COPT Defense Properties Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Summary of Significant Accounting Policies (Policies)

Summary of Significant Accounting Policies (Policies)

3 Months Ended

Mar. 31, 2019

The COPT consolidated financial statements include the accounts of COPT, the Operating Partnership, their subsidiaries and other entities in which COPT has a majority voting interest and control. The COPLP consolidated financial statements include the accounts of COPLP, its subsidiaries and other entities in which COPLP has a majority voting interest and control. We also consolidate certain entities when control of such entities can be achieved through means other than voting rights (“variable interest entities” or “VIEs”) if we are deemed to be the primary beneficiary of such entities. We eliminate all intercompany balances and transactions in consolidation.

We use the equity method of accounting when we own an interest in an entity and can exert significant influence over but cannot control the entity’s operations. We discontinue equity method accounting if our investment in an entity (and net advances) is reduced to zero unless we have guaranteed obligations of the entity or are otherwise committed to provide further financial support for the entity.

When we own an equity investment in an entity and cannot exert significant influence over its operations, we measure the investment at fair value, with changes recognized through net income. For an investment without a readily determinable fair value, we measure the investment at cost, less any impairments, plus or minus changes resulting from observable price changes for an identical or similar investment of the same issuer.

These interim financial statements should be read together with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2018 included in our 2018 Annual Report on Form 10-K. The unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly state our financial position and results of operations. All adjustments are of a normal recurring nature. The consolidated financial statements have been prepared using the accounting policies described in our 2018 Annual Report on Form 10-K as updated for our adoption of recent accounting pronouncements discussed below.

Reclassification

We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity, including reclassifications of our revenue from real estate operations in connection with our adoption of new lease guidance described below.

Recent Accounting Pronouncements

In February 2016, the FASB issued guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases. This guidance requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. The resulting classification determines whether the lease expense is recognized based on an effective interest method or straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. This guidance requires lessors of real estate to account for leases using an approach substantially equivalent to guidance previously in place for operating leases, direct financing leases and sales-type leases. We adopted this guidance on January 1, 2019 using a modified retrospective transition approach under which we elected to apply the guidance effective January 1, 2019 and not adjust prior comparative reporting periods (except for our presentation of lease revenue discussed below). We elected to apply a package of practical expedients that enabled us to carry forward upon adoption our historical assessments of: expired or existing leases regarding their lease classification and deferred recognition of non-incremental direct leasing costs; and whether any expired or existing contracts are, or contain, leases. We also elected a practical expedient that enabled us to avoid the need to assess whether expired or existing land easements not previously accounted for as leases are, or contain, a lease. In addition, we elected a practical expedient for our rental properties (as lessor) to avoid separating non-lease components that otherwise would need to be accounted for under the recently-adopted revenue accounting guidance (such as tenant reimbursements of property operating expenses) from the associated lease component since (1) the non-lease components have the same timing and pattern of transfer as the associated lease component and (2) the lease component, if accounted for separately, would be classified as an operating lease; this enables us to account for the combination of the lease component and non-lease components as an operating lease since the lease component is the predominant component of the combined components. Below is a summary of the primary changes in our accounting and reporting that resulted from our adoption of this guidance:


•	Property leases in which we are the lessor:


◦	Deferral of non-incremental leasing costs: For new or extended tenant leases, we no longer defer recognition of non-incremental leasing costs that we would have deferred under prior accounting guidance (refer to our 2018 Annual Report on Form 10-K in which we reported amounts deferred in 2018, 2017 and 2016).

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Change in presentation of revenue: Due to our adoption of the practical expedient discussed above to not separate non-lease component revenue from the associated lease component, we are aggregating revenue from our lease components and non-lease components (comprised predominantly of tenant operating expense reimbursements) into the line entitled “lease revenue.” We are reporting other revenue from our properties in the line entitled “other property revenue.” We recast prior periods for these changes in presentation.


◦	Changes in assessment of lease revenue collectability: Changes in our assessment of lease revenue collectability that previously would have resulted in charges to bad debt expense under prior guidance are being recognized as an adjustment to rental revenue under the new guidance. Such amounts recognized by us in prior periods were not significant.


◦	Operating expenses paid directly by tenants to third parties: Operating expenses paid directly by tenants to third parties (primarily for real estate taxes) and revenue associated with such tenant payments that would have been recognized under prior guidance will no longer be reported on our Statement of Operations. Such amounts recognized by us in prior periods were not significant.


•	Leases (the most significant of which are ground leases) in which we are the lessee:

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Balance sheet presentation of property operating lease right-of-use assets: Upon adoption on January 1, 2019, we recognized property right-of-use assets and offsetting lease liabilities for existing operating leases totaling $16 million for the present value of minimum lease payments under these leases, and also reclassified an additional $11 million in amounts previously presented elsewhere on our balance sheet in connection with these leases to the right-of-use assets. We will recognize additional right-of-use assets and lease liabilities as we enter into new operating leases.

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Balance sheet presentation of property finance lease right-of-use assets: Property right-of-use assets of finance leases that previously were presented as properties under prior guidance are being presented as property finance right-of-use assets under the new guidance. As a result, we reclassified $38 million in assets from properties to property finance right-of-use assets upon adoption on January 1, 2019.


◦	Segment assets: We changed our definition of segment assets used for our reportable segments to include property right-of-use assets associated with operating properties, net of related lease liabilities.

In June 2016, the FASB issued guidance that changes how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The guidance replaces the current incurred loss model with an expected loss approach, resulting in a more timely recognition of such losses. The guidance will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases and off-balance-sheet credit exposures (e.g. loan commitments). Under the new guidance, an entity will recognize its estimate of expected credit losses as an allowance, as the guidance requires that financial assets be measured on an amortized cost basis and to be presented at the net amount expected to be collected. The guidance is effective for us beginning January 1, 2020, with early adoption permitted after December 2018. We are currently assessing the financial impact of this guidance on our consolidated financial statements.

In August 2018, the FASB issued guidance that modifies disclosure requirements for fair value measurements. This guidance is effective for us beginning January 1, 2020. Early adoption is permitted for this guidance, and entities are permitted to early adopt with respect to any removed or modified disclosures while delaying adoption of additional disclosure requirements until the effective date. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In August 2018, the FASB issued guidance that aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. FASB guidance did not previously address the accounting for such implementation costs. The guidance is effective for us beginning January 1, 2020, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.