impairment and abandonment considerations,” the report noted.