A major segment of the real estate industry has evolved in recent decades to market and sell time-shares, whereby parties acquire the right to use property (typically, resort condominiums or other vacation-oriented property) for a fixed number of weeks per year (known as intervals). While a vast variety of property types and transaction structures exist, there are certain common features and complexities that have challenged the accounting profession. This post describes accounting standard for time-share transactions of real estate and property. Enjoy!
Time-sharing transactions are characterized by the following:
- Volume-based, homogeneous sales
- Seller financing
- Relatively high selling and marketing costs
- Upon default, recovery of the time-sharing interval by the seller and some forfeiture of principal by the buyer
Detailed guidance for resolution of these issues is provided in SOP 04-2, Accounting for Real Estate Time-Sharing Transactions. Also, FAS 152 amends FAS 66 and FAS 67 to make reference to the guidance provided by SOP 04-2. Specifically, FAS 66 has been amended to provide that time-share transactions are to be accounted for as nonretail land sales, and FAS 67 has been amended to exclude time-share transactions from certain provisions otherwise applicable to incidental rental operations.
Accounting for Time-Share Transactions
SOP 04-2, Accounting for Real Estate Time-Sharing Transactions, provides guidance for a seller’s accounting for real estate time-sharing transactions, including:
- Fee simple transactions in which non-reversionary title and ownership of the real estate pass to the buyer or a special-purpose entity (SPE).
- Transactions in which title and ownership of all or a portion of the real estate remain with the seller.
- Transactions in which title and ownership of all or a portion of the real estate pass to the buyer and subsequently revert to the seller or transfer to a third party.
- Transactions by a time-share reseller.
The major conclusions of this very detailed, specialized standard are as follows: profit recognition, effect of sales incentives, reload transactions, uncollectibles, cost of sales, costs charged to current period expense, incidental operations, SPEs and other complex structures, and continuing involvement by seller or related entities. Let’s discuss about these a little bit. Read on…
A time-share seller should recognize profit on time-sharing transactions as set forth by the provisions of FAS 66 that specify the accounting for other than retail land sales. In order to justify recognizing profit, non-reversionary title must be transferred. If title transfer is reversionary, on the other hand, the seller must account for the transaction as if it were an operating lease.
For a time-sharing transaction to be accounted for as a sale, it must meet the following criteria:
- The seller transfers non-reversionary title to the time-share.
- The transaction is consummated.
- The buyer makes cumulative payments (excluding interest) of at least 10% of the sales value of the time-share.
- Sufficient time-shares would have been sold to reasonably assure that the units will not become rental property.
Effect Of Sales Incentives
The SOP requires that certain sales incentives provided by a seller to a buyer to consummate a transaction are to be recorded separately, by reducing the stated sales price of the time-share by the excess of the fair value of the incentive over the amount paid by the buyer. For purposes of testing for buyer’s financial commitment as set forth under FAS 66, the seller must reduce its measurement of the buyer’s initial and continuing investments by the excess of the fair value of the incentive over the stated amount the buyer pays, except in certain situations in which the buyer is required to make specific payments on its note in order to receive the incentive.
A reload transaction is considered to be a separate sale of a second interval, and the second interval is accounted for in accordance with the profit recognition guidance of FAS 66. For an upgrade transaction, that guidance is applied to the sales value of the new (upgrade) interval, and the buyer’s initial and continuing investments from the original interval are included in the profit recognition tests related to the new interval.
The term un-collectibles is used in SOP 04-2 to include all situations in which, as a result of credit issues, a time-share seller collects less than 100% of the contractual cash payments of a note receivable, except for certain transfers of receivables to independent third parties by the seller. An estimate of uncollectibility that is expected to occur should be recorded as a reduction of revenue at the time that profit is recognized on a time-sharing sale recorded under the full accrual or percentage-of-completion method.
Historical and statistical perspectives are used in making such a determination of anticipated uncollectible amounts. Subsequent changes in estimated uncollectibles should be recorded as an adjustment to estimated uncollectibles and thereby as an adjustment to revenue. Under the relative sales value method, the seller effectively does not record revenue, cost of sales, or inventory relief for amounts not expected to be collected. There generally is no accounting effect on inventory when, as expected, a time-share is repossessed or otherwise reacquired.
Cost Of Sales
The seller should account for cost of sales and timesharing inventory in accordance with the relative sales value method.
Costs Charged To Current Period Expense
All costs incurred to sell time-shares would be charged to expense as incurred except for certain costs that are:
- Incurred for tangible assets used directly in selling the time-shares;
- Incurred for services performed to obtain regulatory approval of sales; or
- Direct and incremental costs of successful sales efforts under the percentage-of-completion, installment, reduced profit, or deposit methods of accounting
Rental and other operations during holding periods, including sampler programs and minivacations, should be accounted for as incidental operations. This requires that any excess of revenue over costs be recorded as a reduction of inventory costs.
SPEs And Other Complex Structures
The accounting treatment for more complex time-sharing structures such as time-sharing SPEs, points systems, and vacation clubs should be determined using the same profit recognition guidance as for simpler structures, provided that the timesharing interest has been sold to the end user. For balance sheet presentation purposes, an SPE should be viewed as an entity lacking economic substance and established for the purpose of facilitating sales if the SPE structure is legally required for purposes of selling intervals to a class of nonresident customers, and the SPE has no assets other than the timesharing intervals and has no debt. In those circumstances, the seller should present on its balance sheet as time-sharing inventory the interests in the SPE not yet sold to end users.
Continuing Involvement By Seller Or Related Entities
If the seller, seller’s affiliate, or related party operates an exchange, points, affinity, or similar program, the program’s operations constitute continuing involvement by the seller, and the seller should determine its accounting based on an evaluation of whether it will receive compensation at prevailing market rates for its program services.