ASC 970: Accounting for Real Estate Projects

Accounting Standards Codification (ASC) 970 is the primary source of U.S. Generally Accepted Accounting Principles (GAAP) for the real estate industry. This standard provides a detailed framework for how entities should account for the various stages of a real estate project, including its acquisition, development, construction, eventual sale, and rental. The principles apply to businesses like real estate developers, construction companies, and any other entities with significant real estate holdings that are intended for sale or rental.

Capitalization of Costs for Real Estate Projects

Under ASC 970, certain costs incurred before a property is acquired can be capitalized, meaning they are added to the balance sheet as an asset rather than being expensed immediately. These preacquisition costs may include payments for options to buy property, legal fees, survey costs, and architectural planning. For these costs to be capitalized, they must be directly identifiable with a specific property, and the acquisition of that property must be probable. If the property is ultimately not acquired, these capitalized costs must then be charged to expense.

Once development begins, property taxes and insurance can be capitalized as part of the property’s cost only during the period when activities to prepare the property for its intended use are in progress. After the construction phase ends and the property is substantially complete and ready for occupancy or sale, any further property taxes and insurance costs must be treated as expenses in the period they are incurred.

Direct costs are those associated with the acquisition, development, and construction of a specific real estate project, including the cost of land, materials, and labor. Indirect costs that relate to several projects, such as the salaries of construction supervisors or project-related administrative support, can also be capitalized and should be allocated among the projects they benefit. General and administrative expenses that are not tied to a specific project, such as corporate office rent or executive salaries, cannot be capitalized and must be expensed as they occur.

A component of project costs is the capitalization of interest. ASC 835 provides the guidance for this, which is referenced by ASC 970. Interest costs incurred during the construction period can be capitalized as part of the asset’s value. Capitalization begins when three conditions are met: expenditures for the asset have been made, activities to get the asset ready for its intended use are in progress, and interest cost is being incurred. The capitalization of interest ceases when the project is substantially complete and ready for its intended use.

Accounting for the Sale of Real Estate

The accounting for the sale of real estate is governed by ASC 606, Revenue from Contracts with Customers. This standard provides a comprehensive framework centered on the transfer of control. Revenue is recognized when the seller satisfies its performance obligations by transferring control of the property to the buyer.

ASC 606 outlines a five-step model for recognizing revenue. The process requires an entity to:

• Identify the contract with the customer.
• Determine the specific promises to the customer, known as performance obligations.
• Establish the transaction price.
• Allocate that price to the different performance obligations.

Revenue is then recognized as the entity fulfills these promises. A consideration in the first step is whether the collectibility of the sales price is probable, which is a factor in determining whether a contract exists.

Under this model, the concept of “transfer of control” is central. Control is considered transferred when the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the property.

Impairment and Valuation of Real Estate Assets

An impairment analysis for real estate assets is not performed on a fixed schedule but is prompted by specific events or changes in circumstances. These “triggering events” suggest that the carrying amount of the asset on the balance sheet may not be recoverable from its future cash flows. Examples of such triggers include a significant decrease in the market price of the property, a change in the way the property is used, or a current-period operating or cash flow loss combined with a history of losses or a projection of future losses.

When a triggering event occurs, a two-step process is used to measure impairment. The first step is a recoverability test, which compares the estimated future undiscounted cash flows from the asset to its carrying amount. If the undiscounted cash flows are less than the carrying amount, an impairment loss must be recognized.

If an impairment is identified in the first step, the second step is to calculate the amount of the impairment loss. The loss is measured as the amount by which the asset’s carrying amount exceeds its fair value. Fair value is the price that would be received to sell the asset in an orderly transaction between market participants. After an impairment loss is recognized, the new lower carrying amount becomes the asset’s new cost basis, and this amount cannot be written back up even if the fair value of the asset subsequently increases.

In situations where a real estate project is abandoned, any capitalized costs must be evaluated for recoverability. If the costs are not expected to be recovered through a future sale or other use, they should be charged to expense in the period the decision to abandon the project is made.