The purpose of this exercise is to review the fundamentals of accounting for real estate transactions.

A. Create a general ledger.

B. Build a chart of accounts.

C. Journal each transaction.

D. Post the transactions to each account.

E. Draw a trail balance.

F. Create an income statement, a balance sheet and a cash flow statement.

G. Identify the transactions that create cash vs. accrual differences.

H. Prepare closing entries.

You are a property investor purchasing your first building, a small 100,000 sf strip shopping center in Westchester County. You close on 1/1/2007. The center has three stores. All stores are leased. The stores are: a clothing store, 10,000 sf; a drug store, 30,000 sf; and a supermarket, 60,000 sf.

The purchase price of the center is $15 million. You contribute $300,000 for five partnership units. You raise $3.0 million from friends and family by selling 30 partnership interests of $100,000 each. ($3 m for the purchase and $.3m for working capital) You borrow the remaining funds from a local bank at 6% for 10 years with a 30 year amortization schedule. You pay the mortgage monthly.

Your accountant attributes 30% of the purchase price to land with the balance to buildings which depreciate over 39 years.

Your tenants pay monthly rent as follows:

Clothing Store $24 sf/yr

Drug Store $20 sf/yr

Supermarket $15 sf/yr

Property taxes are paid twice yearly in June and December based on 2% of fair market value. At closing, you repay the seller for taxes paid this past December. (assume taxes were paid at the going forward rate)

Insurance costs $0.30 sf/yr paid in two equal installments in April and November.

Common area utilities cost $1.20 sf/yr paid monthly. The stores pay their own electric and HVAC directly.

Repairs and maintenance cost $0.60 sf/yr paid monthly.

Each month, in addition to rent the stores pay a "Common Area Maintenance" charge based on each stores' square footage in an aggregate amount that will cover landlord costs (taxes, insurance, utilities and maintenance/repairs).

In November, you must make a major roof repair for $10,000. This is not a "CAM charge," it is a landlord cost.

In July, the clothing store misses both its rent and CAM payment. They pay the past due charges plus a 5% late fee in August.

You pay your accountant $6,000 per quarter for audit and tax fees.

You pay your lawyer $50,000 for setting up and closing your property acquisition and $2,500 per month for general legal services.

You earn 3% of all collected revenues (rent and CAM) as a management fee. This is an expense to the partnership.

The clothing store gives you notice that they are closing on November 30th. They agree to pay a $50,000 lease termination fee. You find a new bath and tile store as a replacement tenant. The lease is signed on August 1. You must pay a brokerage commission of 2% of the total rent, 50% at signing and 50% at opening. You must also agree to pay $25/sf in tenant allowance. The tenant allowance is due on opening day, December 1st which is also the rent start date.

Rent:

Year 0 $2.50 for December

Year 1-3 $35 sf/year

Year 4-6 $40 sf/year

Year 7-10 $45 sf/year

In the event that sales exceed $360 sf/year the tenant will pay 8% of the marginal sales as percent rent. Sales in year 1 are expected to be $300/sf. Sales will grow 7% per year.

Assume all of the CAM (expense) calculations remain the same.

A brief reminder on accounting:

The flow of Accounting:

A company's business activities are memorialized by accounting transactions.

These transactions are recorded in aGeneral Ledgerusing a system of accounting developed in Italy the 1400s.

In the pre- industrial trading days, the primary assets of companies were the debts of their borrowers and these accounts were said to have debit balances. The primary owners of the companies were the suppliers of funds known as creditors, hence their accounts had balances known as credits. In every transaction, the impact on the debtor's accounts had an equal and direct impact on the creditor's accounts so debits must always equal credits.

In this "dual entry system" each transaction represents the flow of value between a minimum of two accounts.

.

There are four primary types of accounts:Assets, Liabilities, Revenues and Expenses.

Expensesrepresent the utilization ofassets(the store of value of a company). These account types generally havedebit balances.

Revenuesrepresent the returns on the company'sLiabilities(capital supplier's investment), both represent the benefits of ownership. The capital suppliers, or creditors, (equity and note holders) own the company. Their accounts havecredit balances.

In accrual accounting, all transactions are said to occur when the economic effect occurs, not necessarily when cash changes hand.

Theincome statementis developed for a period. Revenues and Expenses are income statement accounts. Thebalance sheetis taken a snapshot in time. Asset and Liabilities are balance sheet accounts. Balance sheets can be thought of as bookends to an activity period such as a month, quarter or year. Accounting years can be calendar or fiscal years. Afiscal yearis an arbitrary period of 12 consecutive months representing a business cycle.

Accounts are organized by type according to achart of accounts.

At the close of a period of activity, General Ledger transactions are sorted by account.

The transaction list, sorted by account, with balances, and in accordance with the order specified in the chart of accounts, is called atrial balance.

At the end of each accounting period a series ofadjusting and closing entriesis made.

Periodic accounts (income statement) are brought to zero. Asset and liability accounts (balance sheet) are updated to reflect the impacts of the period's business activity.

Adjusting and closing entries are added to the general ledger. An adjusted trial balance is run. The balances are then fashioned into a set offinancial statements.

Note: the Income Statement is run before all of the periodic accounts are closed out at the end of the period, otherwise the values would all be zero. The balance sheet is run after all of the closing entries have been made.

Debits = creditsso:

If your ledger doesn't balance then you have an error

If any single transaction doesn't balance you have an error

Not every real estate financial analysis begins with a granular accounting. You do however need an understanding of accounting concepts to construct an accurate pro forma.

This is a good format for an excel based ledger:

Transaction #

Date

Account #

Account

Debit

Credit

Comment

Use the data:sort and data:subtotal commands to create your trial balances.

The following Chart of Accounts may be helpful. There are other ways to set up the accounts that will work as well.

Balance Sheet

a/o 12/31/2007

Assets

Short Term

1000

Cash

1005

A/R

1020

Prepaid Expense

Long Term

1050

RE Owned

1060

RE: Land

1070

RE: Building

1075

Legal Fees

1077

LT Asset Roof

1080

T/A

1090

Leasing Commission

1095

Acc Dep

Total Assets

Liabilities

2000

A/P

2010

Mortgage

Total Liabilities

Owners Equity

3010

Partnership equity

Total Equity

Income Statement

Period ending 12/31/2007

Revenues

4010

Rent

4020

CAM Revenue

4030

Late Fee

4040

Termination Fee

Expenses

5010

Maintenance Exp

5020

Prop Tax Expense

5030

CA Utility Exp

5040

Accounting Expense

5050

Legal Exp

5060

Management Fee

5070

Insurance Expense

6010

NOI

5080

Interest

5090

Depreciation

6020

EBTaxes

5095

Income Taxes

6030

Net Income