ACCOUNTING FOR LAND DEVELOPMENT. 4 Thesis for the Degree oijhi-D, . MICHIGAN STATE UNIVERSITY ARJAN T. SADHWANI“ 71971 , .‘.“'-.J.’. ‘M r. -Lb '§ C. 9' r e" 5-». g - \ ‘fiié 1‘ lJLIjIe, R f i i f . t a .. ‘ I ' ' ‘ 'n' '_ :- ';‘,~ -' A! ”a“ l ”mint, .1 Start, 5 e’ u; it Unve'erw‘y' t. r' 3 n _ wavauuxes This is to certify that the thesis entitled ACCOUNTING FOR LAND DEVELOPMENT presented by Arjan T. Sadhwani has been accepted towards fulfillment of the requirements for Ph.D. degree in Accounting and Financial Administration (,7 .’ ‘//// / V-AJZP‘I‘Y L’P/;;:YL(,7.L/ Major professor( / Date February 18, 1971 0-7839 ABSTRACT ACCOUNTING FOR IAND DEVELOPMENT By Arjan T. Sadhwani A deve10ped lot is the final product of long and complex operations requiring a series of production processes, and is essentially a manufactured commodity. In the last few years sev- eral large publicly held corporations have ventured into land de- velopment business. Although the broad purpose of the accounting function in the land development industry is to identify, measure and communicate useful information for external and internal users, the unique features of the industry give rise to many accounting problems. The purpose of this study has been to investigate the account- ing requirements of land developers with primary emphasis on financial accounting with the interests of owners (shareholders) in mind. The emphasis on meeting the needs of the shareholders is justifiable be- cause of the increase in public ownership of land development companies. Actual accounting procedures and practices employed by deve10pers are examined and critically evaluated in the study. Some accounting system changes are proposed to accommodate peculiar features of the industry, and to replace extensive dependence on tax considerations as the basis of accounting. The criteria for evaluation of the accounting practices have been within the theoretical framework outlined in the American Arjan T. Sadhwani Accounting Association's Statement of Basic Accounting Theory (1966). Data about the actual accounting procedures and practices employed by the developers were gathered by means of a mail question- naire and personal visits. In a sample of 65 companies, 30 companies returned completed questionnaires; 10 companies that had sent completed questionnaires were visited to pursue the questions and their replies in greater depth. The choice was made to study fewer subjects (firms) in depth rather than a larger universe in limited depth in order to examine real-world accounting techniques; an attempt is made to find solutions for their accounting problems. The sample companies are engaged in developing subdivisions for various uses, ranging from those for only residential homes to complete communities with schools, civic center, golf course, shopping centers, industrial parks, etc. Many peculiar characteristics and accounting problems can be attributed to complexities of the land development process and to the selling techniques of developers which have evolved over a long period of time. Therefore, part of the study dealt with tracing the evolution of conventional accounting practices employed in the industry since 1901. The study also describes briefly the unique features of the industry and the principal accounting problems at the present time. The analysis of questionnaire responses reveals that the managerial objectives of accounting, such as, determination of accurate cost of each improved lot or group of lots, cash planning and budget- ary control, etc. are given priority over the non-managerial objectives. However, tax considerations appear to be at the heart of the actual practices and procedures used by developers. The use of multiple corporations in the organizational set up of developers and current Arjan T. Sadhwani expensing of carrying charges are common in the industry. However the publicly owned corporations tend to capitalize the carrying charges in order to show rapid earnings improvement in the short run. Further- more, the majority of the companies recognize revenue from lots sold on the installment plan immediately when the sale contract is signed and the down payment is received, but they report under the installment basis for tax purposes. Generally Speaking, developers have not constructed a scientific approach to the allocation of joint costs in Spite of an often expressed desire to know the "exact" unit—lot-cost. The majority of the companies use "number of lots" method under which each lot is assigned the same cost irreSpective of its size, location or other physical features. Companies which had separate land survey, planning and engineering sections in their organizational set up treated large amounts of expen- diture on land survey and engineering as a period cost rather than a cost of improved lots; while others who used subcontractors for survey and planning work inventoried the expenditure and included it in the cost of improved lots. . Conclusions and recommendations in the study are drawn after first evaluating procedures and practices to ascertain how far the Federal income tax law, the Treasury regulations and judicial rulings in many court cases influenced the accounting procedures, and then analyzing each method under theoretical considerations. The pr0posed changes concern classification patterns for costs, accounting treatment of the carrying charges and imputed interest, recognition of revenue from non-installment and installment sales of lots, recognition of 'after costs' and partial reimbursements of utility deposit refunds, revaluation of repossessed lots, and methods of allocation of joint costs. rh-u“ ACCOUNTING FOR.LAND DEVELOPMENT B Y) an Arjan Tl‘Sadhwani A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting & Financial Administration 1971 TO MY FATHER When the going got tough, there was always my father, a source of comfort, inapiration and encouragement. ii ACKNOWLEDGEMENTS I wish to express my sincere appreciation to Dr. Gardner M. Jones, chairman of my Doctoral Committee, for the assistance and counsel, not only during preparation of this dissertation, but during my entire graduate program. Gratitude is also extended to my other committee members, Dr. Charles J. Gaa and Dr. Richard J. Lewis for their valuable assistance and many hours of critical reading of the manuscript. Special appreciation is extended to Dr. James Don Edwards, cflnairman of the Department of Accounting and Financial Administration for his encouragement throughout my doctoral program at Michigan State University. The financial support provided by the Office of Dean is gratefully acknowledged. I am indebted to controllers and other persons in many land development companies for supplying the ideas and data for this di{Beertatiom Special acknowledgement is given Mr. Leo Rademacher, controller of Edward G. Hacker Co., Musing and Mr. John G. Daichendt, cont roller of Thomson-Brown Company, Detroit, who furnished invaluable Suggestions based on their intimate knowledge about accounting require- unatith and the accounting problems in the land development industry. Finally, I must express my deep appreciation to my wife, Lace and daughter Anjali for patience, encouragement and love and putting ‘JF’ ‘Vith frustrations and irritations of graduate study. iii TABLE OF CONTENTS Chapter I. INTRODUCTION Purpose of Research Background Land Development Accounting Need and Significance of the Study Methodology and Investigative Techniques 1. Library research 2. Field research (a) Questionnaire administration (b) Field interviews and observations Limitations of the Study Organization of Chapters II. PECULIAR FEATURES AND PRINCIPAL ACCOUNTING PROBLEMS -- A CRITICAI.ANALYSIS Introduction Land Development Accounting -- A Historical Perspective 1. 1901 - 1920 2. 1921 - 1930 3. After 1930 Unique Features 1. Nature of business . Multiperiod projects . Nature of costs . Excessive use of estimates . Subcontracting . Financing a land development company . Governmental regulations . Taxation features . Nature and type of establishments Pri cipal Accounting Problems . Classification and accumulation of costs . Allocation of costs . Capitalizing versus expensing of carrying charges 4. Recognition of revenue (1) Installment sales and revenue recognition (ii) Repossessions, foreclosures and forfeiture of deposits 2 3 4 5 6 7 8 9 n 1 2 3 iv Page 14 14 15 15 17 25 27 28 28 28 29 29 29 3O 30 31 32 32 33 34 35 35 36 Chapter III. IN], (iii) Proceeds received from dedication of land, sale of timber, gravel, etc. (iv) Income and expenses on developed property in interim period LAND DEVELOPMENT ACCOUNTING PRACTICES SURVEY Sample Distribution and Response Company Visitations Size Determination Scope of Operations and Use of Subsidiary Corporations 1. Development of subdivisions 2. Use of subsidiary corporations 3. Area of operations Objectives of the Accounting Function in the Land Development Industry Evaluation of Accounting Practices Classification and accumulation of costs Items of expenditure included in cost of land Capitalization vs. expensing of carrying charges Inclusion of imputed interest Adjustment of cost of developed lots Recognition of revenue 1. Non-installment sales 2. Installment sales Partial reimbursement of expenditure of roads, sewers, utility deposits and easements, etc. Valuation of repossessed land and treatment of gains and losses Lot Costing and Valuation Methods Method of allocation of joint costs Cost arising due to Special conditions Computation and allocation of selling and administrative overhead Cost and revenue from lots sold to civic agencies, schools, churches, etc. Treatment of revenue realized on sale of gravel, timber, sand, etc. discovered on site INFLUENCE OF INCOME TAXATION ON ACCOUNTING PROCEDURES -- A CRITICAL ANALYSIS Introduction The Use of Capital Gains Provision of the Code . Method and purpose of acquisition of land . Length of holding period . Activities related to development . The 'five-lots' and 5% rules . Judicial rulings (i) Malat case (ii) Post-Malat cases (iii) Substantial revenue and activities tests LIIfiLDNl-I' V Page 37 37 38 38 39 4O 45 45 46 48 49 58 58 61 62 65 66 69 69 71 75 76 77 77 81 83 86 88 9O 90 91 92 92 92 93 94 94 95 96 Chapter Carrying Charges Joint Cost Allocation Methods Subsequent Adjustment of Improvement Costs Recognition of Revenue from Installnent Sales Partial Reimbursement of Costs of Roads, Sewers, etc. and Refund of Utility Deposits Use of Multiple Corporations (a) Tax advantages 1. Splitting of income between multiple corporations 2. Position prior to the Tax Reform Act of 1969 (i) Sham theory under section 61 (ii) Section 269 attack (iii) General power under section 482 (iv) Limitations under section 1551 (v) Other limitations 3. Position after the Tax Reform Act of 1969 (1) Restriction under section 401 of the Tax Reform Act of 1969 (ii) Relief measures for controlled- groups (b) Non-tax advantages (i) Limited liability (ii) Administrative advantages (iii) Separate corporation for Specialized activity V. THEORETICAL CONSIDERATIONS AND IAND DEVELOPMENT ACCOUNTING TECHNIQUES Assumptions and Accounting Concepts 1. Going concern assumption 2. Conservatism 3. Other fundamental concepts Accounting Standards Evaluation of Land Development Accounting Procedures and Practices 1. Classification and accumulation of costs 2. Cost of land and carrying charges 3. Imputed interest 4. Recognition of revenue (a) Realization concept (b) Matching concept (c) Revenue from non-installment sales of lots (d) Revenue from lots sold on the installment plan 5. Recognition of 'after costs' and partial reimbursements 6. Revaluation of repossessed lots vi Page 100 105 108 110 114 120 120 120 122 122 124 125 127 128 129 129 132 134 134 135 135 138 138 139 140 142 142 143 143 146 151 155 155 158 159 162 169 170 Chapter 7. Methods of allocation of joint costs and joint (8) (b) (C) (d) costing principles Bases of allocation or lot costing methods Lump sum allocation of costs Allocation methods and the 'Accounting Standards' Treatment of revenue realized on sale of by-products -- sand, gravel, etc. VI. SUMMARY AND CONCLUSIONS Brief Summary of the Study Recommendations and Proposed Changes in Accounting Methods Suggestions for Further Research BIBLIOGRAPHY APPENDIX A APPENDIX B vii Page 171 172 180 182 185 187 187 201 218 220 224 227 Table 3.1 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13 3.14 3.15 3.16 3.17 LIST OF TABLES Distribution of companies into large, medium and small according to their own categorization Factors considered by the companies to cate- gorize into large, medium and small Development of subdivisionsfor various uses Use of Subsidiary corporations Area of Operations Analysis of the characteristics of companies which have the defined set of objectives of the accounting function Aggregate Summary of variables indicated by the companies who have defined set of objectives of the accounting function Ranking of the accounting objectives among the given set of objectives (Groups I & II) Classification and accumulation of costs Items of expenditure included in 'Cost of Land' Treatment of carrying charges Adjustment of cost incurred in subsequent periods and allocation to improved lots Recognition of revenue from non-installment sales Recognition of revenue from lots sold on the installment basis Accounting for partial reimbursements Valuation of repossessed land from defaulted contracts Methods of allocating joint cost of land and land development to individual lots 1 viii Page 42 42 46 47 48 52 53 57 6O 61 63 67 69 72 75 76 79 Table 3.18 3.19 3.20 Page Analysis of the method of allocation used and classification and accumulation of costs patterns, and development of projects involving complete communities 82 Allocation of selling and administrative expenses .84 Determination of cost and treatment of proceeds from lots sold to civic agencies, schools, churches, etc. 87 LIST OF EXHIBITS Exhibit Page I Classification and accumulation of cost into groups and subgroups 203 II Pyramiding process and determination of unit- 1ot-cost -- a simple project 216 III Pyramiding process and determination of unit- 1ot-cost -- a complex project 217 CHAPTER I INTRODUCTION PUrpose of Research The purposes of this research are: (1) To investigate the accounting requirements of land devel- opers. The particularized accounting requirements for this industry are examined with primary emphasis on financial accounting with the interests of owners (shareholders) in mind. Secondary emphasis is placed on accounting requirements in aid of managers of land develop- ment activities. The greater emphasis to meet the needs of the share- holders is justifiable because of the increase in public ownership of the land development companies in recent years. (2) To propose some accounting system changes to accommodate peculiarities of the industry, and to replace extensive dependence on tax considerations as the basis of accounting. The proposed changes will be mainly concerned with the process of identification and measurement of accounting data. The criteria for acceptance of the changes will be within the theoretical framework as outlined in the "Statement of Basic Accounting Theory".1 The standards and guide- lines of the above theoretical framework provide a means of "accept- ing or rejecting accounting methods currently in use, or methods A Statement of Basic Accountinngheory, American Accounting Association (1966). proposed for future use." It is hypothesized that an improved lot sold by the land de- veloper is akin to a manufactured commodity. The manufacturing operations which convert raw land into improved lots are complex processes extending over lengthy periods. The accounting procedures of manufacturing industries can be extended with a few modifications to accommodate the unique characteristics of the land development pro- CESS- W Land is described in the early economic literature as consist- ing of many ingredients and ready for use for a variety of purposes. With increase in population, trade and commerce, land has become a complex manufactured commodity, requiring a series of production pro- cesses very much like any manufactured commodity. The degree of complexity necessary to produce the final product increases as one moves from land used in farming to land used for urban real estate. Ratcliff very aptly describes the nature of urban real estate in the following words: Urban real estate is a complex commodity. In the first place it is a manufactured product (emphasis added). The original gift of nature, the surface of the earth which gives support and provides Space for the activities of city dwellers, is extensively modified before it can be put to use for urban purposes. The land is one of the many components. It may have to be leveled off if it is hilly, or filled if it is marshy. It is of no use to anyone if it is not accessible, and so we construct streets and side walks. That man's activities will not be flooded out when it rains or when the snow melts, we put curbs and gutters along the streets and install miles of underground storm water sewers ... require a complex distribution system of pumps and buried pipes with hydrants for fire fighters who Stand off the holocaust which periodically wiped out ancient cities. We should die like flies before onslaught of disease but for costly and efficient waste diSposal facilities of sanitary sewer laterals, mains, interceptors, and diSposal plants. In addition to these community installations, each tract or parcel of land is procesged and improved in accordance with its intended use. The long and complex process of producing lots to meet the Specifications of intended use accompanied by advances in engineering and technical aspects of land develOpment have given rise to the Specialized land development industry. Separate land develOpment companies are organized to develop land for different uses. A great number of the land development companies in the industry are Special- izing in subdividing large tracts of land and creating new communities. The existing realty companies which were not engaged in land develop- ment projects have started to realize the large potential in the land development business; and separate sub-organizations within their company structures are being established to handle the development business. Land Development Accounting Accounting is defined broadly "as the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by the users."3 Identification and measure- ment entail systematic classification of business transactions, events, and selection of appropriate alternatives for measurement of events or transactions. Communication involves reporting and interpreting the results. The structure through which the accounting process flows 2 Richard U. Ratcliff, Real Estate Analysis, McGraw-Hill Book Company, Inc., New York, 1961, p. 2. A Statement of Basic Accounting Theory, American Accounting Association (1966), p. l. is termed an accounting system and is recognized as a "major quanti- tative system of almost every organization."4 The users of information are classified as external users, who are ultimate owners of the business, creditors or other potential in- vestors, SEC and other government agencies; and internal users who are managers and other persons reSponsible for planning and control func- tions in the organization. Accounting in the land development business is expected to serve the same broad purposes of identifying, measuring and communicating useful information. However, the nature of the industry and its peculiar characteristics and types of establishments require Special consideration for classification of events and business transactions and selection of different accounting alternatives for measurement and recording of these transactions. Although it is rec- ognized by many developers that accounting is a very important function in the organization, the actual attention to accounting methods seems to be less than satisfactory. While land has become a complicated manufactured commodity and technological progress has kept up, rela- tively little attention has been given to the correSponding accounting. A cursory examination of land developer organizations reveals that the accounting function is relegated to the background by the domination of engineering and marketing functions. Need and Significance of the Study The need for the study becomes apparent when land development accounting is compared with the advances in other related aSpects of 4 Charles T. Horngren, Cost Accounting: A Managerial Emphasis, Prentice-Hall, Inc., Englewood Cliffs, N.J., (1967), p. 3. of the business. The situation becomes glaring when the advances in accounting in manufacturing industries are compared with land develop- ment accounting. A few practicing accountants in the United States and other parts of the world have expressed concern over the neglect in land development accounting. John W. Bennett, a Canadian Chartered Accountant, writing about the problems in land development accounting stated: As the business of the land development company has be- come increasingly complicated, sophisticated and diver- sified, the only important aspect that has not kept pace is accounting practice. In Australia, realizing the dearth of authoritative literature on the subject, the Queensland division of the Australian Chartered Accountants Research Society held a panel discussion on the various aspects of land development accounting from a practitioner's view point. In concluding remarks, the chairman of the panel, Mr. J.L. Amies, stated: The discussion tonight emphasized the need for accountants to give further consideration to accounting aSpects arising from: the desire of management to capitalize certain de- velopment and holding costs; determination of a fair value of unsold land; the formula used to determine cost of sales in a given period; the effect of State laws on repossession or rescinded contracts; the contingent liability which might arise from an action for damages; providing for future costs of collection on term sales; providing for deferred income tax when figures differ; providing for anticipated other possible contingencies and losses. Until recently, the persons who were engaged in the business of land development were typically Super-entrepreneurial types who had learned "the tricks of the trade" by experience acquired in the —g 5J.W. Bennett, "Problems in Land Development Accounting," Canadian Chartered Accountant, April, 1969, p. 778. 6Summary by Chairman Mr. J.L. Aimes, "Presentation of Practitioners View Points on Accounting for Land Development Companies" The Australian Chartered Accountant, June 1964, p. 778. business. They considered themselves as being a highly creative type and having very little need for an accounting system to gather and furnish information for their day-to-day operations and for investment decisions. They possessed intuition which made them very Skilled pro- moters and operators. Consequently, the form of organization in the industry typically was a closed corporation or a partnership of a few persons who were quite close to each other and who needed very little help from an accounting function. In the last few years a growing number of large publicly held corporations have ventured into the land development business. Examples of a few include Aluminum Company of America, Pennsylvania Railroad, Kaiser Industries, and Atlantic Richfield Company. It has also been reported that General Electric is planning the development of hundreds of 'new towns' -- complete communities, including all necessary busi- ness, public service and other facilities -- in various parts of the United States.7 There also is a trend among large corporations toward acquiring real estate develOpment companies. Examples include the Pennsylvania Railroad's acquisition of Macco Realty, and Boise Cascade Corporation's acquisition of S.V. Hunsaker and Deane Brothers. One encounters news about Such mergers quite often. On December 17, 1969, the Wall Street Journal reported an acquisition of two Florida land development companies by Fuqua Industries, Haft Gains Co., a Fort Lauderdale developer which is building a 10,000 condominium project with three golf courses and other recreational facilities; and Kagnuson Corporation, a Miami based developer of subdivisions totaling 7,200 Robert P. Jones, "Tax ASpects of Real Estate Investments," .Arthur Young Journal, Winter, 1967, p. 10. acres on the island of Great Exuma in the Bahama Islands. These companies have been in the land development business for nearly 15 years. The public information on accounting practices followed by these closely held corporations has been practically non-existent. Concern has been expressed by practicing accountants over this lack of information on actual practices followed by land deve10pers. As early as 1960, when corporations were just beginning to enter into this specialized industry, LeRoy Cole, partner in the Los Angeles office of Arthur Young and Company, said that "because most real estate development in the past has been undertaken by individuals, or closely held corporations on which little public information is available, the entry of large publicly held corporations into the field has presented new accounting problems and view points."8 Although the product sold by a deve10per is an improved lot and is comparable to any other manufactured commodity, the valuation of inventory presents a puzzling problem for him. Short-term turnover of inventory as found in a manufacturing company is missing in a land development company. The inventory has a high unit cost and a very low turnover. This gives rise to some peculiar problems and needs very thorough examination within both a theoretical and a practical frame- work. Extended production periods involved in the production process create subaccounting periods which are some times quite arbitrary but which are critical in the measurement process. Robert K, Mautz, discussing the meaning of research in account- ing describes it "as thinking seriously, patiently and in an organized 8LeRoy H. Cole, "Accounting for Real Estate Developments," The .Journal of Accountancy, October, 1960, p. 59. fashion about the problems of accounting in an effort to understand accounting better and to arrive at useful solutions to its problems together with related activities as are necessary to obtain data helpful to this purpose."9 Later, discussing kinds of research in accounting, he describes Critical Research "as searching review of theories or practices to discover unexpected weaknesses or strengths with a view toward improvement of the idea or procedure studies."10 Finally, classifying 'levels of interest', he categorizes one of the research interests as a level where "actual application of techniques and procedures in practice" is the "object of research".11 This dissertation effort falls in the category of investiga- tion of 'actual application of techniques and procedures' and is con- cerned with a penetrating examination and analysis of those principles and practices employed by the land develOpment companies. The principal accounting problems will be investigated and solutions to these will be sought within the established theoretical accounting framework. It is critical research involving review of accounting principles and basic concepts behind the accounting practices of the land development companies. HOpefully, the prOposed accounting system changes will improve practices under actual operational conditions. 9Robert K. Mautz, "The Role of American Accounting Association in Accounting Research," in Jaedicke, Ijiri, Nielsen (ed.) Research in Aggounting Measurement, The American Accounting Assoc., p. l. 101bid., p. 2. 11 Ibid., p. 4. Methodolggy and Investigative Techniques The methodology is primarily one of descriptive and critical analysis of actual accounting practices and problems of land develop- ment companies. It consists of both library research and field re- search. (1) Librarngesearch The library research provided a review of pertinent literature on land development accounting and related topics. The secondary sources such as published articles, books, financial statements of land development companies, prOSpectuses issued at the time of new issues by various companies etc. were supplemented by field research to gain insight into: (i) Unique features of the land development industry; and (ii) Principal accounting problems in the industry due to its unique features. (2) Field Research The field research was aimed at examining actual accounting problems and practices and the role of the accounting function within an organization of land development companies. Two types of inves- tigative techniques -- questionnaire administration and field inter- views and observations -- were used to gather data needed for the study. (a) Questionnaire Administration: A four part questionnaire (Appendix-B) based on guidelines out- lined in Appendix-A was deve10ped and sent to 65 selected land develop- rnent companies. The selected sample consisted of two groups. 10 Group I - 35 companies selected from a list of large and medium-size Michigan companies obtained from the regional home builders' associations at Lansing, Detroit, and Grand Rapids, and some well-known large or medium-size companies in Jackson and Flint. Group II - 30 companies selected from Dun and Bradstreet Million Dollar Directory, 1970, from those listed under standard industrial classification code 6552 -- Real Estate: Subdividers and Developers except cemeteries. Under S.I.C. code 6552, 220 companies located in 37 states are listed. Eighty-five of these are classified under S.I.C. code 6552 only. The rest have more than one classification, indicating that these companies are also engaged in other related activities like homebuilding, construction of industrial estates, real estate brokerage, etc. Out of 30 companies selected in Group-II, 20 are classified under S.I.C. code 6552 only, and 10 although primarily engaged in the land development business, also had additional related classification such as general building contractors and/or Operative builders. The descriptions of the companies in the Dun & Bradstreet Million Dollar Directory, 1970, Standard and Poor's Register of Cor- poration, and other published sources were used to ensure that the company can at least be classified as large or medium-size, based on these descriptions. About 75% of the Group-II companies are located in three states, viz. Florida, California, and Texas, where the greatest activity in the industry takes place. 11 (b) Field Interviews and Observations From the list of 35 companies in Group-I, 10 companies were selected for intensive personal interviews with accounting and other executives to enable the researcher: (a) (b) (C) (d) (e) to observe actual operations of the land develOpment companies; to pursue various questions and reSponses in greater depth; to discuss the present role of the accounting functions in land development companies; to assess the direction in which the role of the account- ing function is expected to proceed in the future, since large publicly held corporations have made in-roads into the industry; and to assess the consequences of expansion in the industry and the impact of automated data processing techniques on the land development accounting methods. Limitations of the Study (1) The scope of the study is limited to the investigation of accounting requirements for urban land development intended to be used for residential, commercial and industrial purposes. (2) The field interviews and observations are limited to the land development companies located in the state of Michigan. Although the large land development companies are located in states of Florida, Nevada and California where large tracts of raw land are available for development into new full-fledged communities or cities, quite a few 12 companies in the Detroit area have been engaged in large complex pro- jects. Many of their projects involve simultaneous development of residential, commercial and industrial subdivisions. Some of the companies have been in the land development business for over 25 years and have grown significantly in the last decade. Investigation during company visitations indicated that the accounting practices and problems of a company located in Florida or Texas are not significantly differ- ent from those of a company located in Michigan. Limiting the area of visitations was necessary to keep the scope within financial and time constraints. (3) The sample of companies selected for questionnaire admin- istration and visitations is selective. The investigation results are not amenable to statistical analysis. In other words, the study does not aim to formulate a hypothesis about the accounting techniques employed by developers and confirm or refute the hypothesis based on sample statistical tests of data. Rather, the study belongs to the category of prOblem solving studies in which real world accounting techniques are examined and an attempt is made to find solutions for the accounting problems of developers. The choice was made to Study fewer subjects (firms) in depth rather than a larger universe in limited depth. Organization of Chapters Chapter I deals with introduction and provides background material, purpose, need and significance of the research, outlines research methodology and data-gathering techniques, and limitations of the study. 13 Chapter II discusses land develOpment accounting in historical perspective since 1900 and reviews the unique features and principal accounting problems in the industry. Chapter III summarizes the results of the land development accounting practices survey. In this chapter, common accounting pro- cedures an practices employed by developers are gathered for critical analysis in the two following chapters. Also data accumulated during company visitations is included along with summaries or explanations for various questions of the questionnaire. Chapter IV examines and evaluates accounting procedures and practices to trace the influence of the Federal income tax law, and of the Treasury regulations on accounting techniques used by developers. Chapter V deals with theoretical considerations, accounting concepts and theoretical standards involved in land development account- ing. Based on the concepts and standards, different alternative account- ing methods used in the land development industry are examined and cr it ica 11y evaluated. Chapter V1 is devoted to overall summarization of results and outlines recommended accounting system changes. A few areas which need additional investigation are suggested for further research. ———-—-~ A .. CHAPTER II PECULIAR FEATURES AND PRINCIPAI.ACCOUNTING PROBLEMS -- A CRITICAL ANALYSIS Introduction The land developer has to select such accounting principles and practices that his accounting system is tailor-made to serve his needs. The tailoring generally refers to selection of a set of accounting practices from.various alternative methods to account for a transaction. The selection of methods requires understanding of the peculiar features of the industry and various accounting problems arising due to those features. Also, the selection process entails an understanding of assumptions and accounting concepts underlying the alternative methods, and evaluation of the relative importance of different concepts to accommodate peculiarities of the land development business. In the land development industry, many peculiar characteristics and accounting problems can be attributed to complexities of the land development process and selling techniques of developers evolved over a long period. At various points in time, a few attempts have been made to evaluate some accounting practices and conventions in the industry. A few changes were suggested to accommodate the evolved features or accounting problems of the time; some were accepted and others were rejected mostly on taxation considerations. Past is a guide to the future; and the study of history furnishes many clues. To gain insight into the past and to find some 14 15 clues related to the present accounting problems of the industry, this chapter attempts: (i) to trace the evolution of conventional accounting practices employed in the industry since 1901; and (ii) to examine and analyze the unique features of the industry and principal accounting problems at the present time. IAnd Deve10pment Accounting: A Historical Perspective (1) 1901-1920: The first comprehensive paper completely deal- ing with the accounts of a land development company appeared in the issue of The Accountant of May 19, 1906.1 The paper starts with an out- line of four distinguishing features of interest to auditors: (a) Trad- ing in fixed assets, viz. plots of deve10ped land; (b) outstanding liabilities accruing over a number of years; (c) difficulties in valuation of residual assets and consequent computation of realized profits; and (d) treatment of non-realizable assets whose precise value cannot be indicated. Also, there was brief discussion of different features of installment sales and auditing problems connected with verification and certification of these sales, bookkeeping methods related to computation of cost of land sold, apportionment of cost among various lots, and accrual procedures for uncompleted improvements. Furthermore, some of the problems connected with consolidation of accounts of subsidiary companies engaged in the land development busi- ness and how the auditor should go about solving the problems in the best possible manner, were touched briefly. The emphasis in the paper Garratt, Percy, "Notes on the Accounts of Land Development Com- panies," The Accountant, May 19, 1906, p. 637-643. 16 centers around accountability of the management to the shareholders, and the methods which should be used by the auditor to examine the correctness of the balance sheet items. The first pioneering book in the wider field of real estate accounting appeared in 1917.2 Since the land develOpment activity comprised a major activity of a real estate company, the book dealt with accounting methods applicable to a land development company. The examination of the book in historical perSpective reveals a con- formity to a noticeable trend toward uniform accounting systems. During earlier parts of the century, various trade associations or practicing accountants intimately associated with an industry, carried a 'crusade' of designing and publishing the uniform system of accounts applicable to the industry.3 Probably cost consciousness among the firms of an industry accelerated the movement for the establishment of a uniform accounting and costing system for the industry. Also, accountants engaged in different industries felt that each industry has some peculiar featuresand that generalized text book accounting methods could not deal adequately with the peculiarities of an industry. 2Walter Mucklow, Real Estate Accounts, Ronald Press (1917); The successor edition of the book entitled Land Accounts appeared in 1935, and dealt with the narrower topic of land development accounting. 3For example in 12 issues of The Journal of Accountancy in the year 1917, there are six articles dealing with uniform accounting of the following industries. Electric Utilities Accounting (P. 326 Vol. 23 ), Cost Accounting for Contractors (P. 177, Vol. 23), Navy Yard Cost Accounting (P. 28, Vol. 24), Accounting Systems for Retail Merchants (P. 100, Vol. 24), Construction Records and Accounts (P. 28, Vol. 24), Uniform Cost Accounting for Milk Distributors (P. 424, Vol. 24), Uni- form Accounting for Third Class Cities, New York. In 1917, at least following 5 books were published dealing with uniform accounting: Milk Production Cost Accounts: Principles and Methods; Printer's Aggounts, Rubber Companies Accounts, Real Estate Accounts. One can list books for about 30 uniform systems of accounting published during first two decades of the century. 17 Mr. Mucklow was a practicing accountant, and had had considerable experience in real estate accounting, and sensed the need at that time for a book dealing with Specialized accounting -- real estate accounting. Mr. Mucklow's book was the first book to treat the deve10ped lot of a developer as "stock-in-trade". Also the book outlined some of the special features of the industry and attempted to define a few terms peculiar to the industry. The Federal income tax law came into effect on March 1, 1913 and the accountants of the period used various provisions of the law as standards for explaining the knotty problems in accounting for certain transactions. Mr. Mucklow, in conformity with the practice of the period, used the income tax law and Treasury rulings under the income tax law to evaluate or explain some problems related to realization of profits, provision for cancellation of con- tracts, treatment of contracts receivable and treatment of profit from installment sales. Bookkeeping methods, forms, records, etc. are also described in great detail. (2) 1921-1930: During the early twenties, industry, trade and commerce expanded rapidly. The growth and prOSperity created a tremendous demand for improved land for industrial, commercial and residential purposes. This demand was joined by speculative demand and created an unprecedented boom in the land develOpment industry. Since the greatest activity occurred in the state of Florida, the boom was called the 'Florida real estate boom.‘ "During the recent past, business in Florida real estate has been so active that the ribald and pro- fane regard it as a 'boom', rather than a natural 18 or prOper regard of undoubted merit".4 During the boom period, the activity in the industry was feverish. "From the Western Union messenger boy to the millionaire, everyone was drawn into the orgy of buying and selling."5 The boom created two opposite forces: (a) there was great volume and many complexities in real estate transactions which needed the concentrated attention of trained accountants; (b) instead, accounting was ne- glected since many persons got involved in varied joint ventures and seemed uninterested in a systematic accounting of their ventures. Only when "the smoke of battle" cleared away in the Spring of 1926, and the fortunate ones faced the prOSpect of accounting to the Federal Government for their profits, were the public accountants of the state called upon to perform the very arduous duties of determining from the maze of settlement sheets, contracts, receipts, and checks just what had taken place.6 A few practicing accountants, viz. Walter Mucklow, Lewis Winter- mute, F.E. Ross, O.W. Boyd and at least one academician, H.F. Taggart, who came to be recognized as authorities on land development accounting during the period, wrote some interesting articles or a book on land development accounting and problems in accounting for various complex 4Walter Mucklow, "The Accountant and the Real-Estate Developer," .Ihe Journal of Accountancy, November, 1926, p. 327. SOrtonw. Boyd, "Accounting Problems of the Florida Real Estate lioom," Accountinijeview, September, 1926, p. 64. 61bid., p. 66. 19 transactions peculiar to the industry. An article by Mr. Mucklow, one by Wintermute and a book by Taggart dealing with subdivision accounts are especially important from the point of view of historical study of land development accounting, and are briefly discussed in the following paragraphs. Mucklow's article -- The Accountant and the Real—Estate Developer --7 discussed the role of the accountant in a land develop- ment company and stressed the co-operation between the accountant and other professionals working in a land development company. The technical accounting jargon and accountant's inability to prepare accounting reports 'in such a language as to be understood by the man on the street' is traced as the cause of lack of interest in accounting by the developer. Mucklow very aptly puts his point in the following words: "It Should be remembered than many of the most able of those engaged in the development business have no such (i.e. accounting) training and that the average layman is as much bewildered by such technicalities as is a patient who hears his disease described in medical terms by a consultant to his colleague." For the first time, Mucklow discussed the peculiar problems of the industry related to the 'theory of accountancy'. Interestingly, he points out, "the difficulties in (this) class are the least in number, and, perhaps, are easiest to deal with, as the complications which sometimes arise should not be found difficult to cope with by «one who is familiar with recognized principles of accounting."9 7Walter Mucklow, "The Accountant and the Real-Estate Developer", frlszournal of Accountancy, November, 1926, pp. 327-348. 8Ibid., p. 328. 9Ibid., p. 330. 20 (Emphasis added). The approved methods for the preparation of the balance sheet issued by the Federal Reserve Board in 1918 were used as recognized methods for theoretical examination.10 The following five items not Specifically covered in the Federal Reserve Board's approved method are briefly discussed:1 1. The price at which land is to be shown on the balance sheet. 2. The establishment of reserves for profits not yet realized. 3. The treatment of prepaid expenses and deferred charges. 4. Contingent liabilities. 5. The method of dealing with sales which have been cancelled. Mr. Mucklow also discussed at great length the difficulties associated with the Federal income tax law in recognizing the profit on installment sales and repossessions arising from defaulted contracts. The Federal Income Tax Act, 1926 provided positive recognition of installment sales under certain conditions, and allowed the taxpayer to report the income of a period based on the installments received during the period Subject to the Treasury regulations under the income tax law.12 The Treasury regulations under the income tax law compli- cated the matter by differentiating somewhat arbitrarily between in- stallment sales and deferred-payment sales not on the installment plan, 0 Approved Methods for the Preparation of the Balance Sheet, jggderal,Reserve Bulletin, 1918. llMucklow,‘gp.pgiE., p. 330. 1 2Income Tax Act, 1926, Sec. 212 (d). 21 and by vaguely defining fair market value of the property as "that annunt which would induce a willing seller to sell and a willing "13 buyer to purchase. Mr. Mucklow provided a penetrating analysis of the problems caused by the income tax law and regulations, and suggested a remedy based on recoverability of cost before any profit can be recognized: "In all sales of real estate, no taxable profit shall arise until the vendor has received in cash, or in obligations assumed by the purchaser, the cost of the property; after which all receipts shall constitute taxabel income....... It would also prevent the growth of an erroneous idea which appears to be gaining Strength, there is some mysterious basic difference between various sales, Such as installment sales, sales on deferred-payment plan and closed transactions."14 Mr. Wintermute's article discussed in a limited way the account- ing procedures required for prOper control over certain operations arising out of specific conditions that are not common to most busi- ness undertakings.15 The bulk of the discussion surrounds bookkeeping methods for accounting for different transactions and setting-up of the books and the forms. There is a good bit of discussion on com- putation of unit lot costs, problems associated with apportionment of the total cost over individual lots, and problem of capitalizing or expensing carrying charges, viz. interest on investment in deve10ped and undeveloped land, property taxes, etc. Evaluating this problem, Pun Wintermute remarked: 13Regu1ation 65, articles 45 and 46. 54Mucklow, p. 343. 15Lewis‘Wintermute, "Some Problems of Allotment Accounting," SEhe Journal of Accountancy, September, 1928, p. 161-178. 22 "As a matter of fact, they (i.e. carrying charges) con- tinue to accrue from the date the prOperty is acquired until it is actually diSposed of, but there is here involved not only the theory of accounting but the much more important necessity of being practical."16 As a practical expediency, he Suggested capitalizing carrying charges until the lots were placed on sale and treating them as operating expenses from that date on. In the land development business, many times it is necessary to find the cost of sales prior to completion of all improvements necessary to fulfill the contractual obligation. Mr. Wintermute dis- cusses some of the details associated with estimating the cost of lots sold and procedures involved in setting up of contra accounts. Al- though, he does not mention explicitly the notion of 'matching reve- nues with costs', his discussion implies that matching is highly desirable even if it involves estimating costs for the uncompleted improvements. In 1930, a study17 completely dealing with land development accounting was published by the University of Michigan's Bureau of Business Research. The study focused on "problems involved in the purchases, development, and sale of unimproved property principally 18 for residential purposes." At the outset Taggart noted the paucity of literature on the subject as evidence by (his) meagre bibliography19 16Ibid., p. 163. 17Taggart, Herbert F., Subdivision Accounts, University of Michigan, IBureau of Business Research, Ann Arbor (1930). 18Ibid, p. 8. 19Ibid., p. iii; he cited only nine publications in his biblio- graphy (p. 89) . 23 and lack of interest in accounting by the developers. Contrary to the normal expectation that the subject matter would have been treated and evaluated in a theoretical framework, since the study is a product of an academician in the field of account- ing, the treatment of many important t0pics and resolution of con- troversial points were strictly based on the Treasury regulations and court rulings under the income tax law. Taggart justified this practical treatment of the subject matter on two grounds: (1) "The coercion exerted by the income tax law is almost the only Stimulus able to produce an effective interest in accounts on the part of a real estate dealer. This fact, is one reason for the emphasis on income tax con- sideration in the present work."20 (2) "Most bookkeepers and accountants are content to follow the rules laid down for them by the income tax laws and regulations in the matters of income and valuation--- these rules have become more detailed and definite as each successive revenue act has been passed, so that the guidance thus afforded, if the rules are intelligently interpreted and applied, is adequate for tax purposes and is far better than nothing for accounting purposes."21 Prof. Taggart recognized the limitations of the financial Statements prepared on the basis of income tax rules and regulations. 20Ibid., p. iii (Author's Note). 21 Ibid., p. 2. 24 Alternatively, he suggests that two sets of the statements may be necessary to provide adequate financial information. Interestingly, he favors methods employed by manufacturing companies as methods preferable to those of trading companies for the second set of . 22 financial statements. The strict adherence to the income tax law and Treasury regu- lations under the law and recommendations based on convenience or expediency rather than even the accepted accounting theory of the period astonished a few practicing accountants of the period. Mr. Mucklow, who had been very active in the practice of land development accounting, commented while reviewing the book: "Such a reader may feel Surprised at the deference paid by the author to the regulations and bulletins of the Treasury Department, to which reference is made with a reSpect almost equal to the reverence observed by a Rabbi to the law and prophets: a feeling which is not Shared by all those accountants who have appeared before those prophets, some of whom may be properly classed among the minor prophets; while a few, alas! might, by the cynical, be placed among the false prophets who worship in the 23 house of Baal rather than in the temple of the true God." Another striking feature of the study is a complete omission of any reference to the Federal Reserve Board's approved methods for the preparation of balance sheet statements or its revised version of 1929, "Verification of Financial Statements".24 One would suSpect that Professor Taggart may be dealing with accounts of a firm which is Inot a corporate type of organization, and therefore, the federal 221bid., p. 2. 23Mr.‘Wa.lter Mucklow, Book Review Section, The Journal of Scountancy, April, 1930, p. 336. 2 4"Verification of Financial Statements", Federal Reserve Bu 11etin, May, 1929. It may be possible that the revised version was; pmblished after Taggart had finished writing the book. 25 board's guidelines may not be applicable. On the contrary, he explicitly acknowledges that the principles, procedures and terminology used in the study relate to a corporate form of organization.25 Also, his illustrative statements clearly indicate the corporate form of organization.26 Nevertheless, the study can be considered as a landmark in the literature on land development accounting. The study discusses problems connected with the determination of lot costs, costs related to improvements after sale, and capitalizing vs. expensing of carrying charges in detail. Many methods suggested by Prof. Taggart filtered into the accounting text books and the books specializing in outlining accounting systems for various industries. Even at present, quite a few procedures recommended in his book are being followed by many land develOpment companies. These methods and procedures will be discussed in this research effort wherever it is necessary to explain the origin of the method. To avoid duplication, no detailed discussion is pre- sented in this chapter. (3) After 1930: The depression during the 1930's witnessed a debacle in the stock market, and there was great disenchantment with publicly owned corporations. During the post-depression era, Serious re-appraisals by various government and private bodies were Inade. The Securities Act, 1933, and Security Exchange Act, 1934 ilnposed strict disclosure requirements for the publicly owned corpora- tzion. Accountants were thrust into additional responsibilities of 25 , Taggart, gp. c1t., p. 3. 26Ibid., p. 67-88. 26 certification and verification of the published information by public corporations. During the decade of the forties and fifties, a great number of companies in many industries became publicly owned. The tremendous increase in demand for the products manufactured by many industries, advances in mass production technology and other related factors accelerated the trend of public ownership of corporations. Many of the above factors affected the land develOpment in- dustry, but most of the land develOpment companies were organized either as partnerships or private closely held corporations. Until recently, the public corporation form of organization was not popular in the land development industry. The joint-ventures of the 1920's and 1930's retained their popularity. The lack of interest in account- ing by the management and the owners had an adverse effect on the accounting function. During that period, there were great advances in the practice of accounting elsewhere, but the procedures followed by land development compnaies were oriented mainly toward the fulfill- ment of an obligation to file tax returns. The survey of accounting literature after 1930 indicates very few articles on land development accounting. A successor edition of Mucklow's book27 appeared in 1935. Although the author claimed in the preface that great advances in accountancy had taken place and pro- cedures employed in land develOpment companies should be re-cast, the l>ulk of the material is more or less a summarization of the procedures 61nd practices recommended before 1930. 27M'ucklow,Wa1ter, Land Accounts, American Institute Publishing CO- , Inc., (New York) 1935. 27 Some of the handbooks of accounting methods published after 1930, also outlined accounting systems for real-estate or land develop- ment companies.28 The material in most of these books is based on Taggart's Subdivision Accounts or articles published before 1930. Recently, the entry of public corporations into the industry has aroused interest in the subject of accounting. A few accountants and academicians have discussed problems in land development accounting and complications created by the tax laws. Numerous but scattered court cases and treasury regulations discuss peculiar treatment for various cost and revenue elements. Unique Features The review of existing literature, the published statements of a few land development companies, interviews with executives of land development companies,and actual observation of the land development process provided the material contained in the following paragraphs. Some writers discuss the unique features and the accounting problems in the industry interchangeably; or both are described as 'difficulties' in land development accounting. In the study, two aspects are separately discussed. This separation permits first the discussion of the unique features of the industry, and second the analysis of the effect of such unique features on accounting require- ments of a developer and the principal accounting problems arising therefrom. 28J.K. Lasser (Ed), Handbook of Accounting Methods, D. Van Nostrand Company, New York, 1943, 1p. 1072-1082; Paton, WiIliam (Ed), Accountants Ihandbook, Ronald Press Co., New York (1932), p. 463-518 & 1430-9. 9These are discussed in Chapter-IV. 28 1. Nature of the Business: It is a high unit cost, low in- ventory turnover business. Many develOpment projects contemplate creation of entire new communities with a lake, a golf course or other recreational facilities, shopping centers, and industrial parks. The projects vary considerably in operation. Since improvements differ greatly in detail between projects to Suit topography, location and other physical and social factors, there are few common repetitive operations amenable to standards except for broad engineering standards for earth moving, sewers, etc. 2. Multiperiod Prgjects: Land development projects generally extend over a number of years. A large development project involving thousands of acres may take a period of 25 years before the last lot is developed and sold. Even a medium size develOpment project involv- ing about 200-300 acres of land may extend over a period of five to seven years to complete. Many projects are developed in stages depend- ing upon the market situation or available resources of the developer. The planning, engineering, inSpection and legal formalities in search and transfer of title to the property take long periods of time. Some projects necessitate alteration of zoning provisions in a locality or a community and require extensive negotiations with many parties. 3. Nature of Costs: Land development costs related to assembling of raw land and improvement of undeveloped land are almost always joint costs. Two or more pieces of adjoining undeveloped land may be acquired for one subdivision and improvements carried out .jointly or in parts without considering the individuality of each [Jarcel of land. Many types of improvements involving large expenditures Irelate to the entire subdivision or more than one subdivision. 29 4. Excessive Use of Estimates: There is excessive use of 'estimates' in accounting for various items of costs or reductions from revenue. Since many lots are sold prior to completion of con- tracted improvements, the developer has to use estimated cost for these obligations to reflect the expected cost of improvements. Al- most every published financial statement of a land development com- pany contains a footnote that costs of improvements are based upon internal engineering estimates for uncompleted obligations. In some cases nearly 80%-90% of the costs of improvements were based on the estimates. 5. Sub-Contracting: The bulk of the land development opera- tions is executed on a sub-contracting basis. The tradition in the industry and the strongly unionized labor needed in the operations and consequent labor relations problem are the two main reasons for this feature. Interviews with a few executives or large and medium-sized land development companies revealed that the companies developed and sold thousands of lots over a period but did not own even a single piece of earth moving or concrete nfixing equipment. All the opera- tions, except designing a subdivision, were performed by sub-con- tractors. 6. Financing a Land Deve10pment Company: There are two major forms of financing a land development company: (i) Land contracts based on the mortgage of unimproved land or developed lots. Since the bulk of investment in land develOpment is in land, this collateral is very attractive to the lenders in financing operations. 30 (ii) Borrowings on 'installment sales contracts' of buyers of lots. Since most of the sales are on the install- ment basis and the periodic installments provide a regular source of retirement of the loans, lenders are willing to accept these as collateral. The land development company also benefits by this convenient form of financing. 7. Governmental Regulation: Government at local, state and federal levels has extensively regulated the land development business. The regulations are aimed at protecting both physical and social elements in a community. The most important area of regulation is zoning. It has become universally accepted in this country as well as outside the United States. It controls the use and development of all types of property from residential to heavy industrial use. Zoning laws protect and preserve neighborhoods and property values. local and state regulations Specify provisions for streets, their widths and structure, sewer Systems, requirements for layouts etc. Subsidies for common services like storm sewers, access roads and paving of streets are paid by various local and State authorities. At the national level, indirect influence is exercised by Federal Housing Administration and Public Housing Administration. Loans to individuals or developers depend upon many Specific requirements to be met by them. 8. Taxation Features: Taxation laws and regulations play an important role in the operation of every business. Some businesses have acquired Special features to accommodate Special requirements imposed by these laws. The land develOpment industry happens to be 31 one such industry. It is characterized by a multiplicity of taxation laws, regulations and rules providing many options under different circumstances. Local, state and federal taxes are levied on land and land developers. Numerous court decisions scattered in taxation literature dictate various alternatives for treating different elements of cost, revenue or other recoveries. These factors are becoming more and more significant as vast amounts of capital are invested in diverse development projects. 9. Nature and Type of Establishments: Until recently, land development projects were usually undertaken by private individuals or proprietary companies. These were sort of super-entrepreneurial individuals who had acquired business acumen by experience on the job. Quite often a few individuals or closed companies formed joint ventures for specific projects, and little information of gains and losses was made available to outsiders by them. It is common practice among land developers to organize multiple corporations, either under control of one parent company or on a co-venture organization basis to perform one or more of the following functions: (1) purchase and hold raw tracts until land can be developed into profitable subdivisions; (2) develop the raw tracts and subdivide into improved lots on which residential or other structures can be built; (3) sale of developed lots and/or built structures; and (4) management of property (including rental of structures) until all property or lots are sold. There are very few national land development companies, although a trend toward this direction is increasingly rapidly. 32 Principal Accountigg Problems By its very nature and peculiar features, the land development industry creates accounting problems. In an award winning article, Dr. Gardner Jones Summarized several difficulties: joint costs, income tax provisions, inapplicability of standards, operation of developed prOperties while awaiting for sale, and joint ventures in development. Some other writers have discussed problems connected with recognition of revenue, treatment of partial refunds from civic authorities, in- stallment sales, carrying and holding charges, etc. These can be described briefly under the following four headings: (1) Classification and accumulation of costs and revenues: In land development accounting, classification and accumulation of items and expense are key problems and extend into other areas like allocation of costs to individual lots and periods, and recognition of revenue. Two methods have been suggested to handle the problem of classifica- tion and accumulation of costs: (i) The first method is aggregating cost of land and land improvements related to one or more subdivisions and allocating that cost periodically or at the end of the venture to individual lots. Revenue realized on the sale of lots is matched with costs over a period of time, and the difference between the two amounts represents gross margin. Administrative and selling expenses are classified as period costs of doing business. Refunds and other revenue are also related to the period during which these were received. Obviously, such accounting classification follows the natural basis, is very simple but provides very little value and information expected 3oGardner Jones, "Some Problems in Accounting for Land Development”, Management Accounting (N.A.A.), August, 1968, p. 33. 33 from an accounting function in an organization. (ii) The second nethod is to break down costs into prime classifications such as land cost, carrying charges consisting of property taxes and interest charges, land improvement cost broken down into many sub-classifica- tions such as water system cost, sanitary and sewer system cost, engineering and surveying costs, etc. Special provisions are made for credits for recoverable portions of costs, revneues realized from land dedications, etc. Under this method of classification, an attempt is made to combine natural and functional bases by segmenting items of costs and revenues according to the original purpose within each functional category. Revenue and expenditure accumulated under each prime classification are allocated, using appropriate bases over individual periods and lots. Contra accounts are used to handle the problem of multi-period flows and to satisfy some of the income tax provisions. This method may provide better information but may be laborious and expensive. (2) Allocation of Cost: In the land development industry, the mer- chandise produced for sale consists of lots. These lots are of dif- ferent sizes and have different physical and locational characteristics giving rise to different selling prices. All expenditure, direct and indirect, ultimately must be allocated to individual lots to ascertain the cost of goods manufactured and cost of goods sold. This is one of the major and formidable problems for a land developer. The joint nature of costs can be identified as one of the causes of this prob- lem. It is necessary to provide a classification scheme that will allow the rearrangement of joint cost items by different categories for identifying cost of land or cost of improvements. Furthermore, 34 because, the business is a high unit cost, Slow turnover type, the developer may be forced to use for short periods part of deve10ped property to produce some income. In some cases which arise in many big projects, improvements may be necessary on related land, and the cost of these must ultimately be allocated to lots. These off-site improvements may benefit two or more projects developed over a number of years. Examples of such improvements include off-site street park- ing, golf course, lake construction, parks, marinas, water main and sewer systems. The problem can get complicated if some of these improvements have to be capitalized and offset with income produced from the operation of the facilities. If these facilities turn out to be of a low-income producing type which cannot pay for their capitalized cost, the allocation problem can become more complex. The income tax provisions which require equitable allocation of the expenditure on on-site and off-site improvements to compute gain or loss from each lot sold during the period aggravate this problem. Multi-period projects, which characterize the land development business, also create complicated allocation problems. As the land development progresses, some items of expenditure may become necessary which in fact benefited the lots developed and sold in earlier periods. Should this type of expenditure be estimated and provided as an item of cost before allocation? Or should the extra expenditure be allocated on remaining lots unsold? (3) Capitalization versus expensing of carrying charges: This problem arises because of the nature of the business and multi-year projects of the deve10per. Examples of cost items which might be capitalized or expensed are: prOperty taxes on deve10ped and undeveloped property 35 held as inventory, subsequent clearing of weeds required as a fire prevention measure, interest charges which may be explicit on a mortgage or loans, social security taxes on employees, sales and use taxes on materials used in the develOpment process, insurance premiums related to land and prOperty, and some other incidental expenses. Tax laws and regulations complicate the problem of offering the option either to capitalize or expense some of these without Specifically following sound accounting principles, or Specify one or the other option as mandatory. To illustrate one of the difficulties involved, the election in reSpect to unimproved and unproductive real property applies only to prOperty taxes, interest and other carrying charges and may be made annually. For all other prOperty, the election is binding for subsequent years. The rationale behind such stipulation seems ambiguous and without any support from sound accounting theory. Similarly the definition of a project is Surrounded by ambiguities. Internal Revenue Service Reg. l.266-l(c) states that if an expenditure for several types of the same item are incurred with respect to a single project, the election to capitalize must be applicable to all items of that type. However this does not require capitalization of other types of items listed within the same project. Nor does it require capitalization of the Same items existing in other projects (4) Recognition of Revenue: What comprises revenue of the period and from what lots poses another puzzling problem in land development accounting. It consists of four sub-problems: (i) Installment sales and revenue recognition: This problem involves differentiating between the amount of revenue to be recog- nized as current revenue of a Specific period and the amount to be 36 carried forward as being applicable to future periods. Because of the complexity of terms under which developers make sales and collec- tion of installments before actual delivery of the lot, the determina- tion of the preper income accounting methods present challenging prob- lems. The problems are becoming more important as larger prOportions of sales are made on the installment basis and longer periods are allowed in installment contracts. For example, in one real estate development company, 1962 land receivables represented an unusually high average of 950 days of land sales; for another they represented 425 days.31 (ii) Repossessions, foreclosures and forfeiture of dgposits: Gains and losses can frequently arise from defaulted contracts in- volving repossessions, foreclosures or forfeitures of despoit. These create problems of assigning them to periods and classifying them into ordinary income, extraordinary income and capital gain or loss. In the case of repossession and foreclosure, gain or loss is the difference between original sale price recognized at the time of the sale and the sum of fair value of repossessed or acquired land and cash received since the sale was made. The determination of fair value of land presents another problem. Should fair value be appraised value, market value, realizable value, net realizable value, or some other measure? As with other problems in the industry, income tax laws and regulations can create additional problems of treatment of proceeds into capital gain or ordinary income, and losses into capital loss or bad debt expense. l Lilian Affinito, "Problems in Accounting for Land Sales of Developer," Price Waterhouse Review, Autumn, 1963, p. 20. 37 (iii) Proceeds received from dedication of land, sale of timber, ggavel, etc., governmental subsidies and grants: How the proceeds from these should be treated presents problems. Should these proceeds be treated as extraordinary revenue or reduction in cost of land or land development? Additional problems are created when land is donated to form an adjacent country club which will not be able to make Suf- ficient income for long periods of time to pay for the reasonable cost of land; or land given to water or sewer or electric companies for rights of way or filter systems for nominal value. (iv) Income and expenses on develgped_property in interim_period: When the land developer has to operate deve10ped properties for interim periods until these can be sold, the problem arises of accounting for income and expenses from these properties. He might need a separate set of accounts and accounting methods for income measurement and in- come tax purposes. Also, the main activity of the land developer is to develop the land rather than to hold prOperties for income. The accounting system then should be able to supply information which will be in terms of income, expenses and other related data, to re-evaluate periodically the sell or hold decision. The generation of appropriate measures for required data can cause lots of problems in accounting for these types of items. CHAPTER III LAND DEVELOPMENT ACCOUNTING PRACTICES SURVEY Sample Distribution and Response As indicated in Chapter I, the sample of selected companies was divided into two groups. Group-I is comprised of 35 companies located in the state of Michigan. Group-II is comprised of 30 com- panies from various states selected from Dun & Bradstreet Million Dollars Directory, 1970, from those listed under code 6552 -- Real Estate: Subdividers and developers except cemeteries. From Group-I, 14 companies replied and returned completed questionnaires. The reSponse from this group was 40% and was lower than anticipated. Additional investigation by way of reminders, phone calls and personal visits to some of the non-reSponding companies revealed an interesting practice in the industry. Many companies which were classified as medium size by the regional home builders associations actually were medium size and had a considerable sales volume and amount invested in their develOpment projects. But they did not have any accounting department or accounting section in their organizational set up. They empolyed a couple of bookkeepers or secretaries who maintained routine records of cash and other related transactions. Periodically, the records were summarized and the financial statements for income tax and other purposes were prepared by a public accounting firm. The majority of those companies were privately owned corporations, and managing directors or the presidents 38 39 of the companies did considerable quasi-accounting work on their own for planning and investment decisions. Rules-of-thumb learned by extended association with the land development business were used to handle various accounting problems. Generally the tax considerations and advice from lending institutions guided their actions for treating any peculiar problem which arose in accounting for a transaction. From the 30 Group-II companies, 20 replies were received. Out of the twenty replies, 16 returned the completed questionnaires and four returned uncompleted questionnaires. The 16 completed ques- tionnaires represent about 53% response. Two companies which returned the uncompleted questionnaires declined to participate in the Study; the officers of a third company indicated that they were mainly engaged in the development of agri- cultural land viz. citrus groves, cattle, timber, etc. and considered the questionnaire inapprOpriate for their type of operations; and the respondent for the fourth company replied that their land development activity had been phased out during the last five years and that he did not think it appropriate to participate in the study. Nine companies in Group-II who returned the completed question- naire are located in the states of Florida, Texas, and California, where the greater part of the land development activity in the industry takes place. Company Visitations As indicated in Chapter I, the researcher visited 10 companies that had sent completed questionnaires and are located in the state of Michigan. Six of the companies are large and four are of medium 40 size. Five large companies are engaged in extensive land develop- ment projects and have been in the land development business for over twentyfive years. Since the basis of interviews was to pursue various questions in the questionnaire in greater depth, the information gathered during company visitations and interviews with different executives is summarized together with information gathered in questionnaires. By treating all information related to a question together, survey results portray clearly actual accounting techniques used by developers. Size Determination In almost every industry, accounting practices vary signifi- cantly according to the size of the companies. But the categorization of companies into different sizes has posed many problems to empirical researchers who have tried their hand in defining which companies should be considered small, medium or large. Since some criteria must be used in the process of categorization, sales volume in dollars or physical units, total assets of a company, number of employees, total capacity of a company in relation to the industry capacity, net income or percent of net income over some suitable base such as total assets or total equity, number of branches or plants, etc. are used as bases for categorization. In most cases the sales volume is the main criterion, and others are used as supplementary criteria along with the sales volume. In the land development industry, preliminary investigations before selection of the sample companies and interviews with a few executives of the development companies and the regional home builders 41 associations revealed that the sales volume criterion to categorize developers might prove seriously inadequate because of two reasons: 1. Some companies may have relatively low sales volume due to their recent entry into the industry, eSpecially subsidiaries of some large companies in related industries. Many such companies in the industry have large projects involving sub- divisions of thousands of acres on their drawing boards or in the initial stages of development, with relatively low sales volume in the current or last year. 2. Reluctance of many sample companies to divulge the sale volume or the total assets employed by the company, eSpecially those in Group-I. As a compromise, the following question was asked in part I of the questionnaire: "How do you classify your company in the industry? Small ------- Medium ------- Large ------- " Since the respondents must have used some criteria to categorize themselves, a companion question was asked to identify the factors which should be considered in classifying a company a small, medium or large. Six factors which were the most relevant for the industry were Suggested in the questionnaire and the companies were requested to check those factors they considered in classifying a company in the industry. These were: Amount invested in current development Sales in dollars in a year Number of lots developed in a year Number of subdivisions developed in a year Number of acres developed in a year Number of employees O‘UlbUNI-A o 42 The replies from the companies are summarized in Tables 3.1 and 3.2. Table 3.l--Distribution of companies into large, medium and small according to their own categorization. Category Group-I Group-II Total Number % Number % Number % Large 6 43 6 38 12 40 Medium 8 57 10 62 18 60 Small 0 0 0 O 0 0 Total 14 100 16 100 30 100 Table 3.2--Factors considered by the coTpanies to categorize into large, medium and small Group Group Total Total Factors I II Groups L & M I & II L M L M L M N0. ‘7. Amount invested in current development projects 5 6 4 7 9 13 22 73 Sales in dollars in a year 6 8 6 10 12 18 30 100 Number of lots deve10ped in a year 4 5 2 2 6 7 13 43 Number of subdivisions deve10ped in a year 0 2 0 2 0 4 4 13 Number of acres developed in a year 3 2 1 3 4 5 9 30 Number of employees 1 2 0 4 1 6 7 21 1Since no company categorized itself small, the tables will only Show large (L) and medium (M) sizes. Many companies checked two or more factors therefore total percent is over 100%. 43 Twelve compnaies (40%) categorized themselves as large and 18 (60%) as medium; no company considered itself as small. In Group-I there are 6 large and 8 medium size companies; in Group-II there are 6 large and 10 medium size companies. One company considered sales volume in a year as the only factor which should be considered in categorization. On the other extreme, one company considered all the six factors as relevant factors. Interestingly, all 30 companies considered sales in dollars in a year as one of the factors. Twentytwo companies (73%) considered amount invested in current develOpment projects as the other factor. The number of subdivisions developed in a year scored the minimum number (4) since expansion in the industry has led to the development of large subdivisions and the absolute number of subdivisions developed in ayear has lost its relevance to a great degree in the determination of the size of a company. Probably due to extensive use of Sub-con- tracting in the industry the number of employees was considered by only 7 companies -- one large in group-I and 6 medium Size (2 in group-I and 4 in group-II). This question was further explored during company visitations. The majority of the executives agreed that accounting practices will vary -- sometimes considerably -- between different sizes of companies and also believed that the sales volume and the amount invested in develOpment projects are very important factors in the size deter- mination. However, during one of the initial visits, one top exec- utive of a large company suggested that employment of a qualified2 2It became extremely difficult to lay down objective criteria for considering a person who is a qualified accountant. Instead, a full time accountant with some college degree or equivalent is used as a criterion to check this factor in subsequent investigations. 44 accountant can be considered as one of the factors. He argued that since small companies cannot afford to employ an accountant on a full time basis, it is possible to categorize companies roughly on that basis. Revisits and supplementary inquiries revealed that all thirty companies did employ an accountant to head the accounting de- partment or the accounting function in the company on a full time basis. Consequently, employment of a full time accountant does not appear to be an objective criterion for categorizing a company as medium or large in size. In the absence of any predetermined objective criteria, it was decided to base analysis and evaluation of accounting practices on self-categorization. In other words, the categorization -- large, medium or small -- as indicated by the company is accepted for analysis' and evaluation. Also, other variables such as types of subdivision developed by a company, number of subsidaries owned and location of a company gathered in part-I of the questionnaire are used when necessary to find any tendency or relation between a particular accounting technique used by a company and the variables. During the company visitations, the limitations of self- categorization were further investigated. The majority of executives visited could not suggest any other way to handle the problem, and thought it to be the best possible way of classifying a company. However, two executives, one of a large company and the other of a medium sized company, were somewhat Skeptical about self-categoriza- tion. They argued that a relatively medium size company operating in a concentrated local market and not surrounded by many other companies which are bigger than this company might consider itself a large 45 company; or a relatively large Sized company Operating in a large metropolitan area and surrounded by giants in the industry might con- sider itself medium sized. Since the self-categorization alternative is the only practical way in the present situation, it is accepted as the basis for analyzing practices along with the other variables. Scope of Operations and Use of Subsidiary Corporations Questions 1, 2, and 3 in part I of the questionnaire sought reSponses regarding three other important variables which can signif- icantly affect accounting practices employed by a developer. The variables are: 1. Development of Subdivisions for various uses. 2. Use of subsidiary corporations for some functions which can be considered as a part of the complete business; or other closely related functions. 3. Area of Operations of the company, viz. local (city and county) state, national (other States) and international (outside the U.S.). 1. Development of Subdivisions: A question was asked to indicate whether the reSponding company is involved in the development Of sub- divisions for various uses. To facilitate the response, the six most common uses in which many developers are involved were suggested, and the seventh was open-ended for any closely related use in which a company might be involved. The reSponses are summarized in Table 3.3. 46 Table 3.3--Development of subdivisions for various uses. Group-I Group-II Total Total Development of land for: Groups L & M I & II L M No. % r: 3 t" 3' Residential Homes 5 7 3 5 8 12 20 67 Residential & Recreational 3 4 3 1 6 5 11 37 Residential & Commercial 4 3 2 2 6 5 11 37 Commercial 2 4 1 2 3 6 30 Industrial 2 3 0 3 2 6 8 27 Complete community 2 2 5 6 7 8 15 50 Other uses 1 l 2 1 3 2 5 17 Twentytwo companies are engaged in the development of land for more than one use. Only two companies, one medium size, each in group I and group II, are engaged in the development of land for residential homes only. The remaining six -- 5 in group I, one large and four medium, and one in group II (medium size) -- are developing land for complete communities only. Overall, 15 companies (or 50%) are engaged in the development of land for complete communities which include schools, parks, shopping centers, etc. This indicates in- creased interest in the development of complete communities, generally away from metropolitan centers. The other uses include: apartment and multi-density dwellings; condominiums; and mobile parks. 2. Use of subsidiary corporations: In this question the six most common functions for which subsidiary corporations or multiple companies are used by deve10pers were provided for checking. The seventh alternative was open ended since many deve10pers own subsidiaries for 47 other closely related functions. received: Table 3.4 Summarizes the reSponses Table 3.4--Use of subsidiary corporations Group-I Group-II Total Total Functions Groups L & M I & II L M L M L M NO. % PUrchase and hold land until it is ready for development 5 5 1 4 6 9 15 50 Land improvement and sub- division 5 4 2 5 7 9 16 53 Real estate brokerage 3 l 0 4 3 5 8 27 Management Of property on fee 3 4 O 2 3 6 9 30 Mortgage financing 3 0 1 2 4 2 6 20 Marketing of deve10ped lots 1 0 0 2 1 2 3 10 Others 2 1 5 4 7 5 12 40 Four companies do not own any subsidiary or multiple corpora- tions to perform any of the related functions independently. Two are in group I both medium size, and 2 in group II -- one large and one medium size. Fifty percent of the companies own subsidiaries which purchase and hold land until it is ready for development and 53% own subsidiaries for land improvement and subdivision. Forty percent of the companies Own subsidiaries for closely related Operations viz. construction of residential units, utility operations, hotels or mote1,golf courses or other recreational clubs, mobile parks and cable TV systems. In group 11 there is a tendency to own subsidiaries for utility Operations (5 large companies), since the companies 48 develOp land away from towns or cities and create complete communities requiring such utilities. 3. Area of operations: City, county, state, other States and outside the United States are logical areas in which a company may develop any subdivision. One question Sought an answer from a responding company to indicate whether the company had deve10ped or intended to develop in the near future any subdivision in the above areas. The responses are summarized in Table 3.5. Table 3.5--Area of Operations Group-I Group-II Total Total Area of Operation Groups L & M I & II L M L M L M No. % Local -- city 5 5 4 5 9 10 19 63 county 6 8 5 8 ll 16 27 90 State 6 7 6 8 12 15 27 90 In other states in the U.S. 4 1 3 3 7 4 11 36 In other countries 3 0 O 2 3 2 5 l6 Since some companies Operated in two or more areas, the total percent is more than 100%. The analysis of the replies and subsequent exploration during company visitations showed that this question was a bit ambiguous. For example,the state includes the county and the county includes the city. The intention of the question was to ascertain whether a com- pany had developed or intended to develop in the near future any sub- division in the city, in the County but outside the city, in the state but outside the county where the company was located. There is a 49 possibility that some companies may have checked all three items viz. city, county and state, although it developed land in a city alone. All companies in group I were contacted by either a visit or by phone to correct the ambiguity in answering the question. In group II it was not feasible to contact all companies, al- though there seems to be no apparent error in checking the state column. There is some little possibility of ambiguity in checking of city and county columns. Subject to the above limitation, it can be seen that majority of the reSponding companies develop in the state and the county where they are located. Thirtysix percent of the companies develOp sub- divisions in more than one state and 16% in other countries out- side the country, eSpecially in Canada, Bahamas and EurOpe, where Americans have been buying sites for vacation homes. Objectives of the Accountinngunction in the Land Development Industry In part II of the questionnaire two questions were structured to identify and rank the expected objectives of the accounting function of deve10pers. The main purposes behind the questions were the follow- 1. To ascertain how many reporting companies do actually define the accounting objectives. 2. To ascertain from those companies which do not have a defined set of objectives of the accounting function in their organiza- tion, the assignment of order of importance among a set of the most common Objectives described in the accounting literature. 50 3. To confirm or refute, as indicated by library research, that most development companies consider the accounting function to be that of providing a measure of income for the period for tax purposes only. 4. To provide an additional critical variable -- a set of the accounting Objectives -- along with the other four provided in answers to the questions in part I of the questionnaire, for further analysis of practices and procedures employed by developers. Examination of accounting methods used by various companies along with their identified accounting objectives and priorities will provide an opportunity to ascertain how far the companies employ the procedures to accomplish their declared objectives. 5. To lay the foundation for proposed system changes, Since the need of developers can significantly be inferred from the concensus set of Objectives and the priorities assigned to each of the Objectives. Sixtyeight. percent of the companies answered 'yes' to the first question, i.e. in their companies the accounting objectives are defined. Thirtythree. percent are large companies (10 companies) and 10 are medium size. Out of the 10 large companies, four are in group I and 6 are in group II. This indicates that the companies in group II (located outside the state of Michigan) do not necessarily have a tendency to define explicitly the accounting objectives. On the other hand more large companies (83%) have their accounting objectives defined when compared to the medium size companies (55%). 51 To examine whether there was any correlation between the defini- tion of the objectives in formal terms and the critical variables such as the scope of Operations, the owning of Subsidiaries to perform various related operations or the area of operations, the answers of the companies which replied 'yes' were further analyzed. Tables 3.6 and 3.7 summarize the result of the analysis. The analysis Of results and aggregate summary as presented in the two tables indicate that no conclusion can be drawn about the correlation between the definition of the accounting objectives and the scope of operations, or the owning of the subsidiaries, or the type of subdivisions developed by the company. On one extreme, a large as well as a medium size company, owning no subsidiary company and involved in residential homes subdivisions in the localized area have their accounting objectives defined; on the other extreme there are multi-subsidiary companies who have developed land for various purposes or developed complete communities in many states as well as in other countries that do not have their accounting objectives defined. Further investigations and inquiries at the time of company visitations showed that the definition of accounting objectives de- pended very much upon the personality of the executive in charge of the accounting function in the company. He influenced to a great extent the formalization of the accounting objectives. Two controllers, one of a large company and one of a medium size company, pointed out that they defined the accounting objectives soon after their joining the companies. In four companies, the accounting objectives were only known to the controllers and were briefly described at the beginning of the chart of their accounts. In one company the objectives were 52 Table 3.6-~Analysis of the characteristics of companies which have the defined set of objectives of the accounting function. >5 l . u m .o E >~. Ci cu m :3 a) I u :1 ° U) 'v-i Q) U) Q) (1) O "'i O m a) H -.-¢ B H O t: Charac- L) - >. .a m u u o a . . :3 u u -H m o .c co to teristics .5 m m m 'U -a O E Q) a) '14 -.-¢ "'4 '0 \H H H H O >. u .s 'o 'U m -H m ova m v4 0 U (O J.) 'H 'H '0 (I) c m OH .H (u 'H to Size ~H u m m a .o m m u u a u -H o O m o .O .o m : .c-H c c O c u u ' '° = = m u .. s s '3 .2; :7, a . H H 'H U) m G) (U & company m 3 m m m u m.u .H .H m -H 3 o. m U m ..C.‘ 44 cu O L: :1 La '0 m m a) a: "D E .C: u u :3 c: g ..c: O O -H a) a) $4 a) C1 0 U 3 (I) O O O H Lu 2 U) ad ed 0 m H D O Large-Group I x x x x x x x x x , x x x x x (4 companies) x x x x x x x x x x x x Large-Group II x x x x x x , x x x x x x x (6 companies) x x x x x x x x x x x x x x x x x x x x Medium-Group I x x x x x x x , x x x x x x x (4 companies) x x x x x x x x x x x x x Medium-Group II x x x x x x x ) x x x x x x (6 companies) X x x x x x x x x x x x x x x x x x indicates presence of the characteristic. One row for each company. 53 Table 3.7-~Aggregate Summary of variables indicated by the companies who have defined set of objectives of the accounting function. Group-I Group-II Total Total Factors Groups L & M I & II L M L M L M NO 7.. Scope of Operations Residential Homes 3 4 4 2 7 6 13 46 Residential and Recrea- tional 2 4 3 l 5 5 10 33 Recreational and Com- mercial 3 4 1 3 4 7 11 36 Industrial 1 2 O 2 1 4 5 16 Complete communities 1 1 5 6 5 11 36 Owning of subsidiaries Purchase & hold land 3 4 2 3 5 7 12 40 Land improvement 3 3 3 4 6 7 13 43 Real estate brokerage 2 1 l 3 3 4 7 23 Management of property 2 3 O 2 2 5 7 23 Mortgage financing 3 O 2 l 5 1 6 20 Marketing of lots 1 O 3 2 4 2 6 20 Others 1 0 3 2 4 2 6 20 Area of operations Local - city & county 4 4 5 4 9 8 17 56 State 4 4 5 5 9 9 18 60 National 3 () 2 2 5 2 7 23 International 2 0 1 2 3 2 5 16 defined in their detailed budgets prepared for submission to the board of directors. In another company the objectives appeared in the job description of the accountant who was in charge of the accounting function. The companies which answered 'yes' to the question were requested to give a brief description and indicate the order of importance assigned to each objective, if any. Seventeen companies described the objectives and three chose to rank the given set of the most common accounting objectives. 54 The descriptions and rankings as given by the companies are as follows: Group I: Large companies "Accounting and management information divisions are separate; accounting mainly concerned with collection of figures to pre- pare profit and loss account, and balance sheet. It also supplied data to the data bank in MID (Management information division). MID does all forecasting, analysis, etc. Ranking of objectives: (1) Preparation of financial statements; (2) Budgets and estimates for planning and control; (3) In- come tax return." "(1) cost reductions and control; (2) preparation of income statement and balance sheet; (3) cash flow analysis; (4) evaluation of project profitability, budgeting and estimating." "(1) Computation of cost of each lot to determine profit and loss; (2) preparation of financial statements; (3) preparation of income tax returns; (4) evaluation of subcontractor's per- formance; (5) cash flow analysis." "Accurate costing of lots sold and computation of profits from various departments; historical records for future planning and control." GTOEP II: Large companies "Cash flow analysis and operating budgets." "(1) Management control (Budgets, cost reports, etc.); (2) financial statements." "To provide management with necessary information for decision making." "(1) Cash flow analysis; (2) Budgets and estimates; (3) financial statements and related records preparation; (4) feasibility studies; (5) tax returns." Group 1: Medium "(1) Chart of accounts; (2) complete posting to ledger and trial balance; (3) quarterly cash flow statements and fore- cast." "(1) To properly reflect the cost of development or Operation to aid management in making future decisions; (2) to take advantage of allowable tax write-off." 55 "(1) Managerial Objectives: cash flow analysis, budgeting and profitability analysis; (2) Financial and historical: profit and loss statement and balance sheet from related historical records; (3) tax accounting and deferrals. Note: We use reSponSibility accounting along with profit centers." Group 11: Medium "(1) Cash flow budgeting -- cash flow planning; (2) tax planning to minimize income taxes; (3) accounting to maximize profit by facilitating analysis and planning; (4) to minimize overhead (dont' want tail wagging dog)." "(1) Maintenance of accounting records for historical pur- poses; (2) payment of all financial obligations and receipt bank deposit of funds; (3) preparation of financial state- ments; (4) cash flow analysis; (5) budget and forecast pre- paration including blanace sheet and income statement pre- paration; (6) evaluation of project profitability; (7) accountability for land inventories and all other assets; (8) preparation of income tax returns; (9) cost reduction and control." "Development of revenue estimates, product line profitability, cash flow analysis, cost control, project profitability, income statements, budgets." "To provide management information on: (1) cash flow; (2) current appraisal values on balance sheet; (3) profit and loss and related operations." "Accurate preparation Of results of Operations and balance sheet of its developments." The examination of the accounting objectives indicates that these are interestingly described and at times border on idealism. Some Show the functions performed in the accounting department rather than the accounting objectives. The attitudes and vieWpoints of the accounting executives are reflected in the descriptions. Also, the importance assigned to various objectives reflects the perception of the accountant as to how to fulfill his job to the satisfaction Of the management. The managerial objectives of accounting, viz. cash flow analysis, budgeting, estimating, profitability analysis, etc. 56 are given higher priority than non-managerial objectives. Except for one company, the firms ignore the use of the accounting informa- tion for employee appraisal. There is frequent use of the word management information, indicating the popularity of the word among accountants employed in the industry. One company had a management information division (MID) consisting of personnel from all of the related functions. The MID was responsible for forecasting, fea- sibility analysis and gathering of information for many operations of the company. The companies that answered that they did not have a set of defined accounting objectives were asked to indicate the order of importance among the set given in the questionnaire of the most common accounting Objectives. Except for two large companies in group I, all other eight companies are medium Size; three other large companies and three medium size companies also ranked the objectives. In other words, sixteen companies, or 53%, ranked from the given set of objectives. Table 3.8 summarizes the replies from sixteen companies in both groups. It can be seen that the objectives of evaluation of perfor- mance of employees is ranked as 7th by 12 companies (75%). The pre- paration of financial statements is ranked first by 7 companies (55%). Budgets and estimates is ranked first by 4 companies, second by five companies, and third by 3 companies. Surprisingly, the preparation of income tax return is ranked only second by two companies, fourth by 2 companies, fifth by four companies, sixth by 5 companies and seventh by 3 companies. The cash flow analysis scored favorably, probably due to the cash and credit crunch chronically experienced 57 NH H N H o o o w H H H o o o a o H o o o o mmoonan mo cosm5uowuom mo coHumsHm>m .N H N H N o N H H N H H a N o o o H H N o H NOHHHanHHoNd yummoua mo coHumaHm>m .o H a o a m H o H N H N a H o o N o N H o o Hosuaoo a :oHuuaemN “moo .m o H N H m m a o H N o m N m o o o H o N H wmuaaHuma a muuwesm .s o o N H s m a o o N H N a N o o o o N H N mHmsHmaa SOHC ammo .m H H N N o m N H o o N o N o o H N o o H H noose mocmHmn new ucgmumum OEOUCH MO COHumhmmmhm .N m m a N o N c N m m H o N o H N H H o o o cuoumu xmu oEooaH mo aoHumumaoum .H N o m a m N H N o m a m N H N o m a m N H AmoHemaaou oHv AmOHcmano HHV AmOHcomeOo mv HOOOH muHm EoHuoz ouHm swung wonsmm mo>HuomHno AHH w H maoouov mo>HOOOnnO mo uom co>Hw Ono macaw mo>Huooflno wnHunnoooo oau mo waHxsmmuam.m OHan 58 by many developers and eSpecially felt in the last couple of years. To ascertain the concensus of priorities, the seven Objectives were further grouped into 3 broad categories, viz. managerial, by group- ing cash flow analysis, budgets and estimates, cost reduction and control, project profitability, and evaluation of performance of employees under the managerial Objective; financial statement.preparation; and prepara- tion of income tax returns. It turned out that 9 companies (56%) ranked the managerial objectives first and almost all other companies ranked them second or third. One significant conclusion can be drawn from the analysis of the results. Budgets and estimates and cash flow analysis are considered very important objectives of the accounting function by developers. The next importance is generally assigned to the preparation of the financial Statements. This conclusion is also strongly confirmed from field interviews. The accounting executives as well as other executives agreed that the two objectives should be assigned priority in design of the accounting system. The relegation of the preparation of income tax returns into the background was probably due to increased use of deferrals and the practice of compiling the income tax return by the independent accountants on a fee basis. EVAIUATION OF ACCOUNTING PRACTICES Part III of the questionnaire consisted of questions regarding actual accounting practices and procedures empolyed by land development companies. Classification and Accumulation of Costs The first question asked: "How do you classify and accumulate cost for each subdivision or a development project?" 59 Based on library research and investigations into application of the methods of classification and accumulation of costs in other manufacturing industries with similar or related problems, four logical alternatives were structured. The alternatives can be considered the most common patterns which can be applied by deve10pers. To ascertain any other pattern of classification and accumulation of cost, the fifth alternative was open ended so that the company using a different pattern could specify the details. The replies are summarized in Table 3.9. No company used any other pattern of classification and accumulation of costs. Examination of the summary of reSponseS shows that the third and fourth method are followed by a majority of large companies. In total, about 67% of the companies used the two (third and fourth) methods. The first method is followed by only two companies, one in each of the groups. As a single method, the fourth method is followed by 37% of the companies. Since the method of classification and accumulation of costs extends into other accounting procedures to accomplish the accounting objectives, the examination of the method of classification and accumulation of costs vis-a-vis other factors showed the following noticeable tendencies: 60 Table 3.9 --C1assification and accumulation of costs Group-I Group-II Total Total Method of Classification Groups L & M I & II L M L M L M N0. % 1. All items for land and land development accumulated under ONE heading and then allocated to individual lots. 0 l 0 l 0 2 2 7 2. Land cost and land de- velopment cost sep- arately classified under two separate headings (viz. land cost & land development cost) but allocated in total to individual lots. 1 2 1 4 2 6 8 26 3. Classified and accu- lated under separate headings (viz. land, roads, sidewalks, etc.) but allocated in total to individual lots. 3 3 2 3 5 6 ll 37 4. Classified and accu- mulated under separate headings and each item or group of items separately allocated to individual lots. 2 2 3 2 5 4 9 30 Total 6 8 6 10 12 18 30 100 Both the companies which are using the first method of classifica- tion and accumulation of costs assign the first priority to the pre- paration of the financial statements and lower priority to the managerial Objectives. Both have concentrated localized operations and own less than two Subsidiaries for related operations. All companies using the 61 third and the fourth methods strongly emphasize the managerial ob- jectives. About one-third are involved in development of complete communities and have their operations in more than one state. The companies following the second method of classification and accumula- tion of costs varied in size, the area of operations, as well as in the identification of the accounting Objectives to derive any signif- icant conclusion. Items of expenditure included in Cost of Land For a developer, the cost of land is analogous to the cost of materials to a manufacturing company. However,the developer has an opportunity to include many other material items as a part of the cost of land. To ascertain the range of items included, an open- ended question --"what items of expenditure are included in 'Cost of Land' -- sought the data. The replies are summarized under the five headings in Table 3.10. Table 3.10--Items of expenditure included in 'Cost of Land' Group-I Group-II Total Total Items of expenditure Groups L & M I & II L M L M L M No. % Raw land 6 8 6 10 12 18 30 100 Interest expense 2 2 4 5 6 7 13 43 Real estate taxes 3 l 4 5 7 6 13 43 Commissions 3 1 4 2 7 3 10 30 Legal expense 2 O 1 O 3 0 3 10 Incidental expenses 1 1 1 0 2 1 3 10 62 The above Summary indicates that interest expense and real estate taxes paid prior to the development of a piece of land are in- ventoried as the cost of land by nearly half of the responding com- panies. Commissions are included as an item of expenditure by one- third of the companies. Legal expenses such as finders fees, cost related to option agreements, and incidental expenses such as pre- liminary surveys, insurance expense, other expenses connected with rezoning, etc. are included by relatively fewer companies. One noticeable difference between the companies in group I and group II is in reSpect to inventorying of interest expense and real estate taxes as part of the cost of land. Only 4 companies (23%) include interest expense in the cost of land in the group I vs. 9 companies (56%) in group II, and only 4 companies (29%) include real estate taxes in group I vs. 9 companies (56%) in group II. One large company in group II even uses guidelines for in- clusion of various items. The reply reads: "Purchase price and capitalized interest, real estate taxes and other direct costs of ownership before development or sales, so long as developed cost does not exceed 89% of net realizable value." One medium size company in group II includes "interest and taxes both actual and accrued during (the) period prior to develop- ment." Capitalization vs. expensing of carrying charges To determine the accounting for carrying charges and reasons behind their treatment, the following question was asked: "Under the Federal income tax law, there is an option to capitalize or expense the following items. Please indicate whether you capitalize or expense the following items. If you have done both for different projects, please indicate 63 the most common practice." The tiems were: "(i) Property taxes -- undeveloped land (ii) Second clearing -- undeveloped land (iii) Property taxes -- developed lots (iv) Sales and use taxes on materials (v) Other incidental expenses." Also, the Space was provided for brief reasons. Table 3.11 presents the summary of the answers. Table 3.11--Treatment of carrying charges Group I Group II Total Total Item 7 Groups L & M I & II L M L M L M No. % Property taxes--Undeveloped Land Capitalize 3 1 4 5 7 6 13 43 Expense 3 7 5 5 12 17 57 Second Clearing--Undeveloped Land Capitalize 3 1 3 4 6 5 11 37 Expense 3 7 3 6 13 19 63 Interest paid on Capital invested in a project Capitalize 2 4 5 6 7 13 43 Expense 4 6 5 ll 17 57 Sales and use taxes on materials Capitalize 2 1 l l 3 2 5 17 Expense 4 7 S 9 16 25 83 Other incidental expenses Capitalize l 1 1 1 2 2 4 l3 Expense 5 7 5 9 10 16 26 87 64 About 43% of the companies capitalize property taxes on un- deve10ped land. The percentage of the companies capitalizing this item is relatively larger than that of other items. Surprisingly, there is no relation between the identified accounting objectives such as finding an accurate cost of improved lot necessitating capitalization of this item and the treatment of property taxes in the accounts of the company. About 37% of the companies capitalized second clearing of un- developed land (viz. to prevent fire hazards or meet the local city or county regulations). The percentage of companies capitalizing this item is slightly more in group II than in group I. The treatment of interest paid on the capital invested in a project is nearly the same as for the prOperty taxes. Only a few companies that capitalized the above items pro- vided any reasons. Many companies left the Space provided for the reasons blank. Those companies that gave some reasons gave them in vague terms, such as company policy, easy to compute, or cost control. The companies expensing the above items mentioned 'tax advantage' as the most common reason. Some other reasons described are: "Doesn't add value to land" "Cost control, tax support" "Logical and simple" "To provide correct cash flow analysis" A further exploration of this question during the company visitation revealed an interesting practice. The companies which were privately owned or closed-corporations expensed the carrying 65 charges. A company which went public by merger in the recent past indicated that they had changed from expensing to capitalization after merger on directive from the parent company. Before the merger they expensed because of the tax advantage. Inclusion of Imputed Interest Except for one large company in group I and one medium size company in group II, all the companies answered that they did not in- clude imputed interest charge on funds invested in land for computing the cost of improved lot. Both companies attributed the practice of including the imputed interest to the company policy to reckon all items of cost and evaluate profits from different profit centers since both companies used profit centers for related activities such as property management, construction of new homes, land development, etc. The companies which do not include imputed interest mentioned that it was not allowed by auditors or the AICPA, or that it was not practical. Nine companies, seven of them large, indicated that although they did not include the imputed interest in normal accounting, or for income measurement and presentation in the financial statements, they did include imputed interest at market rate in their feasibility studies, the setting of selling prices of lots, at the time of selling undeveloped land, or in some cost control decisions. One medium size company in group II indicated that they used discounted cash flows for lot costing and selling prices in profitability evaluation at various points in time, and pointed out that imputed interest was taken into account during that exercise in published statements. 66 One company in group I which said that it included the imputed interest was visited. It turned out that in fact they included the imputed interest in their internal reports only, and did not include it in the published financial statements. The vice-president (finance) commented that they used imputed interest as a guideline to control the profit centers and divisions within the organization and would not violate the AICPA rules which they interpret as prohibiting the inclusion of imputed interest. Adjustments of Cost of Developed Lots Two related questions were asked as follows: 1. If a subdivision or a project is developed in parts over more than one accounting period, some items of cost in subsequent periods might be legitimately applicable to lots deve10ped in an earlier period. Do you estimate those costs and include them in the total cost to individual lots? Please describe reasons briefly. 2. If the answer to (1) is 'yes', do you allocate and adjust in subsequent periods the cost of: All sold and unsold lots Only unsold lots Any other (please Specify) Table 3.12 summarizes the answers to the above two questions. 67 Table 3.12--Adjustment of cost incurred in subsequent periods and allocation to improved lots Group-I Group-II Total Total Groups L & M I & II L M L M L M NO X 1. Answering -- Yes 4 ' 5 6 9 10 14 24 80 N0 2 3 0 l 2 4 6 20 2. Adjustments--Cost of Sales All sold and unsold lots 3 4 4 3 7 7 14 47 Only on unsold lots 1 l 2 6 3 7 10 33 Eighty percent of the companies answered that they estimated the cost for subsequent adjustment which might be legitimately applicable to the lots deve10ped in earlier periods, and opened reserve or contra accounts. Fourteen companies (out of 24) answered that they adjusted only the cost of unsolddlots. In other words, they implied that if the reserve proved inadequate in later years when the cost was to be in- curred, or when estimates were revised and needed an increase, the extra amount was spread over only the unsold lots at that point in time. Only one company in group I versus 5 companies in group II answered 'no' to the first question, showing noticeable difference in practice between the two groups. As far as other variables, Such as the size of the company, the owning of subsidiaries and the fulfillment of the accounting objectives are concerned there seems to be no relationship between the practice of providing contra accounts and subsequent adjustments. However, as 68 indicated during the company visitations, the practice depended very much upon the attitude of the accounting executive. If he was a strong believer in the matching process, he would take pains to open many contra or reserve accounts and would make periodic adjustments and revisions in the amounts of those accounts, the cost of sales and the cost of unsold lots. Also, the importance of the matching process and correct accrual accounting is apparent from the following sample of reasons described to Support the practice: reserve "To match revenue with expenses" "To arrive at true accrual" "The basic principle of accounting is to match costs with revenue" 'Necessary for proper accountabilitY" "To compute correct cost of lots sold" "To reflect actual cost; we defer or accrue in earlier periods and adjust in the next period. These accruals are based on engineering estimates." "We try to anticipate total development cost including a small contingency reserve for unforeseen costs and reserve the un- expended amount. We properly match cost and income or to say in other words, we establish sale price needed to make our desired margin or profit." "So as to insure that cost to sales value relationship main- tains to a degree of comparability" "The difference in original cost incurred is applied to balance of lots remaining in the inventory" "Strict accrual accounting; generally lots are sold before the develOpment begins" The reasons for companies not doing adjustments or opening accounts are: "Because it will make accounts messy. We don't do much accruing. Cost of sales and inventory values are based on estimates since most of the lots are sold before the subdivision is fully developed" 69 "Development reserves are examined routinely and amounts per- taining to lots sold are charged to expense regardless of accounting year and balance to remainder of lots in inventory for that particular subdivision." ' Recognition of Revenue Two questions, one for revenue from sale of lots on non-in- stallment sales and the other for those sold on the installment basis were directed toward existing practices for revenue recognition. 1. Non-installment sales: Since a developed lot is a high unit cost product, processed over a long period and many times sold prior to completion of all the required improvements, the question was asked: "When is the revenue from lots sold under non-installment agreement sales recognized? When the sale contract is signed? When deve10ped lot is delivered to the purchaser or his agent? When title to lot is transferred? Any other (please Specify)" The replies are summarized in Table 3.13. Table 3.13--Recognition of revenue from non-installment sales Group-I Group-II Total Total When recognized Groups L & M I & II L M L M L M NO. X When sale contract is signed 2 2 3 6 5 8 13 43 When developed lot is delivered 0 1 IO 0 0 l 1 3 When title to lot is transferred 3 2 2 4 5 6 ll 37 Other-~when full payment received 1 3 l O 2 3 5 17 Total 6 8 6 10 12 18 30 100 70 About 43% of the companies recognize the revenue from non- installment sales at the time when the sale contract is signed. Approximately 37% of the companies wait until the title to the lot is transferred to either the buyer of the lot or to the builder. The full payment criterion is used by 17% companies and only 3% of the companies wait until the delivery of the lot. Nine companies also mentioned, either by way of a note or checking 'any other' column, that they used additional criterion of 'deposit.received' along with the signing of the sale contract or the transfer of title criterion. One medium size company indicated that all three events, viz. signing of the sale contract, the transfer of the title and the receipt of the payment took place Simultaneously. In the tabulation, the company is aggregated under the sale contract criterion since it is the first event among the three Simultaneous events. Further investigations showed that the popularity of the two criteria viz. when the sale contract is signed and when the title to the lot is transferred, was attributable to the industry practice of transferring the developed lots to a builder on a non-installment land contract (with some deposit in most of the cases) who subsequently build the structures and sell or lease to the utlimate users for cash and retire his own debt with the developer. The building construction subsidiaries of developers who Operate independently but are part of the same organization also adopt the above practice. However, some companies have the construction division under one organizational set- up and develop the lot and build the structures on them. They treat the deve10ped lot, although separately priced and shown in the contract 71 of sale, and the structure as one package and recognize the revenue when payment is received for the whole package, mostly from the mortgage financing institutions. 2. Installment sales: A three part question was asked to determine: (i) timing of revenue recognition from lots sold on the in- stallment basis; (ii) whether a provision for cancellation of contracts and collection charges is made by the companies; and what bases are used for computation of each provision; and (iii) any guidelines used for recognition and timing of revenue. (i) Timing of revenue: Table 3.14 represents the tabulation of the reSponses from the companies to the following question: "When is the revenue from lots sold on the installment basis recognized? a. When sale contract is signed? b. When down payment is received? c. When title to the lot is transferred to the purchaser? d. When the deve10ped lot is delivered to the purchaser or his agent? e. On the installment basis?" 72 Table 3.14--Recognition of revenue from lots sold on the installment basis Group-I Group-II Total Tota When recognized 1 Groups L & M I & II L M L M L M No % a. When sale contract is signed 0 O O O O O O O b. When down payment is received 0 0 O O O O O O a. & b. When sale contract is signed and down payment is received 3 2 4 5 7 7 14 47 c. When title to lot is trans- ferred O O 2 1 2 1 3 10 d. When deve10ped lot is delivered 0 O 0 O O O O 0 e. On installment basis 0 4 O l O 5 5 16 No installment sales 3 2 O 3 3 5 8 27 Total 6 8 6 10 12 18 30 100 Seventythree. percent of the companies reported that they sold lots on installment basis and 27% of the companies did not sell lots on installment basis. About 47% of the companies recognize sales revenue when the sale contract is signed and the down payment is received. Only 16% of the companies, all medium size, recognize the revenue on the installment basis, i.e., spread collection over the life of the sale contract. No company waited until the delivery of the lot to the purchaser or his agent. One of the two large companies which recongize the revenue when the lot is transferred also checked 'when down payment is received'. 73 Further investigations revealed that almost all the companies which reported recognizing revenue using (a), (b), (c), or (d) as bases used the installment basis for tax reporting and deferred incomes taxes payable on revenue recognized at the time of sale in their books. Also, it is of interest to note that the five companies reporting on the installment basis are closely held corporations. Further analysis using the defined accounting objectives or identified priorities from the set of the accounting objectives, or other critical variables such as the size, the area of operations, etc. did not show any correlation between method of recognizing revenue and the above variables. However, the increased use of recognition of revenue when the contract is signed and the down payment is received confirmed that the 'absolute-earnings-measure' is weighted heavily in the land develOpment industry and point of sale is viewed as point of realization. During an interview with a general manager of a large company, he remarked that as long as the installment notes could be used as collateral for borrowing funds from the banks or other financial institutions, he would Support the recognition of revenue using (a) or (b) as the bases. Probably, this may be one of the reasons for extensive use of (a) and (b), since many bankers advance large amounts to developers taking the installment receivables or notes as collateral. (ii) Provision for cancellation of contracts and collection charges: Ten companies (out of 17) or about 60% of the companies which recognize revenue from installment sales of lots using (a), (b), (c), or (d) as bases provide for cancellation of contracts; while only one medium size company makes a provision for collection charges. Further investigations showed that the collection charges, although amounting 74 to a large sum in some cases, are treated as a part of administrative expenses as an expedient and practical method. The majority of the companies use past experience in some form as the basis for computing the provision for cancellation of contracts. Some use a percentage (varying from 2% to 25%) of net installment sales. One company uses 10% of contract receivables -- but limited to profit on lots sold on the installment plan, thereby implying that it can sell repossessed lots at least at the original cost to the company in case of repossession arising from default. One large company uses only the gross profit to be lost upon cancellation as the basis for computation of the {novision for cancellation of contracts. Another large company uses the overdue contracts for 60 days or more and past experience as the basis. (iii) Use of lguidelines': Eleven companies (out of 17) use guide- lines for revenue recognition for installment sales. Three companies who replied in the negative also mentioned that they used Internal Revenue Service guidelines for tax reporting. In most cases, the guidelines related to the percentage of down payment or number of installments which must be received before the recognition of revenue. One medium Size company transfers all the lots to an escrow agent who will transfer title to the purchaser after receiving a contracted number of installments, which may not be the entire amount payable. Some companies retain title to the lot, and the deed is not handed to the purchaser until all payments are received. One large company reported that they did not recognize revenue until the purchaser had paid two monthly installments or 2%% of the sale price, whichever occurs first; but the purchaser was not allowed to build until he had paid all 75 installments and acquired the deed from the company. Partial reimbursements of expenditure on roads, sewers, utility ease- {Dent-‘51 etc. Table 3.15 tabulates the replies to the question asking for the accounting treatment of partial reimbursements for roads, sewers, etc. received from local authorities. Table 3.15--Accounting for partial reimbursements Group-I Group-II Total Total Procedure used Groups L & M I & II L M L M L M NO % Reduction in cost of develop- ment of the subdivision 1 5 2 6 3 ll 14 47 Reduction in cost of item for which the refund is made 5 2 4 3 9 5 14 47 Extraordinary revenue for the period 0 l O l 0 2 2 6 Total 6 8 6 10 12 18 30 100 About 47% of the companies treat partial reimbursements as re- duction in the cost of item for which the refund is made. An equal number of companies reduce the cost of development of the subdivision, while only 6% of the companies (all medium size) treat such reimburse- ments as extraordinary revenue for the period. Also, it can be noticed that more large companies treat partial reimbursements as reduction in the cost of the item, and more medium Size companies use the first pro- cedure. Surprisingly, the treatment of the partial reimbursements is 76 not dependent upon the method of classification and accumulation of costs, or method of allocation of total cost to individual lots. Again, expediency, and to a certain extent consciousness of the matching pro- cess prevails in the use of a procedure. Valuation of repossessed land and treatment of gains and losses Two related questions solicited information concerning the practice of valuing repossessed land from defaulted contracts and the treatment of gain or loss arising from repossessions, foreclosures and forfeiture of deposits. Fifteen companies (50%) answered the question on valuation of repossessed land. Their replies are summarized under six headings in Table 3.16. Since the practice of valuation did not depend upon the Size, or the area where the companies were located, the tabulation presents the results in aggregate for clearer analysis. Table 3.16--Valuation of repossessed land from defaulted contracts No. of Valuation Method Companies % 1. Fair market value 1 7 2. Balance due on the contract 4 27 3. Market price or (2) whichever is lower at the date or repossession 2 l3 4. Original cost or (2) whichever is lower at the date of repossession 5 33 5. At original cost 1 7 6. At original cost or market value which- ever is lower at the date of repossession 2 l3 Total 15 100 77 The above results indicate varied methods used by developers in valuing the repossessed land. The second and the fourth methods are used by nearly 60% of the companies who answered the question. The related question on treatment of gain or loss on respos- session of land proved redundant in certain circumstances when the companies were using the second, the third or the fourth method. If a lot is valued as per balance payable on the contract on the date of repossession, there will be no gain or loss at that point in time. However, if market price or the original price is lower than the balance payable on the contract and repossessed lot is valued at cost or market, a loss will arise. Further investigation and enquiries during the company visitations showed that some companies charged the loss against a mortgage reserve account opened for this type of con- tingency; others treated it as an ordinary loss for the period. The four companies which use the first method, the fifth method and the sixth method treated gain or loss as ordinary gain or loss, respectively, for the period. IDT COSTING AND VALUATION METHODS Part IV of the questionnaire consisted of questions regarding lot costing and inventory valuation methods used by developers. Methods of allocation of joint costs The first question asked the methods used to allocate joint cost of land and land development to individual lots. The follwoing five methods which are suggested in the accounting literature were provided for checking. Space was also provided for any other method a company might have used for allocation: 78 l. Tentative selling price of each lot. 2. Frontage feet of each lot 3. Number of lots in a subdivision 4. Area of each lot in a subdivision 5. Assessed value of each lot . Since preliminary investigations had indicated that developers generally use one method for allocating all items of cost, they were required to indicate 'all items' under the method if they used one method for allocating all items of cost. Otherwise, they were to indicate under each method the items of cost allocated using that method as the basis of allocation. This question was intended to be a means of determining the number of companies using each method as well as computing the methods of costing an improved lot, since almost all land and land improvement costs are joint in nature. The question is of great interest since the measurement of income and valuation of inventory are directly affected by the allocation method. Table 3.18 tabulates the replies from all the reSponding com- panies and shows separately the methods used by the companies that allocate all items using one method, and those who use two or more methods for different items or different types of subdivisions. Seventyseven percent of the companies use one method to allocate all items of cost. Two companies in group II--one large and one medium size--reported that they use two different methods for different types of subdivisions. The large company uses the tentative selling price method to allocate all items of cost for industrial subdivisions and the number of lots for residential subdivisions which generally had 79 0 mm OH mm mm unmoumm o a m mH oH ssHemz a swung "Hmuoe o a 0 NH 0 asHeoz o H m a a amuse ANV a AHV Hence 0 m m m m 55:52 o H o N H swan A3133. 0 H o H H asHemz o H o N H swung " HH nacho o N m N N 5382 o o o o o owned " H 95.5 Ammflamasou D 953 .34 $3333 uoz Amy o m o w m 8:362 o o o o m was: 3 H33 0 m o e N .83me o o o H N emu—«H "HH 96.5 o o o q H 6:352 o o o m H owns " H macaw Ammwcmnaoo mmv mew: HH< $3832 3 ”.3“ some mufim .w mo woflm> uoH uOH comm mo wuoH uoH come no ooHua asouu pommomvé some mo no.5 ummm owgcoum mo unpasz waHHHom mfiumucos monumz muOH HNDUH>HUCH 0U USGEQOHOKVmU VCGH USN UCMH HO umOU UCHOH wEHUNUOHHU HO WUOSUQZIINHom QHDQH. 80 standard size lots. Both methods are used on different parts of the project if it involves development of complete community or residential and commercial lots under one project. The medium size company uses the number of lots method to allocate all items except taxes, interest, clean-up cost and advertising for a residential subdivision and the area of each lot method for apartment and commercial sites. Two com- panies, one large company in group I and one medium size company in group II, use two methods for different items of cost. The large com- pany allocates the cost of land on the basis of the area of each lot and uses the number of lots method for all other items. The medium size company uses the frontage feet method for cost of side walks, street, and sewer system, and the area of each lot method for all other items. Two medium size companies (6%) stated that they used all methods except the assessed value method for different items under different circumstances and for different types of subdivisions. These companies did not have a fixed pattern or method of allocation for various items except that they always tried to match the cost to the revenue as best they could. One company, as an example, indicated that they used the tentative selling prices method for river front residential recrea- tional subdivisions or for commercial lots; the number of lots method for raw land, surveying and grading cost; the frontage feet method for cost of curbs, gutters, streets, water, sewer and side walks; and the area of each lot method for commercial subdivisions con- sisting of lots varying in Size and shape. The analysis of the tabulated results shows that the majority, or 63% of the companies use the number of lots method and about 33% of the companies use the tentative selling price method. No company 81 reported use of the assessed value method; while only 10% of the companies use the frontage feet method and 23% use the area of each lot method. Since some companies use more than one method, the total percent is more than 100%. A further analysis was made to determine whether the pattern of classification and accumulation of cost or development of land for complete communities had any bearing on the method of allocation used. The results which are tabulated in Table 3.19 indicate no re- lation between the pattern of classification and accumulation of costs, and the development of projects invovling complete communities. Com- panies using all the four patterns of classification and accumulation of costs use every method of allocation. The same results are shown for the companies that deve10ped large complete communities involving lots of different shapes, sizes, selling prices, and use. Cost arising due to Special conditions. Developed raw land varies greatly in physical condition, and large Sums may be spent on development of a lot or a group of lots due to such conditions or variations. To ascertain whether developers charge these costs directly to a lot or a group of lots or treat them as an overall cost of development of the subdivision, the question was asked: "if there are any items of cost which arise due to Special conditions for one or more lots, do you charge these items to identified lot(s) to compute the cost of these lots". Along with 'yes' and 'no' alternatives, the companies were requested to describe briefly the reasons 0 82 o m H N o mmHuHanaaou mumHaaoo nuHs muowmoua mo usmaaoHo>mv aH vo>Ho>bH .HH 0 N o m N muoH HmSpH>chH ou pmumooHHm mBouH mo macaw no aouH some can mwchmo: mumuwmmm pops: meMHaasuom paw pmHMHmmmHu o m H N e muoH cu Hmuou :H pmuwooHHm use mwaprms mumummom pops: pmumHsssouw paw pmHMHmmmHo o H N o q muOH HmspH>Hch cu Hmuou :H woumooHHm use mwchmos ouwuwamm osu nope: ooHMHmmeu umou unmaaoHo>op pcwH paw menu 0 H o H o muoH HmSpH>chH ou pouoooHHm cmnu wow wavam: mso Home: pmeHmmmHo umoo ucoaaon>mp vawH paw pGQH cumuumm aoHumonHmmmHo .H uOH some uoH some uoH come no moHua mo osHm> uOH some mo ovum muOH wcHHHmm muouowm pmmmmmm< mo swam owmucoum mo nonasz m>HumuamH moonuoz mmHuHaaaaou muoHaaoo wcH>Ho>aH muowfioua mo uamBaon>oo can .mnumuuwa mumoo mo coHumHsasoom can :oHumoHWHmwwHo new mom: aoHuwooHHm mo ponuma ecu mo mHmuHmsaeaa on scapegoaaaw 216 mumou unusaoao>on .omwz whosom .mpmom muwmnco mama coma and mo II... no oownm mwauHHHuD umoo mongounm muamuao mucm8o>ouaeH newsman ouamummo wswzuuau noonoum manage < -u umoonuoanuflco mo coHuocaauouoa pom mmoooum mewpaamumm HH BHmHmNm 217 whoa amaea>aeaa on coaumooaaa mumoo a e m a N a H a _ ..>on coHuoom a0auoom coauomm :oHuoom one: _ a _ a m onwamm .mpmom cowma>wpn=m ouamuoo ' Hmauaoefimom L Swag mos a . 0H Hm W [3qu m. .3315 aoama>aenam m 3. n Hmauaoeamom m. mucus kHHamm u uo>ouaaH uwuanz 3 mumoo uses - o nooam>op HmaoHuoom muwm so ,M mo coaumowmwmmmao anoHum> d rlllllj EJSRGea _ a Hmwouoaaoo m. S m * m... was among mucoam>ouaaH I. mo meweuzunonaaoo onusoo maoo m. umoo N e W a Hooumm moauuoooum w mill 3 muaoao>ouaEH .oomm< huwcnaaoo newsman H * ouwmuwmo wcfihuumo Hoonmm uoohoum xmaaeoo a u- umoonuoauuaca mo soHumcaauouoa pom mmooopm wswpfismnhm HHH HHmmem 218 land cost whereby they lose their identity. Instead, the land and land cost should be identified separately and allocated on the basis of area of each parcel used in different subdivisions or sections. For example, an industrial subdivision may contain one or a number of industrial lots and a particular large lot may include parts of land acquired at different prices. Where the costs are identified for each of the parcels separately, the cost of land for that particular lot can be determined by assembling cost based on the area of each parcel used in that lot. Similarly, pyramiding procedures involving various stages will be used to compute cost of development. The recommended classification pattern will considerably facilitate allocation by stages, because cost which relates to improvements that benefit all lots within a project (off-site and community-wide improvements costs) and those costs which relate to sectional improvements are separately collected. The weighted-average-method of allocation of costs based on benefit received criterion will provide an equitable allocation. In situations where facts and circumstances surrounding a project are either more complex or more simple than the two illustra- tions, suitable modifications can be introduced using Similar logic in the pyramiding process for arriving at the unit-lot-cost. Suggestions for Further Research (i) The accounting system of a developer must also provide meaningful information for evaluating and controlling land deve10p- ment operations. There is a need to examine the role of accounting in planning and control due to peculiar features of the land development 219 industry. In other words, managerial accounting aspects related to management and control practices in the industry need to be explored in depth. (ii) There is a need to explore the use of probabilistic measures in estimates for cost of sales when lots have been sold before all contracted improvements are completed, but revenue is recognized prior to completion. At present engineering estimates based on single-point estimates are used to report cost of uncompleted improvements. (iii) Further research is needed in the direction of feasi- bility of designing a management information system in lieu of the traditional accounting system. In the past, land develOpment com- panies were small and did not require the information to meet the dynamics of the land development industry in planning and control of their organization. In the past few years, many large corporations have ventured into the industry and there has been continual growth and expansion of these firms through domestic and foreign expansion, mergers and acquisitions. These changed environments have seriously strained the existing information provided by the accounting system. Large corporations are eager to introduce advances in technology, particularly in the field of electronic computers and use of analytic techniques for planning and control and are generating stimulating changes of a significant nature to create management information divisions in their organizational set up and to make data banks accessible by way of teletypes hooked into various departments. BIB LIOGRAPHY BIBLIOGRAPHY Books American Accounting Association. A Statement of Accountinngheogy, Evanston: American Accounting Association, 1966. Atlas, Martin. Tax Aspects of Real Estate Transactions, 4th Edition, Revised and Annotated, Washington, D.C.: BNA, Inc., 1966. Dickey, Robert I. (ed). Accountants' Cost Handbook, second edition, New York: Ronald Press, 1960. Engel, Invine, M. Real Estate and Income Taxes, New York: Practicing Law Institute, 1965. Gaa, Charles J. Taxation of Corporate Income, Urbana: University of Illinois Press, 1944. . Federal Income Taxation Fundamental Questions, Problems and Cases, Volumes I and II, New York: McGraw-Hill Book Company, Inc., 1965. Hendriksen, Eldon S. Accounting Theory, second edition, Homewood, Illinois: Richard D. Irwin, Inc., 1970. Horngren, Charles T. Cost Accounting: A Managerial Emphasis, second edition, Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1967. Lasser, J.K.(ed). Handbook of Accounting Methods, New York: D. Van Nostrand Company, 1943. McMichael, S.L. Real Estate Subdivisions, Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1949. Mucklow, Walter. Real Estate Accounts, New York: Ronald Press, 1917. . Land Accounts, New York: American Institute Publishing Company, 1935. National Association of Accountants. Costing Joint Products, New York: National Association of Cost Accountants, 1957. Ratcliff, Richard U. Real Estate Analysis, 3rd edition, New York: MCGraw-Hill Book Company, Inc., 1961. 220 221 Ring, Alfred A. and North, Nelson. Real Estate Principles and Practices, Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1967. Salmonson, Ronald F. Basic Financial Accounting Theory, Belmont, California: Wadsworth Publishing Company, Inc., 1969. Schreiber, Irving (ed). How to Plan for Tax Savings in Real Estate Transactions, New York: The Macmillan Company (and Panel Publishers, Inc.), 1969. Taggart, Herbert F. Subdivision Accounts, Ann Arbor, Michigan: University of Michigan, Bureau of Business Research, 1930. Weimer, Arthur and Hoyt, Homer. Real Estate, fifth edition, New York: Ronald Press, 1965. Articles and Periodicals Affinito, Lilian. "Problems in Accounting for Land Sales of DeVEIopers," Price Waterhouse Review, Autumn 1963, p. 19-23. Altman, George T. "Does Malat Signal Trouble Ahead for Real Estate Dealers Seeking Capital Gain?", The Journal of Taxation, February 1967, p. 118-119. American Accounting Association, Concept and Research Study Committee (1964). "The Matching Concept," Accounting Review, April 1965, p. 368-372. Bennett, J.W. "Problems in Land Development Accounting," Canadian Chartered Accountant, April 1969, p. 220-224. Berge, Robert. "Special Tax Problems of Participants in Real Estate Developments," Taxes--The Tax Magazine, February 1967, p. 161-1660 Boughner, Jackson L. "Getting Capital Gain Treatment on Sale of Land With or Without Section 1237," The Journal of Taxation, September 1966, p. 172-175. Boyd, Orton W. "Accounting Problems of the Florida Real Estate Boom," Accounting Review, September 1926, p. 64-73. Brighton, Gerald D., "Choosing the Correct Treatment of Subdivider Utility Deposits Refunds," The Journal of Taxation, September 1969, p. 174-177. Briloff, Abraham J. "Castles of Sand? An Expert Questions the Accounting Practices of Land Development Companies," Barron's, February 2, 1970, p. 3. 222 Cole, LeRoy H. "Accounting for Real Estate Deve10pments," The Journal of Accountancy, October 1960, p. 59-63. Collins, William E. "Forms of Organization for Subdividers," American Bar Association Section of Taxation Bulletin, January 1965, (part 2), p. 21-27. Ellis, Raymond E. "Cost Accounting for Residential Housing Develop- ments," Texas Certified Public Accountant, May 1959, p. 25-31. Garratt, Percy. "Notes on the Accounts of Land Development Companies," The Accountant, May 19, 1906, p. 637-643. Griffith, Robert D. "Capital Gains from Real Estate and Certain Intangible Business Assets," Taxes--The Tax Magazine, May 1967, p. 346-352. Hanson, Randell B. "When Will the Dealer in Real Estate Receive Capital Gains?", The Journal of Taxation, January 1970, p. 40-44. Jones, Gardner M. "Some Prdblems in Accounting for Land Develop- ment," Management Accounting,(N.A.Ap), August 1968, p. 27-33. Jones, Robert P. "Tax ASpects of Real Estate Investments," Arthur Young Journal, Winter 1967, p. 10-21. "Tax Problems of Real Estate Developer--From Acquisition through Disposition," The Journal of Taxation, January 1966, p. 32-390 Lotharius, Richard G. and Brown, Michael. "Accounting for Land Deve10pment Costs--A Reappraisal," Florida Certified Public Accountant, May 1965, p. 5-11. Mucklow, Walter. "The Accountant and the Real Estate Developer," The Journal of Accountancy, November 1926, p. 327-348. Mulvey, Bernard M. "Avoiding the Disposition Trap when Installment Receivables are Pledged," The Journal of Taxation, September 1969, p. 148-151. Paley, Robert J. "Multiple Corporations Face Ever Increasing Attack: Realty Developments Vulnerable," The Journal of Taxation, March 1968, p. 130-137. "Presentation of Practitioners View Points on Accounting for Land Development Companies," The Australian Chartered Accountant, June 1964, p. 769-679. Spencer, David A. "Accounting for Land Development Companies," Canadian Chartered Accountant, June 1960, p. 565-569. 223 Spring, John A. and Reehl, C.B. "Forecasting Financial Results," Price Waterhouse Review, Spring 1965, p. 18-23. Wintermute, Lewis. "Some Problems of Allotment Accounting," The Journal of Accountangy, September 1928, p. 161-178. Worthy, Martin. "Multiple Corporations," Proceedings of the Fourteenth Annual Tulane Tax Institute, 1965, p. 136-170. APPENDI CES APPENDIX -A Questionnaire Guidelines Part-I This consists of questions regarding size and complexity of operations, and company philosophy pertaining to the segregation of accounting, engineering and other functions within an organization or within multiple corporation structure within an organization. The size and complexity Of operations are important to examine (a) identified expected objectives of the accounting function, and (b) normative objectives as perceived by the management (as detailed in Part-II). Also, the accounting problems and resultant procedures to solve those problems may be considerably dependent upon the size, complexity of Operations and organizational structure of a land de- velOpment company. Answers to questions in other parts will be examined in relation to responses to questions in this part. Part-II This part consists of two broad questions Structured to identify and rank the expected objectives of the accounting function of de- velopers. The first question is open-ended and seeks the description of the identified objectives of the accounting function in a company. The second question is a close-ended question giving a set of objectives of the accounting function as normally considered in accounting liter- ature.‘ One of the responses is "any other objectives" to handle 224 reSponse 225 8 other than those contained in the set of answers. Part-III practice reSponse (1) (2) (3) (4) (5) (6) (7) (8) (9) Part-IV ventory This part consists of questions regarding actual accounting 8 employed by a company. In particular, questions seek s to ascertain: How costs and revenue items are classified and accumulated. What is included in cost of land and land development cost. How and why carrying charges are treated in accounts of the company. Whether they include imputed interest in computing carrying charges and holding cost for unsold lots. How and why revenue is recognized for accounting and tax purposes; and whether different criteria are used for each purpose. What treatment is accorded to revenue from sale of land to churches, schools, etc. What procedures are employed for accounting for lots sold on the installment sales basis. How repossessed land is valued and gains and losses accounted for. How and why income and expenses on temporarily managed pro- perty are accounted for. This consists of questions regarding different costing and in- valuation methods. The reasons behind these will be probed to ascertain whether the methods actually represent 'sound' accounting 226 treatment or are considered from one or more points of View. (Such as to keep records for tax purposes, or simplicity, etc.) APPENDIX B MICHIGAN STATE UNIVERSITY East Lansing, Michigan 48823 Graduate School of Business Administration Department of Accounting & Financial Administration - Eppley Center I am a doctoral candidate at the Graduate School of Business Administration, Michigan State University. I am conducting a factual examination of accounting practices and prOblems in the land develop- ment industry, as a basis for my thesis on "Accounting for Land De- velopment." I am very hopeful that this Study will make a Significant contribution in spotlighting the accounting practices and problems, since I have found no comprehensive study of land development account- ing. I shall greatly appreciate your assistance in answering the en- closed questionnaire. Replies from a large number of companies will help to insure the reliability of data concerning the accounting practices of the industry and its unique features. All individual replies will remain strictly confidential. All necessary precautions will be taken to ensure anonymity in Summarizing the results. Your assistance is essential in success of the study and the completion of my thesis. I shall be very grateful for your help by completing and returning the questionnaire by the middle of April. Sincerely yours, Ar j an Sadhwan i lAND DEVELOPMENT ACCOUNTING PRACTICES SURVEY GRADUATE SCHOOL OF BUSINESS ADMINISTRATION MICHIGAN STATE UNIVERSITY Instructions: On the following pages are a series of questions. Most are followed by a series of alternative answers, So it is merely necessary to place check marks Opposite the answers which apply in your particular case. When none of the listed answers apply, and for a few other questions for which it was not practical to list a series of possible answers, you are requested to fill in the requested information. All answers will remain strictly confidential. Please answer all questions. Some questions may not be applicable to your type of system, or there may be doubt about the meaning of certain terms in a question. In either case please provide the answer you believe best answers the question, 95 put a question mark through the question. In this way it will be known that the question was not merely overlooked. All rgplies will be valued. It is recognized that some companies have quite sophisticated accounting systems, while other firms rely on the more traditional methods of accounting for costs and revenues. Regardless of what type of system you're using, your answers will be respected and valued. Have a pencil in hand. May I Suggest that you (or the executive to whom you delegate this task) have a pencil in hand, since most of the questions can be read 229 answered in little more time than would be necessary for reading alone. Your cooperation is gratefully appreciated. Please mail completed questionnaire to: Arjan Sadhwani, Doctoral Student Graduate School of Business Administration, Department of Accounting and Financial Administration, Michigan State University East Lansing, Michigan 48823 LAND DEVELOPMENT ACCOUNTING PRACTICES SURVEY GRADUATE SCHOOL OF BUSINESS ADMINISTRATION, MICHIGAN STATE UNIVERSITY STRICTLY CONFIDENTIAL Part-I l. 4(1) Please indicate whether your company has been involved in development of sub- divisions for: ( ) Residential homes ( ) Commercial use ( ) Residential 8 recreational Industrial use Residential & commercial Complete community with schools, parks, shopping centers, etc. AAA ( ) Any other (please Specify)_ Does your company own any subsidiary companies or multiple corporations, independent in their operations, for the following: ( ) PUrchase and hold undeveloped land ( ) Management of property on fee basis until it is ready for development ( ) Mortgage financing ( ) ( ) Land improvement & Subdivision Marketing of developed lots ( ) Real estate brokerage ( ) Any other (please Specify) Please indicate whether your company has developed or intends to develOp in the near future, any Subdivisions: ( ) In city where you are located ( ) In other states ( ) In county " " " " ( ) In other countries ( ) In the State " " "- How do you classify your company in the industry: Small___ Medium Large ___ (ii) In your industry, what factors should be considered to classify a company into 2. Small, Medium and Large? ( ) Amount invested in current development ( ) Sales in dollars in a year projects ( ) NO. of lots developed in a year ( ) No. of Subdivisions developed in a year ( ) No. of Acres developed in a year ( ) No. of employees Part-II 1. Have the objectives of the accounting function been defined in your company: ( ) Yes ( ) No If the answer to (1) is 'Yes', please describe briefly and give order of importance assigned to each objective, if any l. -2- If the answer to question number (1) is 'No', can you identify and indicate the or- der of importance among the following set of objectives (i.e. indicate l,2,3,....) of accounting function in your company: Preparation of Income Tax returns Preparation of Income Statement and Balance Sheet Cash flow analysis Preparation of budgets and estimates for planning and control Cost reduction and control Evaluation of project profitability . Evaluation of performance of employees Any other (please specify) Part-III: QUESTIONS T0 EVALUATE ACCOUNTING PRACTICES EMPLOYED BY THE COMPANY. How do you classify and accumulate cost for each Subdivision or a development project? ( ) All cost items for land and land development accumulated under gag heading and then allocated to individual lots ( ) Land cost and land development cost separately classified under two separate headings (viz. land cost and land development cost) BEL allocated in total to individual lots ( ) Classified and accumulated under separate headings (viz. land, roads, sidewalks, etc.) but allocated in total to individual lots ( ) Classified and accumulated under separate headings and each item or group of items separately allocated to individual lots ( ) Any other pattern (please Specify) What items of expenditure are included in 'Cost of Land'? Under Federal Income Tax law, there is an option to capitalize or expense the follow- ing items. Please indicate whether you capitalize or expense these items. If you have done both for different projects, please indicate the most common practice: Capitalize Expense Items Brief Reasons ( ) ( ) Property taxes-undeveloped land ( ) ( ) Second clearing~undeveloped land ( ) ( ) Interest paid on capital invested in undeveloped land ( ) ( ) Property taxes-developed lots ( ) ( ) Sales and use taxes on materials ( ) ( ) Other incidental expenses viz. -3- A. Do you include 'imputed interest charge' on funds invested in land for computing cost of improved lot? () Yes () No Please describe reasons briefly 5(1) If a subdivision or a project is developed in parts over more than one accounting period, some items of cost in subsequent periods might be legitimately applicable to lots deve10ped in earlier period. Do you estimate these costs and include in the total cost allocated to individual lots? () Yes () No Reasons (Please describe briefly) (ii) If your answer to 5(i) is 'Yes', do you allocate and adjust in subsequent periods the cost of: ( ) All sold and unsold lots ( ) Only unsold lots ( ) Any other (please specify) 6. When is the revenue from sale of lots on NON-INSTALLMENT SALES recognized? ( ) When the sale contract is signed ( ) When title to lot is transferred ( ) When developed lot is delivered to ( ) Any other (please Specify) purchaser or his agent 7(i) When is the revenue from lots sold on installment basis recognized? a.( ) When sale contract is signed b.( ) When down payment is received e.( ) When title to the lot is transferred to purchaser d.( ) When developed lot is delivered to purchaser or his agent e.( ) 0n installment basis (ii) If your answer to 7(i) is (a), (b), (c), or (d), please indicate whether provision for the following expected expenditure is made: ( ) For cancellation of contracts. Basis used ( ) For collection charges. Basis used (iii) Do you use any "Guidelines" for recognition of revenue from sales on installment basis? 8. -4- How are partial reimbursements of expenditure on roads, sewer system, connections, utility easement, etc. treated in your accounts? ( ) Reduction of cost of development of the subdivision Reductions of the cost of items for which the refund is made Extraordinary revenue for the period Any other (please specify) AAA VVV 9. How is repossessed land from defaulted contracts valued? 10. How are gains and losses arising because of repossessions, foreclosures and for- feiture of deposits treated? ( ) Capital gains for the period ( ) Ordinary income for the period Part-IV 1. In allocating joint cost of land and land development to individual lots, the follow- (i) Tentative Selling Price ) of each lot ) ) ) ) (ii) Number of lots in a ) subdivision ) ) ) ) (iii) Frontage feet of each ) lot in a subdivision ) ) ) ) (iv) Area of each lot in a ) subdivision ) ) ) ) ing allocation methods are Commonly used. Please indicate under each method the items of cost allocated, using that method as the basis of allocation. In case you use only one method for allocating all items of cost, please indicate 'all items' under the method. (v) Assessed value of each lot in a subdivision (vi) Any other (please Specify) ) ) ) ) ) If there are any items of cost which arise due to special conditions for one or more lots, do you charge these items to identified lot(s) to compute the cost of those lots? ()Yes ()No Reasons: Please indicate how you allocate the following items of cost: Advertising Other Administrative Promotion Selling Expenses Expenses Expenses ( ) ( ) ( ) ... To each subdivision only ( ) ( ) ( ) To each subdivision and then allocated to each lot ( ) i ) ( ) ... Charged as expenses for the period. ( ) ( ) ( ) ... Any other Do you ascertain, using regular allocation methods, the cost of lots sold at nominal price or dedicated to schools, churches or to other civic agencies: () Yes () No How are the proceeds, if any, realized from dedication or sale of land to civic authorities, public utilities, etc. treated in your accounts? ( ) Revenue for the period when received Reduction of the cost of developing a subdivision Only the excess of revenue over allocated cost treated as revenue for the period Any other (please Specify) VVV How do you treat the revenue realized on sale of gravel, sand, timber, etc. dis- covered during the process of development of a Subdivision? OTHER COMMENTS: