Pre-acquisition costs are costs related to a real estate property that are incurred for the express purpose of, BUT PRIOR TO, obtaining that property. They may include a variety of costs, such as:
- Payments to obtain an option
- Legal fees
- Architectural fees
- Other professional fees
- Costs of environmental studies
- Costs of feasibility studies
- Costs of appraisals
- Costs of surveys
- Planning and design costs
- Costs for zoning and traffic studies
Principles for the Capitalization of Pre-acquisition Costs
- Payments for options to acquire real property are capitalized.
- Pre-acquisition costs other than the cost of options can only be capitalized if the acquisition of the property (or an option to acquire the property) is probable, and if the costs meet the following two criteria:
- The costs must be directly identifiable with the property.
- The costs would be capitalized if the property were already acquired.
FASB Statement No. 67 has established a high threshold for the capitalization of pre-acquisition costs with the requirement that the acquisition of real property be probable:
- If the purchaser is not actively seeking to acquire the real estate property or does not have the ability to fi nance or obtain financing for the property, or if there is an indication that the real estate property the purchaser seeks to acquire will not be available for sale, the project is not considered probable.
- Any costs (other than costs relating to an option to acquire real estate) incurred before a project is considered probable have to be expensed as incurred.
- If the project becomes probable at a later point in time, costs incurred prior to the project becoming probable cannot subsequently be capitalized.
Example Of Pre-acquisition Costs
Company B plans to build five storage centers in various cities throughout the United States. Ten suitable land parcels have been identified. The land parcels upon which B is considering building the storage centers are for sale, and B has the ability to obtain financing. The final decision as to which locations to use for the storage centers will be made after certain feasibility studies have been completed. To date, B has paid advisors $1 million for feasibility studies. Can B capitalize the costs incurred for these feasibility studies?
The answer is: No.
Reason: Since B has not identified the specific locations for the storage centers, the costs incurred should be expensed.
Pre-acquisition costs that meet the requirements for capitalization outlined above are capitalized. Once the real estate property is acquired, any capitalized pre-acquisition costs are included in project costs. If, on the other hand, a company determines that the acquisition of the property is no longer probable, capitalized pre-acquisition costs are charged to expense to the extent they are not recoverable through the sale of plans, options, etc.
The proposed SOP, Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment, states with respect to pre-acquisition costs when it becomes probable that the property will not be acquired:
If it becomes no longer probable that specific PP & E [property, plant, and equipment] will be acquired or constructed, previously capitalized pre-acquisition stage costs related to the specific PP & E should be reduced to the lower of cost or fair value. A rebuttable presumption exists that the fair value of the asset consisting of those pre-acquisition stage costs (excluding option costs) is zero (that is, the costs of the asset would be charged to expense), unless management, having the authority to approve the action, has committed to a plan to either (a) sell the asset and the proceeds can be reasonably estimated or (b) redeploy the asset in other specific PP & E of the entity and the redeployed asset meets the criteria for capitalization under the project stage framework in this SOP. If an entity subsequently acquires or constructs PP & E previously considered no longer probable to acquire or construct, pre-acquisition stage costs charged to expense under this paragraph should not be reversed.
AcSEC establishes a rebuttable presumption that the fair value of any capitalized pre-acquisition costs is zero once a project is abandoned, because the majority of the costs incurred in this stage would be “ soft ” costs that would generate only limited value for other projects.
Capitalization of Internal Pre-acquisition Costs
Activities in the pre-acquisition stage may be carried out by a company ’ s in – house departments, which raises the question of (1) whether and (2) to what extent such internal pre-acquisition costs should be capitalized.
Emerging Issues Task Force (EITF) Issue No. 97 – 11, Accounting for Costs Relating to Real Estate Property Acquisitions, provides that internal pre-acquisition costs 10 are only capitalizable if the property is expected to be non-operating at the date of acquisition. They are not capitalizable if the property is expected to be operating at the date of acquisition, such as internal pre-acquisition costs relating to the purchase of an existing shopping mall.
A prerequisite for the capitalization of internal pre-acquisition costs is that they be directly identifiable with the specific property. While “directly identifiable” is not further defined in Statement 67, the term has been interpreted narrowly in practice.
One may look to the proposed SOP, Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment, for implementation guidance:
. . . directly identifiable costs include only:
- Incremental direct costs of PP & E pre-acquisition activities incurred for the specific PP & E.
- Certain costs directly related to pre-acquisition activities performed by the entity (or by parties not independent of the entity) for the specific PP & E. Those costs include only payroll and payroll benefit – related costs (for example, costs of health insurance) of employees who devote time to a PP & E pre-acquisition stage activity, to the extent of time the employees spent directly on that activity and in proportion to the total hours employed.
Further, that proposed SOP states that costs of facilities, such as rent and depreciation, as well as general and administrative costs, should be expensed as incurred, as should all costs of executive management, corporate accounting, acquisitions, office management and administration, marketing, human resources, and similar costs or functions. 15
While that proposed SOP has never been issued in final form, the guidance provided by that proposed SOP nevertheless proves helpful when interpreting the provisions in Statement.
Payments to obtain an option . . . to acquire PP & E. Notwithstanding the foregoing, an option to acquire property, plant, and equipment that meets the definition of a derivative instrument within the scope of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, is accounted for following the guidance in Statement 133.
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