ASC 360-10, Overall

Property, plant, and equipment (sometimes referred to as “fixed assets,” “tangible long-lived assets,” or as “plant assets”) are tangible property used in a productive capacity that will benefit the reporting entity for a period exceeding one year.

Among the accounting issues that can arise in accounting for fixed assets are:

1. Determination of the amounts at which to initially record the assets, whether acquired through purchase or nonmonetary exchange or through construction by the reporting entity.
2. Whether management capitalizes discrete assets in groups or separately capitalizes the major individual components of individual assets (determination of the unit of account)
3. The proper accounting for postacquisition costs incurred with respect to the assets during their useful lives
4. The rate and pattern of allocation of amounts capitalized to the proper future periods, including, if applicable, periods during which the assets become impaired
5. Events that cause the assets to be reclassified to or from categories such as held and used, held for sale, or idle
6. Derecognition—the recording of sale, exchange, retirement, and/or disposal of the assets at or before the end of their productive lives.

Comparison of accounting and impairment rules. The following diagram summarizes and compares the rules affecting the accounting for tangible and intangible long-lived assets.

ASC 360-20, Real Estate Sales

The substance of a sale of any asset is that the transaction unconditionally transfers the risks and rewards of ownership to the buyer. However, the economic substance of many real estate sales is that the risks and rewards of ownership have not been clearly transferred. The turbulent and cyclical environments in the real estate and debt markets have led to the evolution of many complex methods of financing real estate transactions. For example, in some transactions the seller, rather than an independent third party, finances the buyer, while in others, the seller may be required to guarantee a minimum return to the buyer or continue to operate the property for a specified period of time. In many of these complex transactions, the seller still has some association with the property even after the property has been sold. The question that must be answered in these transactions is: At what point does the seller become disassociated enough from the property that profit may be recognized on the transaction?

Another question is under what circumstances is a transaction in substance the sale of real estate. To make that determination, ASC 360-20 suggests the preparer considers the nature of the entire component being sold, that is, not just the land, but the land plus the property improvements and integral equipment. Further, that determination shall not consider whether the operations in which the assets are involved are traditional or nontraditional real estate activities. For example, if a ski resort is sold and the lodge and ski lifts are considered to be affixed to the land (that is, they cannot be removed and used separately without incurring significant cost), then it would appear that the sale is in substance the sale of real estate and that the entire sale transaction would be subject to the provisions of this Subtopic. Transactions involving the sale of underlying land (or the sale of the property improvements or integral equipment subject to a lease of the underlying land) shall not be bifurcated into a real estate component (the sale of the underlying land) and a non-real-estate component (the sale of the lodge and lifts) for purposes of determining profit recognition on the transaction.

Accounting for retail land sales is governed by ASC 976. The purpose of ASC 360-20 is to present the guidelines that need to be considered when analyzing nonretail real estate transactions. ASC 840-40 dealing with sales-type real estate leases and sales-leaseback real estate transactions is covered in the chapter on ASC 840.

Cost Considerations—Initial Acquisition

Determination of costs is critical to proper accounting for property, plant, and equipment. Upon acquisition, the reporting entity should capitalize all the costs necessary to deliver the asset to its intended location and prepare it for its productive use. This includes interest costs incurred during the period of time necessary to ready the asset for use. (ASC 835-20-05-1) Examples of delivery and asset preparation costs relative to personal property include:

1. Sales, use, excise, and other taxes imposed on the purchase
2. Import duties
3. Finders' fees
4. Freight costs and related shipping insurance
5. Storage and handling costs
6. Installation and setup costs
7. Testing and breaking-in costs
8. Foundations and other costs related to providing proper support for the asset
9. Costs of reconditioning assets that are purchased used in order to prepare them for use.

When the asset consists of one or more buildings, capitalized costs include such items as:

1. Demolition of preexisting structures occupying the land, as well as costs related to excavating, grading, or filling the land to ready it for the new structure
2. Contract price paid to the general contractor and subcontractors
3. Architectural and engineering costs
4. Building permits
5. Costs of renovating a preexisting purchased building to convert it for use by the buyer.

Construction of tangible assets for internal use. All direct costs (labor, materials, payroll, and related benefit costs) of constructing an entity's own tangible fixed assets are capitalized. However, a degree of judgment is involved in allocating costs between indirect costs—a reasonable portion of which are allocable to construction costs—and general and administrative costs, which are treated as period costs.

Prudence suggests that management establish a carefully reasoned policy that is consistently followed and fully disclosed in the notes to the financial statements, to unambiguously inform the user about the methods used and amounts involved.

Interest cost. The recorded amount of an asset includes all of the costs necessary to get the asset set up and functioning properly for its intended use, including interest.

The principal purposes accomplished by the capitalization of interest costs are:

1. To obtain a more accurate measurement of the costs associated with the investment in the asset
2. To achieve a better matching of costs related to the acquisition, construction, and development of productive assets to the future periods that will benefit from the revenues that the assets generate.

All assets that require a time period to get ready for their intended use should include a capitalized amount of interest. However, accomplishing this level of capitalization would usually violate a reasonable cost/benefit test because of the added accounting and administrative costs that would be incurred. In many such situations, the effect of interest capitalization would be immaterial. Accordingly, interest cost is only capitalized as a part of the historical cost of the following qualifying assets when such interest is considered to be material. For more detailed information on capitalization of interest costs, see the chapter on ASC 835.

Acquisition of the residual value in leased assets. Upon acquisition, an interest in the residual value of a leased asset is recorded as an asset. The asset is recorded initially at:

• The amount of cash disbursed,
• The fair value of other consideration, and
• The present value of liabilities assumed.

To measure cost, use the fair value of the interest acquired if it is more evident than the fair value of assets or services surrendered or liabilities assumed.

Accounting for assets acquired in a group. It is important to differentiate the acquisition of assets in a group from those acquired in a business combination. To aid the practitioner in this endeavor, ASC 805 provides that, if the assets acquired and liabilities assumed constitute a “business,” the transaction is a business combination; otherwise, it is accounted for as an asset acquisition.

The definition of a business is

…an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

Significantly, the definition does not

1. Require that outputs be present, although they frequently are present
2. Require that a business be self-sustaining. Rather it emphasizes that the activities and assets be capable of providing a return. Thus, an entity that is in its development stage and has not yet commenced its planned principal operations that otherwise meets the definition is considered to be a business.

When a reporting entity acquires assets and assumes liabilities that do not constitute a business, the transaction is accounted for as an asset acquisition. Assets acquired in an asset acquisition are initially recognized at their cost to the acquirer, including related transaction costs. The costs of assets acquired as a group are allocated to the individual assets acquired or liabilities assumed based on their relative fair values. Goodwill is not to be recognized in a transaction of this nature.

If assets are transferred between entities under common control, the entity receiving the net assets or equity interests initially recognizes the assets and liabilities transferred at their carrying amounts to the transferring entity at the transfer date. If there is a difference between the carrying amounts of the net assets transferred and their historical cost of the parent company because, for example, push-down accounting had not been applied, then the financial statements of the recipient entity are to reflect the transferred assets and liabilities at the historical cost of the parent of the entities under common control.

Unit of accounting. No specific guidance is provided in GAAP as to the unit of accounting to be used by management in capitalizing long-lived assets. Management might choose, with respect to assets it acquires or constructs, to aggregate individually identifiable assets and record them as if they were a single asset, and then depreciate them accordingly. Conversely, management might choose, with respect to longer-lived assets such as buildings or aircraft, to disaggregate the purchase price and separately record and depreciate the asset's major components over each component's own, individually determined estimated useful life. (Note that there may be significant tax advantages to separately accounting for components.)

Absent specific guidance regarding such practices, it is important that the financial statements provide sufficient information regarding the reporting entity's policies regarding capitalization of fixed assets and the criteria used by management to determine whether to record specified categories of assets in groups and/or by component. These policies are to be followed consistently, once adopted, with any future voluntary, postadoption changes in the policies subject to ASC 250, Accounting Changes and Error Corrections.

Other Asset Acquisition Concerns. For general guidance on assets acquired

• In a business combination, see ASC 805-20-25
• In a nonmonetary transaction, see ASC 845-10-30-1 through 30-10
• Under a capital lease, see ASC 840-30
• In a troubled debt restructuring, see ASC 310-40.

Cost Considerations—Postacquisition

Many different terms are used to describe costs that occur subsequent to initial acquisition including, but not limited to, the following:

Irrespective of the terminology used to describe a cost, the proper accounting treatment depends on a careful analysis of whether the cost is expected to provide future benefits to the reporting entity and, if so, the nature of those expected benefits.

Costs that increase the value of the asset. If the cost adds to the existing asset, in effect a new asset has been acquired that is subject to the same capitalization considerations applied in recognizing the original asset. As a practical expedient, most reporting entities establish a dollar threshold under which such costs are charged to expense, irrespective of their purpose (e.g., all costs under $1,500 are charged to expense). This is done under the assumption that the costs of capitalizing and depreciating the item exceed the benefits to users of the financial statements. In effect, these items are considered to be immaterial to the financial statements, both individually and in the aggregate.

Costs that increase the future service potential of the asset. If the cost increases the future service potential of the asset, it is accounted for in one of the following manners, depending on the individual facts and circumstances:

1. Costs that do not extend the overall useful life of the asset. If a portion of the original asset is being replaced, theoretically, the carrying value, if any, of the corresponding portion of the asset that is being replaced (cost less accumulated depreciation and less any impairment charges recognized in prior periods) should be removed from the accounting records and recorded as a loss in the period of the replacement. This accounting is seldom used in practice because, in general, accounting records for fixed assets are not maintained in the painstaking detail necessary to determine the carrying value of the individual components that comprise each asset. Instead, most companies will capitalize the replacement components under the rationale that the portion of the asset being replaced would have been depreciated sufficiently based on the useful life of the host asset so that at the time of replacement, little or no carrying value would remain to be removed.
2. Costs that extend the overall useful life of the asset. If, as a result of incurring a cost, the useful life of the host asset is extended without increasing its productivity or capacity, it has been suggested that the costs be recorded as a charge to accumulated depreciation, rather than capitalizing them as additions to fixed assets. Recording the transaction in this manner effectively recovers previously recognized depreciation and has the same effect on the net carrying value as capitalizing the addition. This treatment is seldom used in practice and has little theoretical appeal unless it is accompanied by a prospective change in the remaining estimated useful life of the host asset.

Planned major maintenance activities. ASC 908-360 contains guidance on accounting for the expenses related to airline maintenance activities. Line maintenance and other routine maintenance activities should be expenses as incurred. There are three acceptable methods for accounting for planned major maintenance activities:

1. Expense as incurred
2. Deferral
3. Built-in overhaul method.

Additional guidance can be found in ASC 908-360-25-2 and in the AICPA's Airlines – Audit and Accounting Guide.

Reinstallations and rearrangements. If, as a result of reinstallation and rearrangement activities, the reporting entity expects to obtain benefits that extend into future years arising from improved production efficiency or reduced production costs, these costs can be capitalized and depreciated. If the activities are not expected to provide those future benefits, the costs are to be recognized as expense as incurred.

Relocation. The costs of moving a fixed asset to a new location at which it will operate in the same manner and with the same functionality as it did at its former location does not result in any future benefits, and therefore the costs of dismantlement, packaging/crating, shipping, and reinstallation are to be recognized as expenses as incurred.

Repairs and maintenance. If a cost does not extend an asset's useful life, increase its productivity, improve its operating efficiency, or add additional production capacity, the cost is to be recognized as an expense as incurred.

Depreciation and Depletion

The costs of fixed assets are allocated to the periods of their expected useful life through depreciation or depletion. The method of depreciation chosen is that which results in a systematic and rational allocation of the cost of the asset (less its residual or salvage value) over the asset's expected useful life. The estimation of useful life takes a number of factors into consideration, including technological change, normal deterioration, and actual physical usage. The method used is to be selected based on either a function of time (e.g., technological change or normal deterioration) or as a function of actual physical usage. (ASC 360-10-35-8)

Depreciation methods based on time. Each of the examples below is based on the following facts.

Michele Corporation purchased a production machine and placed it in service on January 1, 20X1. The machine cost $100,000, has an estimated salvage value of $10,000, and an estimated useful life of five years.

1. Straight-line method—Depreciation expense is recognized evenly over the estimated useful life of the asset.

   Formula

   1. Compute the straight-line depreciation rate as

      1

      Estimated useful life

   2. Multiply the depreciation rate by the cost less estimated salvage value.

2. Accelerated methods—Depreciation expense is higher in the early years of the asset's useful life and lower in the later years. These methods are more appropriate than straight-line if the asset depreciates more quickly or has greater production capacity in the earlier years than it does as it ages. They are also sometimes used on the theory that maintenance and repair costs typically increase as assets age; therefore, in conjunction with accelerated depreciation total ownership costs (depreciation, maintenance, and repairs) will approximate straight-line.
   1. Declining balance—Annual depreciation is computed by multiplying the book value at the beginning of the fiscal year by a multiple of the straight-line rate of depreciation as computed above. (ASC 360-10-35-7)

      Formula

      Double-declining balance (ceases when the book value = the estimated salvage value)2 × Straight-line depreciation rate × Book value at the beginning of the year

      The ASC specifically prohibits use of the IRS's Accelerated Cost Recovery System (ACRS) if a reasonable range of the asset's useful life is not reflected within the years specified by the ACRS. The ASC also states that the annuity method of depreciation is not acceptable. (ASC 360-10-35-9)

Partial-year depreciation. When an asset is either acquired or disposed of during the year, the full-year depreciation calculation is prorated between the accounting periods involved.

As an alternative to proration, an entity may follow any one of several simplified conventions.

1. Record a full year's depreciation in the year of acquisition and none in the year of disposal.
2. Record one-half year's depreciation in the year of acquisition and one-half year's depreciation in the year of disposal.

Depreciation method based on actual physical usage—units of production. Depreciation is based upon the number of units produced by the asset in a given year.

Other depreciation methods. In addition to the foregoing, a group (composite) method is sometimes used. This method averages the service lives of a number of assets using a weighted-average of the units and depreciates the group or composite as if it were a single unit. A group consists of similar assets, while a composite is made up of dissimilar assets.

Depreciation expense: Depreciation rate × Total group (composite) cost

Gains and losses are not recognized on the disposal of an asset but are netted into accumulated depreciation.

Depletion. Depletion is the annual charge for the use of natural resources. In order to compute depletion, it is first necessary to establish a depletion base, the amount of the depletable asset.

The depletion base includes the following elements:

1. Acquisition costs—The cost to obtain the property rights through purchase or lease, royalty payments to the property owner,
2. Exploration costs—Typically, these costs are expenses as incurred; however in certain circumstances in the oil and gas industry, they may be capitalized,
3. Development costs—Intangible development costs such as drilling costs, tunnels, shafts, and wells,
4. Restoration costs—The costs of restoring the property to its natural state after extraction of the natural resources has been completed.

The amount of the depletion base, less its estimated salvage value, is charged to depletion expense each period using a depletion rate per unit extracted, or unit depletion rate that is computed using the following formula:

The unit depletion rate is revised frequently due to the uncertainties surrounding the recovery of natural resources. The revision is made prospectively; the remaining undepleted cost is allocated over the remaining expected recoverable units.

Income tax methods. Income tax deductions for depreciation (referred to in income tax law as “cost recovery deductions”), including the Section 179 and bonus depreciation deductions discussed below, are not in accordance with generally accepted accounting principles because, in general, they are not based on estimated useful lives and do not allocate cost to future periods benefited on a systematic and rational basis. Therefore, differences between financial statement and income tax depreciation result in temporary differences between the carrying values of the long-lived assets for income tax and financial reporting purposes. These temporary differences are taken into account in the calculation of deferred income taxes, as discussed in the chapter on ASC 740.

Accelerated Cost Recovery System. Assets placed in service between 1981 and 1986 are depreciated under the Accelerated Cost Recovery System (ACRS). ACRS ignores salvage value. Thus, the asset's entire income tax basis is depreciable over the specified recovery period to be used for each class of asset. Property is placed into classes and the depreciation method and life for each class is specified. Election of optional depreciation methods was also permitted. Depreciation deductions are calculated by multiplying the asset's unadjusted basis by the specified depreciation percentage for the related time period. The depreciation percentage will depend upon the asset's class, recovery year, depreciation method, and convention used to compute depreciation in the year of acquisition.

Modified Accelerated Cost Recovery System. For assets placed in service after 1986, income tax depreciation is calculated using the Modified Accelerated Cost Recovery System (MACRS) under IRC §168, which also ignores salvage value and divides assets into classes. Depreciation deductions are calculated by multiplying the asset's unadjusted basis by the appropriate depreciation percentage. The percentages are based on the type of property, class life, depreciation method, and acquisition-year convention. Depreciation deductions are limited for certain assets such as listed property (primarily automobiles). Optional depreciation methods may also be elected.

Additional deductions available in year placed in service. The U.S. Congress has frequently passed legislation providing businesses substantial income tax benefits in the form of accelerated first-year deductions for newly purchased depreciable property placed in service.

Two such provisions of note that are and have been available to businesses are (1) the “Election to Expense Certain Property under Section 179” (“§179 deduction”), and (2) the special allowance for “Bonus Depreciation: in IRC §168(k),” as recently amended by the American Recovery and Reinvestment Act of 2009.

The benefits of these deductions are taken prior to computing depreciation as described above and, of course, the amount of the deductions reduces the depreciable basis of the affected assets for income tax purposes.

Income tax depreciation will differ in amount from financial statement depreciation because of differences in treatment of salvage value, recovery methods, recovery periods, and the use of conventions for assets placed in service during the year.

The difference between income tax depreciation and financial statement depreciation is reported as a reconciling item (referred to as a “Schedule M-1 or Schedule M-3 adjustment”) on a corporation's U.S. federal income tax return.

Impairment and disposal. The GAAP rules for measuring and recording impairment of assets are not uniform for all assets or for all specialized industries. The table below distinguishes between those assets subject to the general impairment rules and those for which different, specialized rules apply.

Subject to General Impairment Rules (ASC 360-10-35)

Subject to Specialized Impairment Rules

Split between General and Specialized Impairment Standards

Impairment of long-lived assets to be held and used. Under U.S. GAAP, impairment losses are only recognized when the carrying amount of the impaired asset (or asset group) is not recoverable. (ASC 360-10-35-17) Recoverability is determined by comparing the carrying amount of the asset (or asset group) on the date it is being evaluated for recoverability to the sum of the undiscounted cash flows expected to result from its use and eventual disposition. It is important to note that under ASC 360-10-35, an asset's carrying value can exceed its fair value (thus technically it could be considered to be impaired), yet if the carrying value is recoverable from expected future cash flows from its use and disposition, as defined, no impairment loss is recognized.

When to test. ASC 360-10-35 uses “events and circumstances” criteria to determine when, if at all, an asset (or asset group) is evaluated for recoverability. Thus, there is no set interval or frequency for recoverability evaluation. ASC 360-10-35-21 provides a list of examples of events or changes in circumstances that indicate the carrying amount of an asset (asset group) may not be recoverable and thus is to be evaluated for recoverability. It is important to note that the list of events and circumstances below is not intended to be all-inclusive. Rather, it is intended to provide examples of situations that warrant evaluation of an asset or group of assets for recoverability to determine whether an impairment loss must be recognized.

1. A significant decrease in the market price of a long-lived asset (asset group)
2. A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
3. A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator
4. An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group)
5. A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group)
6. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

Financial statement preparers are required to consider, for each interim and annual reporting period, the applicability of these indicators as well as other indicators not included in the list that might be applicable in the circumstances. Reliance should not be placed on “disclosure checklists” for this purpose as they are not designed to be used to determine the correct application of GAAP recognition and measurement requirements.

Measurement of the impairment loss. Under ASC 360-10-35-17, if the carrying amount of an asset or asset group (in use or under development) is evaluated and found not to be fully recoverable (the carrying amount exceeds the estimated gross, undiscounted cash flows from use and disposition), then an impairment loss must be recognized. The impairment loss is measured as the excess of the carrying amount over the asset's (or asset group's) fair value.

Fair value (as defined in the ASC Master Glossary) is the price that the reporting entity would receive to sell the asset on the measurement date in an orderly transaction between market participants in the principal (or most advantageous) market for the asset. To measure fair value, management must determine the asset's (or group of assets') highest and best use, which may not coincide with the manner in which the reporting entity is currently using it. Fair value measurements are discussed and illustrated in the chapter on ASC 820.

In conjunction with the recoverability evaluation, it may also be necessary to review the appropriateness of the method of depreciation (amortization) and depreciable (amortizable) lives of the asset or group of assets. If, as a result of that review the remaining useful life of the asset (group) is revised, the revised useful life is used to develop the cash flow estimates used to evaluate recoverability. Changes to the accounting method (e.g., from straight-line to accelerated depreciation), however, would be made prospectively after the application of ASC 360. (ASC 360-10-35-22)

Asset group impairment analysis. ASC 360 includes the concept of the asset group, defined as the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. (ASC 360-10-35-23)

An asset group could be:

• The whole company
• An operating segment as defined in the ASC Master Glossary
• A reporting unit as defined in the ASC Master Glossary
• A business
• A part of a business (such as a division or department).

Refer to asset groups shown in the diagram entitled “Alternative Balance Sheet Segmentation” in the chapter on ASC 280.

• Asset group (a) is a single division of a subsidiary
• Asset groups (b) and (c) are each separate businesses that comprise another division of the same subsidiary
• Asset group (d) is an entire subsidiary consisting of a single business
• Asset group (e) is a product line that is part of a larger business and, after the disposal of disposal group (f), will constitute an entire operating segment
• Asset groups (g) and (h) are each separate businesses that comprise a subsidiary.

If a long-lived asset cannot be assigned to any asset group because it does not have identifiable cash flows largely independent of other long-lived assets individually or in asset groups (such as a corporate headquarters), then that asset is evaluated for recoverability by reference to all assets and liabilities of the entity. (ASC 360-10-35-24)

The assets and liabilities in the group that are neither long-lived assets nor goodwill are separately identified. Since those assets and liabilities are not subject to the provisions of ASC 360, the GAAP applicable to their valuation is applied before applying ASC 360 to the group. For example, allowances for uncollectible accounts receivable and inventory obsolescence are recorded as necessary. (ASC 360-10-35-27)

Effect of goodwill on grouping. In assessing the composition of asset groups, management must be aware of the interrelationship between ASC 360, Property, Plant, and Equipment, and ASC 350, Intangibles—Goodwill and Other. Goodwill can only be assigned to an asset group that is being evaluated for recoverability if the asset group is either a reporting unit or includes a reporting unit.

Estimates of future cash flows. For the purposes of recoverability evaluation, future cash flows are defined as cash inflows less the associated cash outflows directly associated with, and that are expected to arise as a direct result of, the use and eventual disposition of the asset group excluding interest that is recognized as a period expense when incurred. (ASC 360-10-35-29)

The estimate of future cash flows:

• Is based on all available evidence
• Incorporates assumptions that marketplace participants would use in their estimates of fair value when that information is available without undue cost or effort; otherwise, the entity incorporates its own assumptions, including the “highest and best use” of the asset (or group)
• Is to be consistent with assumptions used by the entity for comparable periods such as internal budgets and projections, accruals related to incentive compensation plans, or information communicated to others
• Is made for the remaining estimated useful life of the asset (or the primary asset of an asset group) to the entity

• Takes into account future expenditures necessary to complete an asset under development including interest capitalized under ASC 835-20
• Includes future outflows necessary to maintain the existing service potential of all or a component of the asset or group of assets
• Excludes cash flows for future capital expenditures that increase the service potential of a long-lived asset or group of assets
• Is required to take into account the likelihood of possible cash flow outcomes if alternative courses of action are being contemplated, or if ranges of cash flows are estimated to occur under different scenarios.

  (ASC 360-10-35-30)

Allocating impairment losses to a group. If an asset group is found to have sustained an impairment loss, the loss is only applied to reduce the carrying amounts of the long-lived asset or assets in the group. In general, the loss is allocated to the long-lived assets in the group based on their relative carrying values. However, the carrying value of any individual asset in the group that has a fair value that is separately identifiable without “undue cost or effort” is not to be reduced below that fair value. (ASC 360-10-35-28)

After recognition of impairment losses, the adjusted carrying amounts of the impaired long-lived assets constitute their new cost bases. Depreciation (amortization) is recognized prospectively over their remaining estimated useful lives. The adjustment to carrying values to reflect an impairment loss may never be restored.

Other impairment considerations. Besides the foregoing, other issues arise as a consequence of applying the impairment rules.

Going concern. The example above included an estimate of cash flows at the entity level to assess whether the building was impaired. If the estimate had indicated that the building was impaired, management must consider whether the cash flows estimated for at least the ensuing year will be sufficient for the entity to continue as a going concern. Disclosure in the financial statements of management's plans may be required under ASC 205-30, Going Concern.

Significant estimates. If, in the example above, the expected cash flows used to assess the recoverability of the building were closer to the building's $4,500,000 carrying value, consideration is given to the applicability of ASC 275, Risks and Uncertainties. The assumptions used in the cash flow estimates could be considered significant estimates for which it is reasonably possible changes could occur in the near term (the ensuing year) and, consequently, disclosure would be required.

Treatment of certain site restoration/environmental exit costs. ASC 360-10-55 discusses how, for the purpose of performing the recoverability evaluation under ASC 360, to treat the costs of future site restoration or closure (referred to as “environmental exit costs”) that may be incurred if the asset is sold, abandoned, or ceases operations. To conform to ASC 360, references to an “asset” are also applicable to an “asset group.”

ASC 410-20, Asset Retirement and Environmental Obligations, requires asset retirement obligations recognized as liabilities to be included as part of the capitalized cost of the related asset and, to avoid double-counting, the cash settlement of those liabilities to be excluded from the expected future cash flows used to evaluate recoverability under ASC 360. If the asset retirement costs have not yet been recognized under ASC 410-20 because the obligation is being incurred over more than one reporting period during the useful life of the asset, then the cash flows for those unrecognized costs are to be included in the expected future cash flows.

The cash flows for environmental exit costs that are not recorded as liabilities under ASC 410-30 may not occur until the end of the asset's life if the asset ceases to be used or may be delayed indefinitely as long as management retains ownership of the asset and chooses not to sell or abandon it. Consequently, management's intent regarding future actions with respect to the asset is to be taken into account in determining whether to include or exclude these cash flows from the computation of the expected future cash flows used to evaluate recoverability under ASC 360. If management is contemplating alternative courses of action to recover the carrying amount of the asset or if a range is estimated for the amount of possible future cash flows, the likelihood (probability) of these possible outcomes is to be considered in connection with the recoverability evaluation under ASC 360.

ASC 360-10-55 provides examples illustrating situations where cash flows for environmental exit costs not recognized as liabilities under ASC 410-30 are either included in or excluded from the undiscounted expected future cash flows used to evaluate a long-lived asset or group of assets for recoverability under ASC 360.

Deferred income taxes. Impairment losses are not deductible for U.S. federal income tax purposes. Consequently, financial statement recognition of these losses will result in differences between the carrying amounts of the impaired assets for financial reporting purposes and income tax purposes. These differences are considered temporary differences and are accounted for under the provisions of ASC 740.

Long-lived assets to be disposed of by sale. An asset may be disposed of individually or as part of a disposal group (see Definition of Terms section in this chapter).

Long-lived assets (or disposal groups) are classified as held-for-sale in the period in which all of the following six criteria are met (ASC 360-10-45-9):

1. Management possessing the necessary authority commits to a plan to sell the asset (disposal group)
2. The asset (disposal group) is immediately available for sale on an “as is” basis (i.e., in its present condition subject only to usual and customary terms for the sale of such assets)
3. An active program to find a buyer and other actions required to execute the plan to sell the asset (disposal group) have commenced
4. An assessment of remaining actions required to complete the plan indicates that it is unlikely that significant changes will be made to the plan or that the plan will be withdrawn
5. Sale of the asset (disposal group) is probable, as that term is used in the context of ASC 450-20 (i.e., likely to occur), and transfer of the asset (disposal group) is expected to qualify for recognition as a completed sale within one year
6. The asset (disposal group) is being actively marketed for sale at a price that is reasonable in relation to its current fair value.

For a long-lived asset (disposal group) that has been newly acquired in a business combination to be classified as held for sale at that date, it must:

• Meet criterion 5 above (subject to the same exceptions noted in 5), and
• Any other of the required criteria that are not met at the date of acquisition are judged to be probable of being met within a short period (approximately three months or less) of acquisition.

  (ASC 360-10-45-12)

If the criteria are met after the date of the statement of financial position but prior to issuance of the entity's financial statements, the long-lived asset continues to be classified as held-and-used at the date of the statement of financial position. (ASC 360-10-45-13) Appropriate subsequent events disclosures would be included in the financial statements in accordance with ASC 855, Subsequent Events.

Measurement. (ASC 360-10-35-43) Long-lived assets (disposal groups) classified as held-for-sale are measured at the lower of their carrying amount or fair value less cost to sell. A loss is recognized for any initial or subsequent write-down to fair value less cost to sell. A gain is recognized for any subsequent increase in fair value less cost to sell, but recognized gains may not exceed the cumulative losses previously recognized. Long-lived assets that are classified as held-for-sale are presented separately on the statement of financial position.

Long-lived assets (disposal groups) being held for sale are not to be depreciated (amortized) while being presented under the held-for-sale classification. Interest and other expenses related to the liabilities of a held-for-sale disposal group are accrued as incurred.

Cost to sell consists of costs that directly result from the sales transaction that would not have been incurred if no sale were transacted. Cost to sell includes brokerage commissions, legal fees, title transfer fees, and other closing costs that must be incurred prior to transfer of legal title to assets. Prior to measurement of fair value less cost to sell, the entity adjusts the carrying amounts of any assets included in the disposal group not covered by ASC 360 including any goodwill (e.g., establishes appropriate valuation allowances for receivables and inventory, recognizes other-than-temporary impairment of applicable investment securities, etc.).

The entity may not accrue, as part of cost to sell, expected future losses associated with operating the long-lived asset (disposal group) while it is classified as held-for-sale. (ASC 360-10-35-38) Costs associated with the disposal, including costs of consolidating or closing facilities, are only recognized when the actual costs are incurred. If the exception to the one-year requirement applies (permitted when there are certain events and circumstances beyond the entity's control), and the sale is expected to occur in more than one year, the cost to sell is discounted to its present value.

Reclassification. If, at any time after meeting the criteria to be classified as held-for-sale, the asset (disposal group) no longer meets those criteria, the long-lived asset (disposal group) is to be reclassified from held-for-sale to held-and-used, measured at the lower of:

• Carrying value prior to classification as held-for-sale, adjusted for any depreciation (amortization) that would have been recognized had the asset (disposal group) continued to be classified as held-and-used, or
• Fair value at the date of the subsequent decision not to sell the asset (disposal group).

The adjustment required to the carrying amount of an asset (disposal group) being reclassified from held-for-sale to held-and-used is included in income from continuing operations in the period that the decision is made not to sell. FASB concluded that impairment losses from long-lived assets to be held and used, gains or losses recognized on long-lived assets to be sold, and other costs associated with exit or disposal activities (as defined in ASC 420) should be accounted for consistently. Therefore, if the entity reports a measure of operations (e.g., income from operations), these amounts are reported in operations unless they qualify as discontinued operations, as explained below. The income statement classification of these amounts is to be consistent with the accounting policy for classifying the depreciation of the underlying assets per the following examples:

If a component of an entity (as defined below) is reclassified as held-and-used, the results of that component that had previously been reported in discontinued operations are reclassified and included in income from continuing operations for all periods presented.

Upon removal of an individual asset or liability from a disposal group classified as held-for-sale, the remaining part of the group is to be evaluated as to whether it still meets all six of the criteria to be classified as held-for-sale. If all of the criteria are still met, then the remaining assets and liabilities will continue to be measured and accounted for as a group. If not all of the criteria are met, then the remaining long-lived assets are to be measured individually at the lower of their carrying amounts or fair value less cost to sell at that date. Any assets that will not be sold are reclassified as held-and-used as described above. (ASC 360-10-35-45)

Long-lived assets to be disposed of other than by sale. Long-lived assets may be abandoned, exchanged, or distributed to owners in a spin-off. Until the actual disposal occurs, the assets continue to be classified on the statement of financial position as “held and used.” During the period prior to disposal, they are subject to conventional impairment rules applicable to assets held and used.

Abandoned assets are considered disposed of under ASC 360 when they cease to be used. Temporary idling of an asset, however, is not considered abandonment. (ASC 360-10-35-49) At the time an asset is abandoned, ASC 360 prescribes that its carrying value be adjusted to its salvage value, if any, but not less than zero (i.e., a liability cannot be recorded upon abandonment). If an acquired asset meets the criteria to be considered a defensive intangible asset, it is prohibited from being considered abandoned upon its acquisition.

If the entity commits to a plan to abandon the asset before the end of its previously estimated useful life, the depreciable life is revised in accordance with the rules governing a change in estimate under ASC 250 and depreciation of the asset continues until the end of its shortened useful life. (ASC 360-10-35-46)

Per ASC 360-10-40-4 if a long-lived asset is to be disposed of either by spinning it off to owners of the company or in an exchange transaction for a similar productive long-lived asset, the disposal is recognized when the actual exchange or spin-off occurs. If that asset (group) is evaluated for recoverability while held and used and before the disposal, the estimates of future cash flows are to assume that the disposal will not occur and that the asset will continue to be held and used for the remainder of its useful life. Two separate impairment losses might be recognized in this scenario.

1. An impairment loss for the asset while it is held and used
2. An additional impairment loss if, upon exchange or spin-off, which are recorded under ASC 845 at the asset's recorded amount, the recorded amount/carrying value exceeds fair value.

Discontinued operations. Discontinued operations are covered in depth in the chapter on ASC 205, Presentation of Financial Statements.

Long-lived assets temporarily idled. The only reference in ASC 360 to the temporary idling of long-lived assets is the provision that prohibits recognizing temporary idling as abandonment. At a minimum, however, if material assets are temporarily idled, the following considerations apply:

1. Idling constitutes a “significant adverse change in the extent or manner in which…” the asset (or asset group) is being used, which is an indicator requiring a recoverability evaluation under ASC 360.
2. The estimates of future cash flows used in performing the recoverability evaluation are to consider, on a probability-weighted basis, the range of outcomes under consideration by management regarding when the asset will be returned to service, sold, or abandoned.
3. Idle property and equipment is to be clearly and unambiguously captioned and segregated on the statement of financial position from both the “held-and-used” and “held-for-sale” categories, since it does not qualify for either classification, with appropriate disclosure of the relevant circumstances.
4. As part of the ongoing review of the appropriateness of useful lives, the remaining useful life of the idle equipment is to be reassessed.
5. Evaluation by management of whether temporary suspension of depreciation or amortization of the asset is warranted until it is returned to service.

Scope

ASC 360-20-15 explicitly states that real estate sales transactions under ASC 360 include real estate with property enhancements or integral equipment. This defines property improvements and integral equipment as (ASC 360-20-15-3a) “any physical structure or equipment attached to real estate or other parts thereof that cannot be removed and used separately without incurring significant cost.” Examples include an office building or manufacturing plant. (For guidance on retail land sales that are sales, on a volume basis, of lots that are subdivisions of large tracts of land, see ASC 976.)

Criteria for Using Full Accrual Method

Profit from real estate sales is recognized in full, provided the following (ASC 360-20-40-3):

1. The profit is determinable (i.e., the collectability of the sales price is reasonably assured or the amount that will not be collectible can be estimated).
2. The earnings process is virtually complete, that is, the seller is not obliged to perform significant activities after the sale to earn the profit.

When both of these conditions are satisfied, the method used to recognize profits on real estate sales is referred to as the full accrual method. If both of these conditions are not satisfied, recognition of all or part of the profit is postponed.

The Codification goes on to say (ASC 360-20-40-4) that for real estate sales, the collectibility of the sales price is reasonably assured when the buyer has demonstrated a commitment to pay. This commitment is supported by a substantial initial investment, along with continuing investments that give the buyer a sufficient stake in the property such that the risk of loss through default motivates the buyer to honor its obligations to the seller. Collectibility of the sales price is also assessed by examining the conditions surrounding the sale (e.g., credit history of the buyer; age, condition, and location of the property; and history of cash flows generated by the property).

The full accrual method is appropriate and profit is recognized in full at the point of sale for real estate transactions when all of the following criteria are met (ASC 360-20-40-5):

1. A sale is consummated.
2. The buyer's initial and continuing investments are adequate to demonstrate a commitment to pay for the property.
3. The seller's receivable is not subject to future subordination.
4. The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale, and the seller does not have a substantial continuing involvement in the property.

On sales in which an independent third party provides all of the financing for the buyer, the seller is most concerned that criterion number 1 above is met. For such sales, the sale is usually consummated on the closing date. When the seller finances the buyer, the seller must analyze the economic substance of the agreement to ascertain that criteria 2, 3, and 4 are also met (i.e., whether the transaction clearly transfers the risks and rewards of ownership to the buyer).

Consummation of a sale. A sale is considered consummated when the following conditions are met (ASC 360-20-40-7):

1. The parties are bound by the terms of a contract.
2. All consideration has been exchanged.
3. Any permanent financing for which the seller is responsible has been arranged.
4. All conditions precedent to closing have been performed.

When a seller is constructing office buildings, condominiums, shopping centers, or similar structures, item 4 may be applied to individual units rather than the entire project. These four conditions are usually met on or after closing, not at the point the agreement to sell is signed or at a preclosing meeting. Closing refers to the final steps of the transaction (i.e., when consideration is paid, the mortgage is secured, and the deed is delivered or placed in escrow). If the consummation criteria have not been satisfied, the seller uses the deposit method of accounting until all of the criteria are met (i.e., the sale has been consummated).

Buyer's initial and continuing involvement. The initial and continuing investment requirements for the full accrual method apply unless the seller receives any of the following as the full sales value of the property (ASC 360-20-40-15):

1. Cash without any seller contingent liability on any debt on the property incurred or assumed by the buyer,
2. The buyer's assumption of the seller's existing nonrecourse debt on the property,
3. The buyer's assumption of all recourse debt on the property with the complete release of the seller from those obligations, or
4. Any combination of such cash and debt assumption.

In computing the buyer's initial investment, debt incurred by the buyer that is secured by the property is not considered part of the buyer's initial investment. This is true whether the debt was incurred directly from the seller or other parties or indirectly through assumption. Payments to the seller from the proceeds of such indebtedness are not included as part of the buyer's initial investment. (ASC 360-20-40-17)

If the transaction does not qualify for full accrual accounting and, consequently, is being accounted for using installment, cost recovery, or reduced profit methods, payments made on debt the preceding paragraph are not considered to be buyer's cash payments. However, if the profit deferred under the applicable method exceeds the outstanding amount of seller financing and the outstanding amount of buyer's debt secured by the property for which the seller is contingently liable, the seller recognizes the excess in income.

Adequacy of the buyer's initial investment. Once the sale is consummated, the next step is to determine whether the buyer's initial investment adequately demonstrates a commitment to pay for the property and the reasonable likelihood that the seller will collect it. This determination is made by comparing the buyer's initial investment to the sales value of the property. ASC 360-20-55-1 and 55-2 specifically detail items that are includable as the initial investment and the minimum percentages that the initial investment must bear to the sales value of the property. To make the determination of whether the initial investment is adequate, the sales value of the property must also be computed.

Computation of sales value. The sales value of property in a real estate transaction is computed as follows:

Composition of the initial investment. Sales transactions are characterized by many different types of payments and commitments made between the seller, buyer, and third parties; however, the buyer's initial investment only includes the following (ASC 360-20-40-10):

1. Cash paid to the seller as a down payment
2. Buyer's notes given to the seller that are supported by irrevocable letters of credit from independent lending institutions
3. Payments by the buyer to third parties that reduce existing indebtedness the seller has on the property
4. Other amounts paid by the buyer that are part of the sales value
5. Other consideration received by the seller that can be converted to cash without recourse to the seller; for example, other notes of the buyer.

ASC 360-20-40-13 specifically states that the following items are not included as initial investment:

1. Payments by the buyer to third parties for improvements to the property
2. A permanent loan commitment by an independent third party to replace a loan made by the seller
3. Funds that have been or will be loaned, refunded, or directly or indirectly provided to the buyer by the seller or loans guaranteed or collateralized by the seller for the buyer.

ASC 360-20-40-15 deals with a range of possible forms of financing and the implications of each for profit recognition under ASC 360. The following guidelines are to be used by a seller of real estate in applying ASC 360:

1. In determining whether a transaction qualifies for accounting using the full accrual method of profit recognition, the initial and continuing investment requirements of ASC 360 must be considered unless the seller has unconditionally received all amounts due and is not at risk related to the financing.
2. In determining the buyer's initial investment, payments made on debt incurred by the buyer that is secured by the property (irrespective of whether the debt is incurred directly from the seller or other parties or indirectly by assumption) is not part of the initial investment. Also excluded from the initial investment are payments made to the seller out of the proceeds from debt described in the preceding sentence.
3. Under the installment method, cost recovery method, and reduced-profit recognition methods, payments described in 2. above are not considered to be cash payments from the buyer. If, however, the deferred profit under the method applied under ASC 360 exceeds the sum of (1) the outstanding amount of seller financing, and (2) the outstanding amount of the buyer's debt secured by the property for which the seller is contingently liable, the excess amount is recognized as income by the seller.

Size of initial investment. Once the initial investment is computed, its size must be compared to the sales value of the property. To qualify as an adequate initial investment, the initial investment must be equal to at least a major part of the difference between usual loan limits established by independent lending institutions and the sales value of the property. The minimum initial investment requirements for real estate sales (other than retail land sales) vary depending upon the type of property being sold (ASC 360-20-40-18). The following table from ASC 360-20-55-2 provides the limits for the various properties:

Lenders' appraisals of specific properties often differ. Therefore, if the buyer has obtained a permanent loan or firm permanent loan commitment for maximum financing of the property from an independent lending institution, the minimum initial investment must be the greater of the following (ASC 360-20-55-1):

1. The minimum percentage of the sales value of the property specified in the above table or
2. The lesser of
   1. The amount of the sales value of the property in excess of 115% of the amount of a newly placed permanent loan or firm loan commitment from a primary lender that is an independent established lending institution
   2. 25% of the sales value.

To illustrate the determination of whether an initial investment adequately demonstrates a commitment to pay for property, consider the following example.

If the sale has been consummated but the buyer's initial investment does not adequately demonstrate a commitment to pay, the transaction is accounted for using the installment method when the seller is reasonably assured of recovering the cost of the property if the buyer defaults. However, if the recovery of the cost of the property is not reasonably assured should the buyer default or if the cost has been recovered and the collection of additional amounts is uncertain, the cost recovery or deposit method is used.

Adequacy of the buyer's continuing investments. The collectibility of the buyer's receivable must be reasonably assured; therefore, for full profit recognition under the full accrual method, the buyer must 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 (both principal and interest) over a specified period. This period is no more than twenty years for land, and no more than the customary amortization term of a first mortgage loan by an independent lender for other types of real estate. For continuing investment purposes, the contractually required payments must be in a form that is acceptable for an initial investment. If the seller provides funds to the buyer, either directly or indirectly, these funds must be subtracted from the buyer's payments in determining whether the continuing investments are adequate. (ASC 360-20-40-19 and 50-20)

The indebtedness on the property does not have to be reduced proportionately. A lump-sum (balloon) payment will not affect the amortization of the receivable as long as the level annual payments still meet the minimum annual amortization requirement. For example, a land real estate sale may require the buyer to make level annual payments at the end of each of the first five years and then a balloon payment at the end of the sixth year. The continuing investment criterion is met provided the level annual payment required in each of the first five years is greater than or equal to the level annual payment that would be made if the receivable were amortized over the maximum twenty-year (land's specified term) period.

Release provisions. An agreement to sell real estate may provide that part or all of the property sold will be released from liens by payment of an amount sufficient to release the debt or by an assignment of the buyer's payments until release. To meet the criteria of an adequate initial investment, the investment must be sufficient both to pay the release on property released and to meet the initial investment requirements on property not released. If not, profit is recognized on each released portion as if it were a separate sale when a sale has been deemed to have taken place. (ASC 360-20-21 and 40-23)

Seller's receivable subject to future subordination. The seller's receivable should not be subject to future subordination. Future subordination by a primary lender would permit the lender to obtain a lien on the property, giving the seller only a secondary residual claim. This subordination criterion does not apply if either of the following occur (ASC 360-20-40-25):

1. A receivable is subordinate to a first mortgage on the property existing at the time of sale.
2. A future loan, including an existing permanent loan commitment, is provided for by the terms of the sale and the proceeds of the loan will be applied first to the payment of the seller's receivable.

If the seller's receivable is subject to future subordination, profit is recognized using the cost recovery method. The cost recovery method is justified because the collectibility of the sales price is not reasonably assured in circumstances when the receivable may be subordinated to amounts due to other creditors.

Seller's continuing involvement. Sometimes sellers continue to be involved with property for periods of time even though the property has been legally sold. The seller's involvement often takes the form of profit participation, management services, financing, guarantees of return, construction, etc. The seller does not have a substantial continuing involvement with property unless the risks and rewards of ownership have been clearly transferred to the buyer.

If the seller has some continuing involvement with the property and does not clearly transfer substantially all of the risks and rewards of ownership, profit is recognized by a method other than the full accrual method. The method chosen is determined by the nature and extent of the seller's continuing involvement. As a general rule, profit is only recognized at the time of sale if the amount of the seller's loss due to the continued involvement with the property is limited by the terms of the sales contract. In this event, the profit recognized at this time is reduced by the maximum possible loss from the continued involvement. (ASC 360-20-40-37)

Continuing investment not qualifying. If the sale has been consummated and the minimum initial investment criteria have been satisfied but the continuing investment by the buyer does not meet the stated criterion, the seller recognizes profit by the reduced profit method at the time of sale if payments by the buyer each year will at least cover both of the following (ASC 360-20-40-33):

1. The interest and principal amortization on the maximum first mortgage loan that could be obtained on the property
2. Interest, at an appropriate rate, on the excess of the aggregate actual debt on the property over such a maximum first mortgage loan.

If the payments by the buyer do not cover both of the above, the seller recognizes profit by either the installment or cost recovery method. (ASC 360-20-40-34)

Graduated payment mortgages. Graduated payment mortgages for which negative principal amortization is recognized do not meet the continuing investment tests in ASC 360, and thus full profit is not to be recognized immediately. (ASC 360-20-40-35) Mortgage insurance is not to be considered the equivalent of an irrevocable letter of credit in determining whether profit is to be recognized, and the purchase of such insurance is not in itself a demonstration of commitment by the buyer to honor its obligation to pay for the property. The sole exception to this rule is that an irrevocable financial instrument from an established independent insuring institution, such as FHA (Federal Housing Administration) and VA (Veteran's Affairs), profits may be recognized under the full accrual method. (ASC 360-20-40-12) The seller may consider these to be the equivalent of irrevocable letters of credit.

Profit-sharing, financing, and leasing arrangements. In real estate sales, it is often the case that economic substance takes precedence over legal form. Certain transactions, though possibly called sales, are in substance profit-sharing, financing, or leasing arrangements and are accounted for as such. These include situations in which (ASC 360-20-40-38):

1. The seller has an obligation to repurchase the property, or the terms of the transaction allow the buyer to compel the seller to repurchase the property or give the seller an option to do so.
2. The seller is a general partner in a limited partnership that acquires an interest in the property sold and holds a receivable from the buyer for a significant part (15% of the maximum first-lien financing) of the sales price.
3. The seller guarantees the return of the buyer's investment or a return on that investment for an extended period of time.
4. The seller is required to initiate or support operations, or continue to operate the property at its own risk for an extended period of time.

Seller's continuing involvement without risks and rewards. Sometimes sellers continue to be involved with property for periods of time even though the property has been legally sold. The seller's involvement often takes the form of profit participation, management services, financing, guarantees of return, construction, etc. The seller does not have a substantial continuing involvement with property unless the risks and rewards of ownership have been clearly transferred to the buyer.

If the seller has some continuing involvement with the property and does not clearly transfer substantially all of the risks and rewards of ownership, profit is recognized by a method other than the full accrual method. The method chosen is determined by the nature and extent of the seller's continuing involvement. As a general rule, profit is only recognized at the time of sale if the amount of the seller's loss due to the continued involvement with the property is limited by the terms of the sales contract. In this event, the profit recognized at this time is reduced by the maximum possible loss from the continued involvement. (ASC 360-20-40-37)

Antispeculation clauses. ASC 360-20-40-39 deals with antispeculation clauses sometimes found in land sale agreements, requiring the buyer to develop the land in a specific manner or within a specific period of time and giving the seller the right, but not the obligation, to reacquire the property when the condition is not met. This option does not preclude recognition of a sale if the probability of the buyer not complying is remote.

Options to purchase real estate property. Often a buyer will buy an option to purchase land from a seller with the hopeful intention of obtaining a zoning change, building permit, or some other contingency specified in the option agreement. Proceeds from the issue of an option by a property owner (seller) are accounted for by the deposit method. If the option is exercised, the seller includes the option proceeds in the computation of the sales value of the property. If the option is not exercised, the seller recognizes the option proceeds as income at the time the option expires. (ASC 360-20-40-45)

Partial sales of property. Per ASC 360-20-40-46, “a sale is a partial sale if the seller retains an equity interest in the property or has an equity interest in the buyer.” Profit on a partial sale may be recognized on the date of sale if the following occur:

1. The buyer is independent of the seller.
2. Collection of the sales price is reasonably assured.
3. The seller will not be required to support the operations of the property on its related obligations to an extent greater than its proportionate interest.

Per ASC 360-20-46 and 47, if the buyer is not independent of the seller, the seller may not be able to recognize any profit that is measured at the date of sale (see the following Buy-sell agreements section).

If the seller is not reasonably assured of collecting the sales price, the cost recovery or installment method is used to recognize profit on the partial sale. (ASC 360-20-40-48)

A seller who separately sells individual units in condominium projects or time-sharing interests recognizes profit by the percentage-of-completion method on the sale of individual units or interests if all of the following criteria are met (ASC 360-20-40-50):

1. Construction is beyond a preliminary stage (i.e., engineering and design work, execution of construction contracts, site clearance and preparation, excavation, and completion of the building foundation have all been completed).
2. The buyer is unable to obtain a refund except for nondelivery of the units or interest.
3. Sufficient units have been sold to ensure that the entire property will not revert to being rental property.
4. Sales prices are collectible.
5. Aggregate sales proceeds and costs can be reasonably estimated.

The deposit method is used to account for these sales up to the point all the criteria are met for recognition of a sale. (ASC 360-20-40-54)

Leases involving real estate. (ASC 360-20-40-60) ASC 840-40 dealing with sales-type real estate leases and sale-leaseback real estate transactions is covered in the chapter on ASC 840.

Buy-sell agreements. A buy-sell clause is not a prohibited form of continuing involvement precluding partial sales treatment, but only if

1. The buyer can act independently from the seller, or if
2. The seller is not compelled to reacquire the other investor's interest in the jointly owned entity.

The decision is judgmental, requiring consideration of numerous factors.

Factors to consider in determining whether the buyer cannot act independently from the seller are:

1. The presence of a predetermined buy-sell price,
2. The seller has a strategic necessity barring it from relinquishing its ownership rights to the buyer,
3. The seller has business arrangements with the jointly owned entity that economically require it to reacquire the real estate to avoid losing economic benefits or escaping negative consequences of the arrangements, or
4. Tax implications compelling the seller to acquire the buyer's interest in the entity.

Factors to consider in determining if the buyer can compel the seller to repurchase the property include:

1. The buyer is financially unable to acquire the seller's interest,
2. The buy-sell clause contains a specified rate of return for either party,
3. The buyer has a strategic necessity requiring it to sell its interest to the seller,
4. The buyer is legally restricted from acquiring the seller's interest,
5. The buyer cannot realize its economic interest by sale to a third party, due to the integration of the real estate into the seller's business, or
6. Tax implications compelling the buyer to sell its interest to the seller.

Selection of Method

The full accrual method of accounting for nonretail sales of real estate is appropriate when all four of the recognition criteria have been satisfied:

1. The sale is consummated,
2. The buyer has demonstrated a commitment to pay,
3. The seller's receivable is not subject to future subordination.
4. The seller has transferred the risks and rewards of ownership and does not have a substantial continuing involvement with the property.

If all of the criteria have not been met, the seller records the transaction by one of the following methods as indicated by ASC 360-20:

1. Deposit
2. Cost recovery
3. Installment
4. Reduced profit
5. Percentage-of-completion.

The installment method is used if the full accrual method cannot be used due to an inadequate initial investment by the buyer, provided that recovery of cost is reasonably assured if the buyer defaults.

The cost recovery method or the deposit methods are used if such cost recovery is not assured.

The reduced profit method is used when the buyer's initial investment is adequate but the continuing investment is not adequate, and payments by the buyer at least cover the sum of:

1. The amortization (principal and interest) on the maximum first mortgage that could be obtained on the property and
2. The interest, at an appropriate rate, on the excess of aggregate debt over the maximum first mortgage.

Full Accrual Method

The full accrual method is simply the application of the revenue recognition principle. Profit under the full accrual method is computed by subtracting the cost basis of the property surrendered from the sales value given by the buyer. Also, the computation of profit on the sale includes all costs incurred that are directly related to the sale, such as accounting and legal fees.

If a loss is apparent (e.g., the carrying value of the property exceeds the sum of the deposit, fair value of unrecorded note receivable, and the debt assumed by the buyer), then immediate recognition of the loss is required.

A real estate sale is recognized in full when the profit is determinable and the earnings process is virtually complete. The profit is determinable when the first three recognition criteria listed above have been met. The earnings process is virtually complete when the fourth criterion has been met.

Installment Method

Under the installment method (ASC 360-20-55-7), each cash receipt and principal payment by the buyer on debt assumed with recourse to the seller consists of part recovery of cost and part recovery of profit. The apportionment between cost recovery and profit is in the same ratio as total cost and total profit bear to the sales value of the property sold. Therefore, under the installment method, the seller recognizes profit on each payment that the buyer makes to the seller and on each payment the buyer makes to the holder of the primary debt. When a buyer assumes debt that is without recourse to the seller, the seller recognizes profit on each payment made to the seller and on the entire debt assumed by the buyer. The accounting treatment differs because the seller is subject to substantially different levels of risk under the alternative conditions. For debt that is without recourse, the seller recovers a portion, if not all, of the cost of the asset surrendered at the time the buyer assumes the debt.

The income statement (or related footnotes) for the period of sale includes the sales value received, the gross profit recognized, the gross profit deferred, and the costs of sale. In future periods when further payments are made to the buyer, the seller realizes gross profit on these payments. This amount is presented as a single line item in the revenue section of the income statement.

If, in the future, the transaction meets the requirements for the full accrual method of recognizing profit, the seller may change to that method and recognize the remaining deferred profit as income at that time.

Cost Recovery Method

When the cost recovery method (ASC 360-20-55-13) is used (e.g., when the seller's receivable is subject to subordination or the seller is not reasonably assured of recovering the cost of the property if the buyer defaults), no profit is recognized on the sales transaction until the seller has recovered the cost of the property sold. If the buyer assumes debt that is with recourse to the seller, profit is not recognized by the seller until the cash payments by the buyer, including both principal and interest on debt due the seller and on debt assumed by the buyer, exceed the seller's cost of the property sold. If the buyer assumes debt that is without recourse to the seller, profit may be recognized by the seller when the cash payments by the buyer, including both principal and interest on debt due the seller, exceed the difference between the seller's cost of the property and the nonrecourse debt assumed by the buyer.

For the cost recovery method, principal collections reduce the seller's related receivable, and interest collections on such receivable increase the deferred gross profit on the statement of financial position. (ASC 360-20-55-14)

For the cost recovery method, the income statement for the year the real estate sale occurs includes the sales value received, the cost of the property given up, and the gross profit deferred. In future periods, after the cost of the property has been recovered, the income statement includes the gross profit earned as a separate revenue item.

If, after accounting for the sale by the cost recovery method, circumstances indicate that the criteria for the full accrual method are satisfied, the seller may change to the full accrual method and recognize any remaining deferred gross profit in full.

Deposit Method

When the deposit method (ASC 360-20-55-17) is used (e.g., when the sale is, in substance, the sale of an option and not real estate), the seller does not recognize any profit, does not record a receivable, continues to report in its financial statements the property and the related existing debt even if the debt has been assumed by the buyer, and discloses that those items are subject to a sales contract. The seller also continues to recognize depreciation expense on the property for which the deposits have been received, unless the property has been classified as held for sale (per ASC 360-10). Cash received from the buyer (initial and continuing investments) is reported as a deposit on the contract. However, some amounts of cash may be received that are not subject to refund, such as interest on the unrecorded principal. These amounts are used to offset any carrying charges on the property (e.g., property taxes and interest on the existing debt). If the interest collected on the unrecorded receivable is refundable, the seller records this interest as a deposit before the sale is consummated and then includes it as a part of the initial investment once the sale is consummated. If deposits on retail land sales are eventually recognized as sales, the interest portion of the deposit is separately recognized as interest income. For contracts that are cancelled, the nonrefundable amounts are recognized as income and the refundable amounts returned to the depositor at the time of cancellation.

As stated, the seller's statement of financial position continues to present the debt assumed by the buyer (this includes nonrecourse debt) among its other liabilities. However, the seller reports any principal payments on the mortgage debt assumed as additional deposits, while correspondingly reducing the carrying amount of the mortgage debt.

Reduced Profit Method

The reduced profit method is appropriate when the sale has been consummated and the initial investment is adequate but the continuing investment does not clearly demonstrate the buyer's willing commitment to pay the remaining balance of the receivable. For example, a buyer may purchase land under an agreement in which the seller will finance the sale over a thirty-year period. ASC 976 specifically states twenty years as the maximum amortization period for the purchase of land; therefore, the agreement fails to meet the continuing investment criteria.

Under the reduced profit method (ASC 360-20-55-16), the seller recognizes a portion of the profit at the time of sale with the remaining portion recognized in future periods. The amount of reduced profit recognized at the time of sale is determined by discounting the receivable from the buyer to the present value of the lowest level of annual payments required by the sales contract over the maximum period of time specified for that type of real estate property (twenty years for land and the customary term of a first mortgage loan set by an independent lending institution for other types of real estate). The remaining profit is recognized in the periods that lump-sum or other payments are made.