Chapter 7
Time-Sharing Transactions
Real estate time-sharing is a concept based on the sharing of vacation properties between different owners. Purchasers of vacation intervals receive the right to use a vacation home, such as a condominium, for a specified number of years, or in perpetuity. In the plain-vanilla form of time-sharing, a purchaser buys into a vacation property in intervals of weeks and obtains the right to occupy the interval purchased during the same week each year.
Typically, ownership of a time-sharing unit is divided into 50- or 51-week interval interests, with one or two weeks reserved for maintenance. Accordingly, each real estate time-sharing unit would have 50 or 51 owners. Exhibit 7.1 depicts a time-share property with seven units; each unit is divided into 51 intervals.
Exhibit 7.1 Time-Share Property with Units and Intervals
In addition to the purchase price, the buyer is also responsible for an annual fee to cover the management, maintenance, and operations of the resort, which generally provides a variety of amenities, such as parks, swimming pools, playgrounds, tennis courts, and golf courses.
Customer demand for flexible arrangements prompted time-share companies to introduce floating weeks,1 exchange programs, and points-based systems.2 Exchange networks, such as Resort Condominium International (now Group RCI) and Interval International were created in the 1970s to facilitate this exchange. Owners of vacation intervals in an exchange network-affiliated resort can exchange their weekly interval for a week at another resort affiliated with the same network. Similarly, some developers of time-share properties maintain exchange programs that allow for an exchange of weekly intervals between different resorts of that developer.
The time-sharing concept was first developed in Europe in the 1960s and was introduced to the United States in the 1970s. The depressed real estate market in the mid-1970s induced hotel and condominium developers to convert hotels and condominium projects into time-share properties in an effort to generate additional revenues. In its infancy, the time-sharing industry had a reputation of selling inferior vacation properties to an uninformed public, often using aggressive sales tactics. This perception started to change in the mid-1980s, when reputable hospitality companies entered the time-sharing market to participate in the relatively high margins in this industry.
As time-sharing grew in popularity, the American Resort Development Association, the industry association of time-share companies, developed standards of conduct, and federal and state regulation increased. The development of industry standards, increased legislation, and monitoring have resulted in higher-quality properties and better consumer information, which has raised consumer confidence and has contributed to the continued demand for time-share properties.
The accounting did not keep pace with the developments in the time-sharing industry.
When the Financial Accounting Standards Board (FASB) issued FASB Statement No. 66, Accounting for Sales of Real Estate, in 1982, the time-sharing industry received little attention. The sale of time-sharing intervals was treated like the sale of condominiums, and the unique risks of the industry were not addressed. These risks include:
A high default rate on sales, which are generally seller-financed
Substantial marketing and sales expenses, largely incurred in periods before a sale takes place
Wide diversity in practice developed in the industry, as time-share companies adapted the sale and profit recognition principles in Subtopic 360-20 (FASB Statement No. 66) to the sale of time-sharing intervals; and as they interpreted the provisions relating to cost deferral in the Real Estate Project Costs subsections of Topic 970, Real Estate—General (FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects).
The steady growth of the time-sharing industry, the multitude of new structures, and the observed diversity in industry practice prompted the American Institute of Certified Public Accountants (AICPA) to form a Task Force under the direction of the AICPA Accounting Standards Executive Committee (AcSEC) with the mandate to develop a comprehensive accounting model for the time-sharing industry. In December 2004, the AICPA issued Statement of Position (SOP) No. 04-2, Accounting for Time-Sharing Transactions, codified in Accounting Standards Codification (ASC) Topic 978, Time-Sharing Activities, which addresses many unique aspects of the accounting for time-sharing transactions, such as the application of the relative sales value method, the determination of the allowance for uncollectibles, the treatment of incentives, and the deferral of marketing and sales expenses.
Exhibit 7.2 Time-Sharing Arrangements
7.2 Types of Time-Sharing Arrangements
Time-sharing arrangements can be categorized into one of three basic types (see Exhibit 7.2):
1. Structures in which deed passes to the buyer (deeded structures)
2. Right-to-use structures
3. Hybrid structures
7.2.1 Deeded Structures
In deeded structures, the purchaser of a time-sharing interval assumes the risk of property ownership and is responsible for any liabilities that arise from the property; the seller relinquishes the usual risks and rewards of ownership and transfers title to the purchaser of the time-sharing interval. To qualify for sale recognition under Subtopic 360-20, title transfer must be nonreversionary; that is, property ownership may not revert back to the time-share seller. A contract-for-deed arrangement, under which the deed to a time-sharing interval will be transferred at a future point in time when the purchaser has paid a specified portion (or all) of the sales price of the time-sharing interval, also meets the transfer of title requirement.3
Various types of time sharing-arrangements fall within the group of “deeded structures:”
Interval ownership The time-share buyer is deeded a specific unit for a specific week. For example, the buyer is deeded the right to use Unit 1A for the first week in July each year.
Undivided interest An undivided interest is a tenant-in-common interest in a specific unit or in the entire vacation property. The interest holder is then assigned a specific week.
Floating time A deed is recorded, with the time-share owner not being entitled to a specific week but to any week within a certain season. Reservation systems are used to manage owners' requests for a specific unit and week.
Throughout this chapter, the term “sale of time-sharing interval” is used to denote a sale of any type of ownership in time-share properties, including interval ownership, undivided interest, and floating time arrangement.
Right-to-Use Structures
In right-to-use structures, ownership of the vacation property remains with the developer; the purchaser of a vacation interval acquires the right to use the unit for a specified number of years.4 This type of structure is similar to a lease. Accordingly, a time-share seller does not record a sale, but treats the arrangement like an operating lease.
Hybrid Structures
Hybrid structures include features of both a sale and a right-to-use arrangement. A sale of a vacation ownership interest in a hybrid structure is accounted for as a lease or sale, depending on whether the developer relinquishes the usual risks and rewards of ownership in the real estate. The floating time concept discussed earlier may be implemented in the form of point systems or vacation clubs, enabling the owner to exchange a week in the purchased resort for a week in another resort.
The accounting treatment of more complex time-sharing structures, such as special-purpose entities (SPEs), points-based systems, and vacation clubs, should follow the sale and profit recognition criteria of the deeded structures or right-to-use structures discussed previously, depending on their characteristics.
Hybrid arrangements frequently encountered include:
Special-purpose entities SPEs may be used to facilitate the sale of vacation properties in countries that place restrictions on the ownership of real estate by foreign nationals, or for other reasons. The time-share seller establishes a special-purpose entity, typically in the legal form of a corporation or trust, and transfers the vacation property to the SPE in exchange for all of the shares/beneficial interests in the SPE. The time-share seller then sells the shares/beneficial interests in the SPE to buyers of time-sharing intervals. If the developer relinquishes the usual risks and rewards of ownership in the vacation property, profit is recognized at the time the shares/beneficial interests are sold to purchasers of the time-sharing intervals. Generally, the accounting for the sale of interests in a time-share SPE is consistent with the accounting for the sale of interests in other real estate entities.5
Term for years arrangements Under a “term for years” arrangement, the purchaser of the time-sharing interval has the right to use the interval for a certain number of years (e.g., 40 years). If the vacation property reverts to a substantive party unrelated to the time-share seller at the end of that term, the time-share seller has relinquished all risks and rewards of ownership; the transaction is treated like a sale of a time-sharing interval.6
7.3 Accounting for the Sale of Time-Sharing Intervals
The accounting for the sale of time-sharing intervals follows the guidance for other than retail land sales in Subtopic 360-20 (FASB Statement No. 66), discussed in Chapter 3.7 In general, a prerequisite for the recording of a real estate sale is that a sale transaction is consummated,8 which requires that: (1) the parties are bound by the terms of a contract, (2) all consideration is exchanged, and (3) any permanent financing for which the seller is responsible is arranged.9 For a sale that is consummated and recorded, the time-share seller needs to determine the appropriate profit recognition method in accordance with the provisions of Subtopic 360-20 (FASB Statement No. 66).
ASC 978-605-10-1 (paragraph 9 of SOP 04-2) states, in part: “This Subtopic provides guidance to illustrate the application of the provisions of Subtopic 360-20 to the specific terms typically encountered in time-sharing transactions. This Subtopic also establishes standards for accounting issues not addressed in that Subtopic.”
7.3.1 Application of the Accrual and Percentage-of-Completion Methods
The accrual method provides for immediate recognition of profit. ASC 360-20-40-3 through 40-4 (paragraphs 3 and 4 of FASB Statement No. 66) provide, in part:
Profit shall be recognized in full when real estate is sold, provided that both of the following conditions are met:
a. The profit is determinable, that is, the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated.
b. The earnings process is virtually complete, that is, the seller is not obligated to perform significant activities after the sale to earn the profit . . .
[C]ollectibility of the sales price is demonstrated by the buyer's commitment to pay, which in turn is supported by substantial initial and continuing investments that give the buyer a stake in the property sufficient that the risk of loss through default motivates the buyer to honor its obligation to the seller. Collectibility shall also be assessed by considering factors such as the credit standing of the buyer, age and location of the property, and adequacy of cash flow from the property.
Determining whether the buyer's financial commitment is adequate is often a critical factor in evaluating whether the accrual method—or percentage-of-completion method for properties that have not been completed—is appropriate.
7.3.1.1 Financial Commitment of the Buyer
A buyer's commitment is measured as the percentage of a buyer's down payment and subsequent principal payments, referred to as initial and continuing investments, in relation to the sales value of the time-sharing interval purchased.10
Formula–calculation Of Buyer's Financial Commitment in Percent
Financial Commitment
= Initial and Continuing Investments/Sales Value of Time-Sharing Interval
ASC 360-20-55-2 (paragraph 54 of FASB Statement No. 66), which specifies different minimum percentages for a buyer's initial investment depending on the specific property type, does not address time-share properties. For real estate time-share sales, time-share sellers have used a threshold of 10%, by analogy to minimum percentage requirements for condominiums used as secondary residences.11
Determination of the Sales Value
As in the sale of other real estate properties, the stated sales price for the time-sharing interval may have to be adjusted when computing the sales value of the interval.12 ASC 360-20-40-8 (paragraph 7 of FASB Statement No. 66) provides as a general concept that payments made by a buyer that are in substance additional sales proceeds to the seller are to be added to the stated sales price and that the net present value of services that the seller performs without compensation (or the net present value of the services in excess of compensation) as well any discounts to reduce the buyer's note receivable to present value are to be subtracted from the stated sales price to arrive at sales value.
Topic 978 (SOP 04-2) specifically addresses how (1) programs to accelerate the collection of receivables, (2) fees charged to buyers, and (3) incentives impact the calculation of sales value.
Programs to Accelerate the Collection of Receivables.13
Time-share sellers may use programs to accelerate the collection of receivables or include contract provisions that encourage prepayment with a reduction of payments as inducement for prepayment. If a seller offers such programs to buyers at the time of sale or has established a practice of offering such programs subsequent to the sale, the seller should incorporate the estimated reduction of payments into the determination of sales value.
Fees Charged to Buyers.14
Time-share sellers may charge fees to a buyer in addition to the stated sales price of a time-sharing interval. The accounting for fees charged to a time-share buyer depends on the nature of the fees:
Fees related to financing Fees related to financing, such as loan origination fees, are accounted for in accordance with Subtopic 310-20 (FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases).
Pass-through fees Pass-through fees are fees that the seller charges to the buyer to pay to a third party, such as a municipality or taxing authority. Pass-through fees are not added to the sales value, and payments made by buyers for pass-through fees are not part of his or her initial or continuing investment on the time-sharing interval.
Other fees Fees charged to a buyer other than fees related to financing and pass-through fees constitute additional sales proceeds; they are added to the stated sales price of the time-sharing interval when determining sales value.
Example—Fees Charged to Buyers
Soleil Inc. (S), a time-share seller, sells a time-sharing interval to Benedict (B) for a stated purchase price of $10,000. In addition to the purchase price, S charges $30 loan origination fees and $70 administrative fees, which will cover recording tax and stamp tax to be paid to a municipality ($20), title costs ($40) to be paid to an affiliate of S as well as S's internal administrative expenses. B makes a down payment of $1,000 on the interval and pays for the loan origination and administrative fees.
How will the fees charged to B affect the sales value of the time-sharing interval and the amount of B's initial and continuing investments?
The $30 loan origination fee does not impact sales value or the buyer's initial and continuing investments. Loan origination fees are deferred and recognized over the life of the loan as an adjustment to interest income in accordance with Subtopic 310-20 (FASB Statement No. 91).
The administrative fee includes $20 of taxes (pass-through fees) to be paid to a municipality. That amount is not included in sales value or the amount of the buyer's initial and continuing investments. The fact that the $20 is included in the administrative fees, rather than stated separately, does not impact the accounting treatment.
The remainder of the administrative fee ($50) is added to the stated sales price when calculating the sales value of the interval, as that amount is being paid to cover costs incurred by the seller and its affiliates. Similarly, the payment of the $50 is included in the amount of the buyer's initial investment.
Incentives.15
Time-share sellers typically offer incentives to buyers, such as airline vouchers or the payment of owners association fees for the first year after the purchase of a time-sharing interval. When calculating the sales value of a time-sharing interval, the stated sales price of the time-sharing interval is reduced by the excess of the fair value of these incentives over any stated compensation. The buyer's down payment is first applied to the incentive; it is not applied pro rata to the sale of the time-sharing interval and the incentive.16
Example—Owners Association Fees Paid by Seller for First Year after Purchase
Benedict (B) purchases a time-sharing interval for a stated sales price of $10,000. The time-share seller agrees to pay the first year of owners association fees (OA fees) for B's interval (fair value of $500). B makes a down payment of $1,000. The seller has determined that 10% initial investment is sufficient for the application of the accrual method. All other criteria for profit recognition under the full accrual method are met.
Is the down payment sufficient to use the accrual method of accounting?
| Stated Sales Price of Interval | $10,000 |
| Less: Fair Value of OA Fees | ($ 500) |
| Sales Value of Interval | $9,500 |
| Required Down Payment (10%) | $950 |
| Down Payment Received from B | $1,000 |
| Less: Portion of Down Payment to be Applied to OA Fees | ($ 500) |
| Down Payment Applied to Interval | $500 |
The down payment is not sufficient to recognize profit on the sale of the time-sharing interval under the accrual method of accounting. The payment of OA fees by the time-share seller represents an incentive17 provided to the buyer that needs to be considered when computing sales value and down payment applied to the interval.
Incentives Conditioned on Sufficient Future Performance.
A time-share seller may commit to providing a buyer with an incentive after the buyer has fulfilled its contractual obligations for a certain period of time. In that case, the time-share seller needs to determine whether the sum of the down payment and future payments (principal and interest) to be received from the buyer until the time the buyer becomes entitled to the incentive satisfies the initial investment criterion of Subtopic 360-20 (FASB Statement No. 66) and is sufficient to cover the fair value of the incentive (plus any interest on the unpaid portion of the incentive).
Topic 978 (SOP 04-2) explains the allocation of a buyer's payments to the interval and the incentive conditioned on future performance:18
For accounting purposes, the seller allocates cash received as if there were two separate notes (with the same interest rate)—one for the purchase of the interval (with a term of the note the buyer signs) and one for the other products or services (with a term ending on the date the buyer can use them). This approach represents a systematic and rational allocation of the cash received between the interval and other products and services.
The application of that guidance is best demonstrated in an example.
Example—Owners Association Fees Paid by Seller for Second Year after Purchase19
Assume the same fact pattern as in the last example, with one exception: The seller is offering to pay the buyer's second year of owners association fees if the buyer remains current on the monthly payments of $175 for one year.
Is the down payment sufficient for the use of the accrual method of accounting?
Excess of OA Fees over Future Payments:
| Fair Value of OA Fees | $500 |
| Future Payments20 | ($ 2,100) |
| Excess of OA Fees over Future Payments | $0 |
| Sales Value of Interval | $9,500 |
| Required Down Payment | $950 |
| Down Payment Received from Buyer | $1,000 |
| Less: Portion of Down Payment to be Applied to OA Fees | ($0) |
| Down Payment Applied to Interval | $1,000 |
The down payment is sufficient to recognize profit under the accrual method of accounting. Since the payments the buyer is required to make before being entitled to the waiver of the OA fees exceed the fair value of the OA fees, the down payment made by the buyer can be applied in full to the time-sharing interval.
A different conclusion is reached in the next example.
Example—Incentive with Insufficient Future Performance21
Assume the same fact pattern as in the last example, with one exception: Instead of paying the buyer's OA fees, the seller is offering to the buyer amusement park tickets with a fair value of $500 if the buyer remains current on the monthly payments ($175) for the next two months.
Is the down payment sufficient for profit recognition under the accrual method of accounting?
Excess of Incentive over Future Payments:
| Fair Value of Incentive | $500 |
| Future Payments22 | ($350) |
| Excess of Fair Value of Incentive over Future Payments | $150 |
| Sales Value of Interval | $9,500 |
| Required Down Payment | $950 |
| Down Payment Received from Buyer | $1,000 |
| Less: Portion of Down Payment to be Applied to Incentive | ($150) |
| Down Payment Applied to Interval | $850 |
The down payment is not sufficient to recognize profit under the accrual method of accounting, since it is less than 10% of the sales value of the interval ($950). The payments the buyer is required to make before being entitled to the amusement park tickets are less than the fair value of the tickets; as such, the down payment made by the buyer needs to be allocated to the amusement park tickets ($150) and the interval ($850). The buyer's first two monthly payments will be allocated in full to the amusement park tickets. After the third payment, the buyer's investment is adequate for the recognition of profit under the accrual method of accounting, as the cumulative payments in excess of the value of the amusement park tickets exceed 10% of sales value of the interval ($850 plus $175).
Continuing Investment
In addition to the initial investment requirement outlined earlier in this section, Subtopic 360-20 (FASB Statement No. 66) also contains continuing investment requirements that must be met for the accrual method of accounting to be appropriate. Specifically, ASC 360-20-40-19 (paragraph 12 of Statement No. 66) requires that the buyer be contractually required to:
pay each year on its total debt for the purchase price of the property an amount at least equal to the level annual payment that would be needed to pay that debt and interest on the unpaid balance over no more than . . . the customary amortization term of a first mortgage loan by an independent lending institution for other real estate.
In a typical sale of a time-sharing interval, any portion of the purchase price not paid for in cash is financed by the time-share seller over a period of five to ten years. Due to this relatively short time frame, meeting the continuing investment requirement generally does not present an issue.
Two circumstances deserve special consideration, however:
1. Time-share property not completed at time of purchase If the time-share property is not completed at the time of purchase, the continuing investment requirement should be applied from the time the seller recognizes the sale and starts applying the percentage-of-completion method, rather than from the time the property is deeded to the buyer, by analogy to ASC 360-20-40-53 through 40-55 (Emerging Issues Task Force (EITF) Issue No. 06-8, Applicability of the Assessment of a Buyer's Continuing Investment under FASB Statement No. 66 for Sales of Condominiums).
2. Incentives conditioned on sufficient future performance As outlined earlier, an incentive conditioned on the buyer's future performance requires the allocation of the buyer's payments so that the incentive is paid for in full at the time the buyer becomes entitled to it. If the initial investment is adequate, the application of the accrual method of accounting is considered appropriate, even if the buyer's future payments are allocated solely to the incentive until the incentive (plus any interest on the unpaid portion of the incentive) is paid for in full rather than being allocated to the interval. When deliberating that issue, AcSEC concluded that the buyer's continuing performance on the contract did provide sufficient assurance of the buyer's commitment to fulfill its obligations.23
7.3.1.2 Determining a Project's Percentage of Completion
If a time-sharing project has not been completed—including improvements, facilities, and amenities—the percentage-of-completion method of accounting is used, assuming the criteria outlined in ASC 360-20-40-50 (paragraph 37 of Statement No. 66) are met; otherwise, the deposit method is appropriate.
The percentage of project completion is determined by measuring the relationship of costs already incurred to the sum of the costs already incurred and future costs expected to be incurred (often referred to as cost-to-cost method).24 Sales and marketing costs, which constitute a relatively large portion of the total cost of a time-sharing project, are excluded from the percentage-of-completion calculation.25
7.3.1.3 Application of the Relative Sales Value Method
The provisions of Subtopic 360-20 (Statement No. 66) are generally applied to the sale of real estate on a transaction-by-transaction basis. However, for time-sharing sales, cost of sales is recognized based on a pool of costs and expected sales from a project26 rather than on a transaction-by-transaction basis. The relative sales value method, which is similar to a gross profit method, is used to determine cost of sales in conjunction with a sale. Under the relative sales value method, cost of sales is calculated by applying a cost-of-sales percentage to total estimated time-sharing revenue.
The estimate of total revenue (actual to-date plus expected future revenue) shall incorporate factors such as incurred or estimated uncollectibles, changes in sales prices or sales mix, repossession of intervals that the seller may or may not be able to resell, effects of upgrade programs, and past or expected sales incentives to sell slow-moving inventory units.27
Effects of Changes in Estimate
Cost estimates may need to be adjusted during the construction period to reflect price changes or changes in the design of the project or its amenities. Similarly, estimates of revenues may change as a result of changed market conditions. A time-share seller should review its estimates for revenues and project costs at least quarterly. The effects of changes in estimate are accounted for in the period of change so that the balance sheet at the end of the period of change and the accounting in subsequent periods reflect the revised estimates.29
Example—Relative Sales Value Method30
Time-share company Soleil Inc. (S) has completed Phase 1 of its luxury resort in West Palm Beach, Florida. S expects to sell the time-sharing intervals for $10 million. S estimates that approximately 10% of the buyers will default and that the recovered intervals will be recovered and resold for a total of $950,000.
Other Relevant Data
| Initial down payment (nonrefundable) | 10% |
| Buyers' forfeiture on defaulted notes | 100% of cash paid |
| Inventory cost | $ 2,500,000 |
| Sales for Year 1 | $ 5,025,000 |
S has determined that the accrual method of accounting is appropriate. What are the journal entries to record sales and corresponding cost of sales in Year 1?
Expected Revenues From Phase 1
| Estimated sales from intervals (original sales) | $ 10,000,000 |
| Additional sales from recovered intervals | $950,000 |
| Total sales | $ 10,950,000 |
| Estimated uncollectible notes | ($985,500)31 |
| Estimated net sales from Phase 1 | $9,964,500 |
Cost-of-Sales Percentage
| Total project cost of Phase 1 | $ 2,500,000 |
| Net sales from Phase 1 | $ 9,964,500 |
| Cost-of-sales percentage | 25.08906% |
Journal Entries Year 1
| Notes Receivable | $ 4,522,500 | |
| Cash | $ 502,500 | |
| Sales | $5,025,000 | |
| Estimated Uncollectible Sales (sales contra) | $ 452,25032 | |
| Allowance for Uncollectibles | $452,250 | |
| Cost of Sales | $1,147,26033 | |
| Inventory | $1,147,260 |
Example—Implementation of a Change in Estimate
Continuing the previous example: If time-share seller Soleil Inc. at the end of Year 2 estimates that the default rate for the project phase will approximate 13% rather than 10%, as originally anticipated, an adjustment would have to be recorded.
Expected Revenues From Phase 1
| Estimated sales from intervals (original sales) | $10,000,000 |
| Additional sales from recovered intervals | $950,000 |
| Total sales | $10,950,000 |
| Estimated uncollectibles | ($1,281,150)34 |
| Estimated net sales from Phase 1 | $9,668,850 |
Cost-of-Sales Percentage
| Total project cost of Phase 1 | $ 2,500,000 |
| Net sales from Phase 1 | $ 9,668,850 |
| Cost-of-sales percentage: | 25.585622% |
Journal Entries to Adjust Uncollectibles and Inventory from Year 1 Sales to the Revised Estimates:
| Estimated Uncollectible Sales (Sales Contra) | $135,675 | |
| Allowance for Uncollectibles | $135,67535 | |
| Inventory | $12,00736 | |
| Cost of Sales | $ 12,007 |
7.3.2 Accounting for Costs to Sell Time-Sharing Intervals
Costs to sell time-sharing intervals are largely incurred for a project or phase as a whole rather than in connection with individual sales transactions. The costs are allocated to a specific sale transaction based on the ratio of the relative fair value of the interval sold to the fair value of the project or phase. Industry practice has been diverse regarding treatment of costs to sell time-sharing intervals; before the issuance of SOP 04-2, companies in the time-sharing industry frequently deferred certain marketing and sales costs, such as costs to generate leads or to tour vacation resorts, until profit on the sale of an interval was recognized.
ASC 978-720-25-1 (paragraph 44 of SOP 04-2) provides as a general rule that costs to sell are to be expensed, unless they specifically qualify for deferral. A deferral of costs—until sale and related profit is recognized—is only appropriate if the costs meet one of the following criteria:37
The costs are reasonably expected to be recovered from the sale of the time-sharing intervals or from incidental operations, and they are incurred for either of:
Tangible assets that are used directly throughout the selling period to aid in the sales of the time-sharing intervals, such as the costs of model units and their furnishings, sales equipment, and semipermanent signs.
Services that have been performed to obtain regulatory approval of sales, such as the costs of preparing and filing of prospectuses.
Other costs incurred to sell time-sharing intervals are deferred until profit from a sale transaction is recognized, if the costs meet all of these criteria:38
They are reasonably expected to be recovered from the sale of the time-sharing intervals.
They are directly associated with the sales transactions.
They are incremental; that is, the costs would not have been incurred by the seller had a particular sale transaction not occurred.
Costs that meet these criteria for deferral include sales commissions and payroll and payroll benefit-related costs of sales personnel for time spent directly on successful sales efforts. They are charged to expense in the period in which the related profit is recognized. If a sales contract is canceled, the related unrecoverable deferred selling costs are charged to expense in the period of cancellation.39
Additional Limitations on Cost Deferral
Additional limitations are placed on cost deferral, if the deposit or cost recovery method of accounting is used:
Under the deposit method of accounting, deferred selling costs are limited to the nonrefundable portion of the deposits received by the seller.40 This limitation is intended to eliminate the risk of not recovering deferred selling costs in the event of a buyer default.
Under the cost recovery method of accounting, all selling costs are expensed because of uncertainties regarding the recoverability of deferred selling costs.
ASC 978-720-25-2 (paragraph 48 of SOP 04-2) reiterates that all other costs that do not satisfy the criteria for cost deferral have to be expensed as incurred, including:
all costs incurred to induce potential buyers to take sales tours (for example, the costs of telemarketing call centers); all costs incurred for unsuccessful sales transactions; and all sales overhead such as on-site and off-site sales office rent, utilities, maintenance, and telephone expenses.41
Direct incremental costs of the tour itself are expensed at the time the tour takes place.42
7.4.1 Uncollectibility of Receivables
In a typical time-share sale, a large portion of the sales price is seller-financed, and collectibility of the sales price is a major concern for time-share sellers. Delinquency and default rates of receivables from time-share sales vary significantly, depending on the customer group, the location and desirability of the project, the quality of credit checks performed by the time-share seller, and other factors, such as the general state of the economy.
As a general rule, Subtopic 360-20 (Statement No. 66) provides that profit be recognized in full when real estate is sold, provided “[t]he profit is determinable, that is, the collectibility of the sales price is reasonably assured or the amount that will not be collectible can be estimated.”43 Unless a time-share seller is able to estimate the default rate based on historical data, the use of the accrual method of accounting is not appropriate. When estimating default rates for a new project, time-share sellers may use their prior experience with projects that have the same characteristics as the new project. Industry experience cannot be substituted for a company's own experience, due to the wide fluctuations in default rates; a company new to the time-sharing industry with no historical data may have to use the installment or cost recovery method during the first few years of a project due to its inability to estimate uncollectibles.
Example—Analysis of Allowance for Uncollectibles44
Time-share seller Soleil Inc. (S) sells time-sharing intervals in a project in West Palm Beach, Florida. The project is similar to S's previously sold vacation property in Palm Coast, Florida, which enables S to use the historical data of that prior project to estimate uncollectibles for the West Palm Beach project. Prior experience shows that over the lifetime of the project, S should expect a 12% default rate.
S is calculating the allowance for uncollectibles to be recorded at the end of fiscal year (FY) 2007, as outlined in the table.
In FY 2007, S records an allowance for uncollectibles of $7,470.50 In subsequent years, S continues to monitor the defaults on its sales by year. The use of historical data enables S to identify and analyze any deviation in default rates from default rates experienced historically and to adjust the allowance percentage accordingly.51
A time-share seller that uses the accrual or percentage-of-completion method of accounting must estimate uncollectible amounts and reduce time-sharing revenue by the amounts that are estimated to be uncollectible. Subsequent to the sale, a time-share seller is required to evaluate the adequacy of the allowance for uncollectibles at each reporting period and at least quarterly. Any subsequent adjustments to the allowance are recorded through a contra-revenue account (estimated uncollectibles) rather than through bad debt expense. A corresponding adjustment is also made to cost of sales and inventory.52
The time-share seller must compute the allowance for uncollectibles:
based on consideration of uncollectibles by year of sale, as well as the aging of notes receivable and factors such as the location of time-sharing units, contract terms, collection experience, economic conditions, and other qualitative factors as appropriate in the circumstances.53
Time-share companies predominantly use a method to track uncollectible amounts of time-share revenues by year of sale, often referred to as static pool analysis. That method is not dissimilar to the way insurance companies monitor their losses in determining the appropriate amount of loss reserves.
Troubled Debt Restructuring
The restructuring of debt is considered a troubled debt restructuring if a creditor for economic or other reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider.54 Note receivable modifications, deferments of payments, or downgrades of time-sharing intervals constitute forms of troubled debt restructuring that should be accounted for in accordance with Topic 310, Receivables (FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan). ASC 978-310-35-4 (paragraph 34 of SOP 04-2) explains the accounting consequences:
Any reductions in the recorded investment in a note receivable resulting from the application of that Topic shall be charged against the allowance for uncollectibles, because the estimated losses were recorded against revenue at the time the time-share sale was recognized or were recorded subsequently against revenue as a change in estimate. Incremental, direct costs associated with uncollectibility, such as costs of collection programs, shall be charged to expense as incurred.
7.4.2 Incentives and Inducements
In the time-sharing industry, it is common to provide buyers with incentives, such as airline or amusement park tickets, when they purchase time-sharing intervals. ASC 978-605-20 (the Glossary of SOP 04-2) defines “incentive” as a product or service that the seller of a time-sharing interval provides to the buyer for stated compensation that is less than the fair value of that product or service (or for no compensation). Topic 978 (SOP 04-2) differentiates between incentives and inducements. “Inducements” are products or services provided to potential buyers regardless of whether a sale occurs. They are included in a time-share seller's selling expenses. (See Exhibit 7.3.)
Exhibit 7.3 Accounting Treatment of Incentives and Inducements
The sales price of a time-sharing interval is reduced by the fair value of an incentive. Section 7.3.1.1 of this chapter discusses the impact of an incentive on the calculation of sales value and the allocation of the buyer's payments to the interval and the incentive. The accounting for incentives is based on Subtopic 605-50, Revenue Recognition—Customer Payments and Incentives (EITF Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)). That subtopic differentiates based on the classification of the incentive as either cash or noncash. Subtopic 605-50 (EITF Issue No. 01-9) provides that:
cash consideration . . . given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor's products or services and, therefore, shall be characterized as a reduction of revenue when recognized in the vendor's income statement. . . . If the consideration consists of a free product or service . . . the cost of the consideration shall be characterized as an expense (as opposed to a reduction of revenue) when recognized in the vendor's income statement. That is, the free item is a deliverable in the exchange transaction and not a refund or rebate of a portion of the amount charged to the customer.55
Cash Incentives
Topic 978 (SOP 04-2) provides that a cash incentive is either (1) cash or (2) a product or service provided to a buyer for less than its fair value that the purchaser would otherwise be required to purchase, such as the seller's payment of a buyer's owners association fees.56 Providing a product or service to the buyer that the buyer is otherwise required to pay for is equivalent to the seller reimbursing the buyer for that product or service; therefore, such products or services are treated like cash incentives.
Both the stated sales price of a time-sharing interval and the seller's cost of providing the product or service are reduced by the fair value of products or services that are deemed to be cash incentives.57
Noncash Incentives
A noncash incentive is a product or service provided to a buyer free of charge or for less than its fair value that the buyer is not required to purchase in conjunction with the purchase of a vacation interval. For example, the payment of the buyer's membership fees in an exchange program for one year is a noncash incentive if the buyer is not required to purchase the membership in the exchange program. Noncash incentives (products or services) are accounted for by analogy to ASC 360-20-40-8(b) and 40-43(d) (paragraphs 7(b) and 31 of FASB Statement No. 66): The product or service provided to the buyer is recorded as a separate revenue item at fair value with associated costs of sales.
7.4.3 Incidental Operations
The time period that time-sharing intervals are held and available for sale is referred to as holding period. Time-share companies typically rent unsold intervals to recover some of their operating costs, or they offer prospective buyers a stay in a vacation resort, which generates significant “traffic” for a new time-share property and serves as a marketing tool.
During development and holding periods, time-share properties are accounted for as inventory and are not depreciated,58 and rental and other revenue-producing activities are accounted for as incidental operations:
Incremental revenues from incidental operations in excess of incremental costs of incidental operations are accounted for as a reduction of inventory costs. Incremental costs of operations during holding periods are costs associated with holding unsold intervals; they include maintenance fees and subsidies to owners associations. If a time-share property is expected to create excess revenues during the development or holding period, such excess should not be factored into the calculation of project revenue for purposes of applying the relative sales value method.59
Incremental costs in excess of incremental revenue are charged to expense as incurred.60
Direct incremental costs incurred to rent units during holding periods are deferred until the rental takes place to the extent their recovery from the rental of units is reasonably expected. An example of direct incremental costs incurred to rent would be a commission related to a particular rental transaction. At the time the rental takes place, the costs are either charged to expense (if incremental costs exceed incremental revenues) or recorded as reduction of inventory costs (if incremental revenues exceed incremental costs).61
7.4.4 Upgrade and Reload Transactions62
Subsequent to the purchase, a satisfied buyer of a time-sharing interval may enter into a contractual agreement with the time-share seller to trade his or her time-sharing interval for a larger or more luxurious one (a so-called upgrade), or the buyer may purchase a second interval (a second week of usage), referred to as a reload. The guidance provided in Subtopic 360-20 (Statement No. 66) is applied to determine the appropriate accounting for upgrade and reload transactions.
Upgrade Transaction
In an upgrade transaction, buyer and seller agree that the interval purchased be exchanged for a more expensive one. Upgrade transactions are not obligations to repurchase,63 because “both buyer and seller must agree to an upgrade transaction. Neither has a unilateral right to compel the other.”64 Rather, an upgrade transaction is considered a modification and continuation of the original sale transaction. The buyer's initial and continuing investments from the original interval and any down payment received on the upgrade interval are combined and compared to the sales value of the upgrade interval when evaluating whether the buyer's financial commitment is adequate for the application of the accrual method of accounting.
Example—Upgrade
In January 2007, Benedict (B) purchases a time-sharing interval at a stated sales price of $10,000 and makes a down payment of $1,000, with the remainder being financed by the seller. The stated sales price is equal to the sales value of the interval. The note is deemed to be collectible. In January 2009, buyer and seller enter into an upgrade arrangement, under which the buyer will upgrade to a more luxurious interval with a sales value of $15,000. The buyer does not make any additional down payment when entering into the upgrade transaction. In the years 2007 and 2008, B has made principal payments of $2,000 on his note for the interval originally purchased. The seller has determined that 10% initial investment is sufficient for the application of the accrual method.
At the time of the upgrade transaction, is the buyer's investment adequate for the use of the accrual method?
| Sales Value of Upgrade Interval: | $ 15,000 |
| Required Down Payment Percentage: | 10% |
| Required Initial Investment for Upgrade Interval: | $ 1,500 |
Payments Included when Evaluating the Adequacy of Buyer's Financial Commitment.
| Down Payment on Original Interval: | $ 1,000 |
| Principal Payment on Note: | $ 2,000 |
| $ 3,000 |
The buyer's investment is adequate for the use of the accrual method of accounting, since the buyer's down payment on the original interval purchased and the subsequent principal payments on the note exceed the minimum investment requirement of 10% on the upgrade interval.
Reload Transaction
A reload transaction is the purchase of an additional interval, which is considered a transaction separate from the purchase of the original interval. Therefore, the seller should not include the buyer's initial and continuing investments from the original time-sharing interval toward the measurement of the buyer's commitment for the second interval.65
7.4.5 Seller Support of Operations
Owners of time-sharing intervals are responsible for paying the costs of owning and managing their intervals, such as property taxes, repairs and maintenance, and reservation systems. Generally, a time-share developer establishes a nonprofit organization that acts as owners association, manages the day-to-day operations of the vacation property, and collects owners association fees. During the early stages of project sellout, a large percentage of the time-sharing intervals is still owned by the developer. Rather than paying owners association fees for the unsold intervals, the developer may subsidize the owners association to cover operating deficits. These seller subsidies generally diminish as additional time-sharing intervals are sold. Payments by the seller of dues or maintenance fees, as well as any amounts paid to subsidize losses of the owners association, are charged to expense as incurred, except when accounted for as incidental operations.66
Subsidies that extend beyond sell-out periods or that do not diminish during the sell-out period raise the question whether the seller has transferred substantially all the risks and rewards of ownership of the time-sharing intervals sold, that is, whether sale recognition is appropriate.67
7.4.6 Division of Project into Phases68
Similar to other real estate projects that are completed over several years, time-share developers often divide projects into phases to allow for proper cost allocation. If a project is divided into phases, the relative sales value method is based on the individual phase rather than the project as a whole. For a variety of reasons, a time-share developer may decide to change the phases of a time-share project in subsequent periods.
Such change is accounted for on a retrospective basis as a change in accounting principle pursuant to the provisions of FASB Statement No. 154, Accounting Changes and Error Corrections. Retrospective application requires that the financial statements for each individual prior period presented be adjusted to reflect the period-specific effects of applying the new accounting principle.69
7.5 Financial Statement Presentation and Disclosure70
A time-share developer should disclose its policies with respect to the criteria established for assessing a buyer's commitment and the collectibility of the sales price. Topic 978 (SOP 04–2) provides for these presentation and disclosure requirements related to receivables from time-share sales:
Gross notes receivable from time-share sales, a deduction for the allowance for uncollectibles, and a deduction from notes receivable for any profit deferred under Subtopic 360-20 (FASB Statement No. 66)
Maturities of notes receivable for each of the five years following the date of the financial statements and in the aggregate for all years thereafter
The weighted average and range of stated interest rates of notes receivable
A roll-forward of the allowance for uncollectibles (the balance of the allowance at the beginning and end of each period, additions associated with current-period sales, direct write-offs charged against the allowance, and changes in estimate associated with prior period sales)
A roll-forward of the allowance for uncollectibles for receivables sold with recourse
For time-share projects that have not been completed, a time-share developer should disclose the estimated costs to complete improvements and amenities.
If the financial statements include a change in accounting estimate (e.g., related to the application of the relative sales value method or the percentage-of-completion method71) or a change in accounting principle (such as a change relating to the delineation of the project into phases), the financial statements should include the disclosures required by Topic 250 (FASB Statement No. 154).
7.6 Synopsis of Authoritative Literature (Pre-Codification References)
FASB Statement No. 66, Accounting for Sales of Real Estate
Outline provided in Chapter 3.
FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects
Outline provided in Chapter 1.
AICPA Statement of Position 04-2, Accounting for Real Estate Time-Sharing Transactions
SOP 04-2 provides guidance on the accounting by a seller for real estate time-sharing transactions. A time-share seller should apply the relative sales value method to determine the appropriate amounts of revenues and cost of sales to be recorded. The method of profit recognition follows the provisions in FASB Statement No. 66. The issues addressed by SOP 04-2 include accounting for uncollectibility of receivables, the treatment of marketing and selling costs, accounting for incentives, and operations during holding periods.
Notes
1. In a floating system, the owner can purchase an interval within a particular season but not a specific week.
2. Under a points-based system, the customer obtains vacation credit each year that may be redeemed at different resorts.
3. ASC 978-840-25-1 (AICPA Statement of Position (SOP) No. 04-2, paragraph 13).
4. Right-to-use structures may also be set up as floating unit/floating week arrangements.
5. ASC 978-810-25-3 provides this exception:
a special-purpose entity shall be viewed as an entity lacking economic substance and established solely for the purpose of facilitating sales if both of these conditions are met.
a. The special-purpose entity structure is legally required by the applicable jurisdiction(s) to sell time-sharing intervals to the nonresident customers that the developer-seller wishes to sell to (for example, for purposes of being able to sell intervals to United States citizens in a country in which citizens of other countries are not allowed to own real estate).
b. The special-purpose entity has no assets, other than the time-sharing intervals, and the special-purpose entity has no debt.
In those circumstances, the seller should show on its balance sheet as time-sharing inventory the interests in the special-purpose entity not yet sold to end users (paragraph 56 of SOP 04-2).
6. SOP 04-2, paragraph A49 (not codified).
7. ASC 978-605-25-1 (FASB Statement (FAS) No. 66, paragraph 37).
8. ASC 360-20-40-7 (FAS 66, paragraphs 6 and 20).
9. ASC 360-20-40-7 (paragraph 6 of FASB Statement No. 66) states that all conditions precedent to closing must have been met, which would include a certificate of occupancy. However, ASC 360-20-40-28 (paragraph 20 of FASB Statement No. 66) provides an exception to this requirement for buildings that require longer construction periods, such as condominiums, which also applies to time-sharing properties.
10. ASC 360-20-40-8 – 40-20 (FAS 66, paragraphs 7–12).
11. ASC 360-20-55-2 (paragraph 54 of FASB Statement No. 66) allows for an analogy to other types of properties, if the property sold is not specifically addressed.
12. See Chapter 3 for a more detailed discussion of items that require an adjustment of the stated sales price.
13. ASC 978-605-30-10 (SOP 04-2, paragraph 22).
14. ASC 978-605-30-9 (SOP 04-2, paragraph 21).
15. ASC 978-605-25-6 – 25-10 (SOP 04-2, paragraphs 24–27).
16. Special rules apply for incentives conditioned on future performance, as explained in Section 7.3.1.1 of this chapter under “Incentives Conditioned on Sufficient Future Performance.”
17. Section 7.4.2 in this chapter further explains the accounting treatment for incentives, differentiating between cash incentives and noncash incentives.
18. ASC 978-605-25-7 (SOP 04-2, paragraph A14).
19. This example ignores any interest considerations.
20. To be entitled to a waiver of the second-year owners association fees, the buyer has to make 12 monthly payments: 12 × $175 = $2,100.
21. This example ignores any interest considerations.
22. To be entitled to the amusement part tickets, the buyer has to make two monthly payments: 2 × $175 = $350.
23. ASC 978-605-25-7 (SOP 04-2, paragraph A14).
24. ASC 978-605-55-33 (SOP 04-2, paragraph B3).
25. ASC 978-605-25-4 (SOP 04-2, paragraph 12).
26. If a project is divided into several phases, the relative sales value method is based on the individual phase rather than the project as a whole [ASC 978-330-30-1 (SOP 04-2, paragraph 40)].
27. ASC 978-330-35-1 (SOP 04-2, paragraph 41).
28. If a project is divided into phases: Cost of sales is determined based on sales and costs relating to each individual phase rather than the project as a whole.
29. ASC 978-330-35-1 (SOP 04-2, paragraph 41).
30. Adapted from ASC 978-605-55-38 (SOP 04-2, Appendix B, Example 1).
31. Calculated as:
| Sales: | $ 10,950,000 |
| Less: Down payment | $1,095,000 |
| $9,855,000 | |
| 10% default rate | $985,500 |
32. Calculated as:
| Sales Year 1 | $ 5,025,500 |
| Less: Down payment | $502,500 |
| $ 4,522,500 | |
| 10% default rate | $452,250 |
33. Calculated as:
| Sales Year 1 | $ 5,025,000 |
| Less: Uncollectibles | $452,250 |
| $ 4,572,750 | |
| Cost-of-sales percentage (25.08906%) | $ 1,147,260 |
34. Calculated as:
| Sales | $ 10,950,000 |
| Less: Down payment | $1,095,000 |
| $9,855,000 | |
| 13% default rate | $1,281,150 |
35. Calculated as:
| Allowance Year 1 (previously recorded) | $452,250 |
| Allowance Year 1 (per revised estimate) | $587,925 |
| Adjustment to be recorded: | ($ 135,675) |
36. Calculated as:
| Sales Year 1 | $ 5,025,000 |
| Less: Uncollectibles (revised) | $587,925 |
| $ 4,437,075 | |
| Cost-of-sales Percentage (rev.) 25.58622% | $ 1,135,253 |
| Cost of Sales (originally recorded) | $ 1,147,260 |
| $12,007 |
37. ASC 978-340-25-1 (SOP 04-2, paragraph 45).
38. ASC 978-340-25-2 (SOP 04-2, paragraph 46).
39. ASC 978-340-40-2 (SOP 04-2, paragraph 47).
40. ASC 978-340-25-3 (SOP 04-2, paragraph 46).
41. For advertising costs incurred, the guidance in SOP 93–7, Reporting on Advertising Costs, should be followed [ASC 978-720-25-2 (SOP 04–2, paragraph 48)].
42. ASC 978-720-25-2 (SOP 04-2, paragraph 48).
43. ASC 360-20-40-3 (FAS 66, paragraph 3).
44. Adapted from ASC 978-605-55-50 – 55-62 (SOP 04-2, Appendix D).
45. Sales, net of down payments.
46. $660 is the amount of defaults that occurred in 2007 relating to 2006 sales.
47. For simplicity, earlier years have been combined.
48. Time-share seller S expects a 12% default rate relating to its FY 2007 sales ($10,000): $1,200.
49. The amount of $970, which represents the allowance for uncollectibles relating to FY 2007 sales to be recorded as of December 31, 2007, is calculated as:
| Sales FY 2007: | $ 10,000 |
| Expected uncollectibles (12%): | $1,200 |
| Less defaults in FY 2007: | $230 |
| Expected defaults in future periods: | $970 |
50. Calculated as:
| Allowance relating to FY 2007 sales: | $970 |
| Allowance relating to FY 2006 sales: | $ 1,280 |
| Allowance relating to FY 2005 sales: | $ 1,920 |
| Allowance relating to FY 2004 sales: | $ 2,400 |
| Allowance relating to earlier years' sales: | $900 |
| Total allowance needed: | $ 7,470 |
51. See ASC 978-605-55-50 – 55-62 (SOP 04-2, Appendix D) for more detailed analyses and financial statement disclosures relating to uncollectibles.
52. ASC 978-310-35-5 (SOP 04-2, paragraph 36).
53. ASC 978-310-35-6 (SOP 04-2, paragraph 37).
54. ASC 470-60-15-5 (FAS 15, paragraph 2).
55. ASC 605-50-45-2 – 45-3 (EITF Issue No. 01-9, paragraphs 9 and 10).
56. ASC 978-605-30-6 (SOP 04-2, paragraph 18).
57. ASC 978-605-30-6 (SOP 04-2, paragraph 18).
58. ASC 978-330-35-6 (SOP 04–2, paragraph 51).
59. The relative sales value method is a method of allocating inventory cost and determining cost of sales. Cost of sales is calculated as a percentage of net sales by applying a cost-of-sales percentage, determined as the ratio of total estimated inventory cost (including costs to complete, if any) to total estimated time-sharing revenue [ASC 978-310-20 (SOP 04-2, Glossary)]. The inventory balance reported in the balance sheet is considered to be a pool of costs that will be charged against future revenue (SOP 04-2, Glossary).
60. ASC 978-330-35-3 (SOP 04-2, paragraph 50).
61. ASC 978-330-35-5 (SOP 04-2, paragraph 52).
62. ASC 978-605-25-11 – 25-13 (SOP 04-2, paragraphs 28 and 29).
63. If the terms of a real estate transaction allow the buyer to compel the seller to repurchase the real estate sold, sale accounting is not appropriate [ASC 360-20-40-38 (FAS 66, paragraph 26)].
64. ASC 978-605-55-5 (SOP 04-2, Appendix C).
65. In a points-based time-sharing transaction, the purchase of additional points is considered a reload transaction [ASC 978-605-20 (SOP 04-2, Glossary)].
66. ASC 978-720-25-3 (SOP 04-2, paragraph 59); see Section 7.4.3 of this chapter for a discussion of incidental operations.
67. ASC 978-605-55-13 (SOP 04-2, Appendix C, section titled “Seller Support of Operations”).
68. ASC 978-250-35-1 (SOP 04-2, paragraph 15).
69. ASC 250-10-45-5 (FAS 154, paragraph 7).
70. ASC 978-310-50-1 (SOP 04-2, paragraphs 63 and 64).
71. ASC 978-330-35-1 (SOP 04-2, paragraph 41).