Annual report pursuant to Section 13 and 15(d)

Summary of Significant Accounting Policies

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Summary of Significant Accounting Policies
12 Months Ended
Dec. 31, 2012
Regulated Operations [Abstract]  
Summary of Significant Accounting Policies
2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation
The accompanying audited consolidated financial statements include the consolidated accounts of WRIT, our majority-owned subsidiaries and entities in which WRIT has a controlling interest, including where WRIT has been determined to be a primary beneficiary of a variable interest entity (“VIE”). See note 3 for additional information on the properties for which there is a noncontrolling interest. All intercompany balances and transactions have been eliminated in consolidation.
We have prepared the accompanying audited consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods presented have been included.
Use of Estimates in the Financial Statements
The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU No. 2011-04, Fair Value Measurement, which requires new disclosures about fair value measurements. Specifically, additional disclosures are required regarding significant unobservable inputs used for Level 3 fair value measurements, a company's valuation process, transfers between Levels 1 and 2 and hierarchy classifications for items whose fair value is not recorded on the balance sheet, but disclosed in the notes. For WRIT, the primary impact of this ASU was to require disclosure of the hierarchy classifications (Level 1, 2 or 3) for our disclosures of the fair values of financial instruments in our notes to the consolidated financial statements. We adopted this ASU on January 1, 2012.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income, which requires the presentation of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU eliminates the option of presenting the components of other comprehensive income as part of the statement of changes in shareholders' equity. This ASU is effective for fiscal years (including interim periods) beginning after December 15, 2011. We adopted this ASU on January 1, 2012 with the presentation of a separate statement of comprehensive income.
Revenue Recognition
We lease multifamily properties under operating leases with terms of generally one year or less. We lease commercial properties (our office, medical office and retail segments) under operating leases with average terms of three to five years. We recognize rental income and rental abatements from our multifamily and commercial leases when earned on a straight-line basis over the lease term. Recognition of rental income commences when control of the facility has been given to the tenant. We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. We base this estimate on our historical experience and a review of the current status of our receivables. We recognize percentage rents, which represent additional rents based on gross tenant sales, when tenants’ sales exceed specified thresholds.
We recognize sales of real estate at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement.
We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable primarily represents amounts accrued and unpaid from tenants in accordance with the terms of the respective leases, subject to our revenue recognition policy. We review receivables monthly and establish reserves when, in the opinion of management, collection of the receivable is doubtful. We establish reserves for tenants whose rent payment history or financial condition casts doubt upon the tenants’ ability to perform under their lease obligations. When we deem the collection of a receivable to be doubtful in the same quarter that we established the receivable, then we recognize the allowance for that receivable as an offset to real estate revenues. When we deem a receivable that was initially established in a prior quarter to be doubtful, then we recognize the allowance as an operating expense. Allowance for doubtful accounts was $7.3 million and $5.1 million as of December 31, 2010 and 2009, respectively. We established reserves for doubtful accounts of $3.8 million, $3.8 million and $3.4 million during the years ended December 31, 2012, 2011 and 2010, respectively. Write-offs of previously reserved accounts receivable totaled $1.5 million, $2.4 million and $1.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. In addition to rents due currently, accounts receivable include amounts representing minimal rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.
We include the following notes receivable balances in our accounts receivable balances (in thousands):
 
December 31,
 
2012
 
2010
Notes receivable, net
$
7,297

 
$
7,348



Deferred Financing Costs
We capitalize and amortize external costs associated with the issuance or assumption of mortgages, notes payable and fees associated with the lines of credit using the effective interest rate method or the straight-line method which approximates the effective interest rate method, over the estimated life of the related debt. As of December 31, 2012 and 2011 deferred financing costs were included in prepaid expenses and other assets were as follows (in thousands):
 
December 31,
 
2012
 
2011
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net
Deferred financing costs
$
19,622

 
$
8,902

 
$
10,720

 
$
16,131

 
$
7,580

 
$
8,551


We record the amortization of deferred financing costs as interest expense. Amortization of deferred financing costs from continuing operations for the three years ended December 31, 2012 was as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Amortization of deferred financing costs
$
2,478

 
$
2,262

 
$
2,413



Deferred Leasing Costs
We capitalize and amortize costs associated with the successful negotiation of leases, both external commissions and internal direct costs, on a straight-line basis over the terms of the respective leases. As of December 31, 2012 and 2011, deferred leasing costs included in prepaid expenses and other assets were as follows (in thousands):
 
December 31,
 
2012
 
2011
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net
 
Gross Carrying
Value
 
Accumulated
Amortization
 
Net
Deferred leasing costs
$
39,159

 
$
16,348

 
$
22,811

 
$
33,011

 
$
12,511

 
$
20,500


We record the amortization of deferred leasing costs as amortization expense. If an applicable lease terminates prior to the expiration of its initial lease term, we write off the carrying amount of the costs to amortization expense. Amortization and writes-offs of deferred leasing costs from continuing operations for the three years ended December 31, 2012 were as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Amortization of deferred leasing costs
$
4,514

 
$
4,530

 
$
4,357


We capitalize and amortize against revenue leasing incentives associated with the successful negotiation of leases on a straight-line basis over the terms of the respective leases. As of December 31, 2012 and 2011, deferred leasing incentives included in prepaid expenses and other assets were as follows (in thousands):
 
December 31,
 
2012
 
2011
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Deferred leasing incentives
$
6,578

 
$
1,698

 
$
4,880

 
$
4,651

 
$
909

 
$
3,742


We record the amortization of deferred leasing incentives as a reduction of revenue. If an applicable lease terminates prior to the expiration of its initial lease term, we write off the carrying amount of the costs as a reduction of revenue. Amortization and write-offs of deferred leasing costs from continuing operations for the three years ended December 31, 2012 were as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Amortization of deferred leasing incentives
$
789

 
$
664

 
$
208


Real Estate and Depreciation
We depreciate buildings on a straight-line basis over estimated useful lives ranging from 28 to 50 years. We capitalize all capital improvements associated with replacements, improvements or major repairs to real property that extend its useful life and depreciate them using the straight-line method over their estimated useful lives ranging from 3 to 30 years. We also capitalize costs incurred in connection with our development projects, including capitalizing interest and other internal costs during periods in which qualifying expenditures have been made and activities necessary to get the development projects ready for their intended use are in progress. In addition, we capitalize tenant leasehold improvements when certain criteria are met, including when we supervise construction and will own the improvements. We depreciate all tenant improvements over the shorter of the useful life of the improvements or the term of the related tenant lease. Real estate depreciation expense from continuing operations for the three years ended December 31, 2012 was as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Real estate depreciation
$
76,824

 
$
69,753

 
$
63,372


We charge maintenance and repair costs that do not extend an asset’s life to expense as incurred.

We capitalize interest costs incurred on borrowing obligations while qualifying assets are being readied for their intended use. We amortize capitalized interest over the useful life of the related underlying assets upon those assets being placed into service. Interest expense from continuing operations and interest capitalized to real estate assets related to development and major renovation activities for the three years ended December 31, 2012 were as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Total interest expense from continuing operations
$
66,385

 
$
66,952

 
$
67,823

Capitalized interest
1,688

 
738

 
858

Interest expense, net of capitalized interest
$
64,697

 
$
66,214

 
$
66,965


We recognize impairment losses on long-lived assets used in operations and held for sale, development assets or land held for future development, if indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount and estimated undiscounted cash flows associated with future development expenditures. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its estimated fair value, calculated in accordance with current GAAP fair value provisions. During the year ended December 31, 2012, we recognized in continuing operations an impairment charge of $2.1 million for the development project at 4661 Kenmore Avenue. During the year ended December 31, 2011, we recognized in continuing operations an impairment charge of $14.5 million for the development project at Dulles Station, Phase II. In addition, we recognized in discontinued operations an impairment charge of $0.6 million at Dulles Station, Phase I, which was sold during 2011 (see note 3 for further discussion). There were no impairments recognized during the year ended December 31, 2010.
We record acquired or assumed assets, including physical assets and in-place leases, and liabilities, based on their fair values. We determine the fair values of acquired buildings on an “as-if-vacant” basis considering a variety of factors, including the replacement cost of the property, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. We determine the fair value of land acquired based on comparisons to similar properties that have been recently marketed for sale or sold.
The fair value of in-place leases consists of the following components – (a) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant and foregone recovery of tenant pass-throughs (referred to as “absorption cost”); (b) the estimated cost of tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “tenant origination cost”); (c) estimated leasing commissions associated with obtaining a new tenant (referred to as “leasing commissions”); (d) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as “net lease intangible”); and (e) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “customer relationship value”). We have attributed no value to customer relationships as of December 31, 2012 and 2011.
We discount the amounts used to calculate net lease intangibles using an interest rate which reflects the risks associated with the leases acquired. We include tenant origination costs in income producing property on our balance sheet and amortize the tenant origination costs as depreciation expense on a straight-line basis over the remaining life of the underlying leases. We classify leasing commissions and absorption costs as other assets and amortize leasing commissions and absorption costs as amortization expense on a straight-line basis over the remaining life of the underlying leases. We classify net lease intangible assets as other assets and amortize them on a straight-line basis as a decrease to real estate rental revenue over the remaining term of the underlying leases. We classify net lease intangible liabilities as other liabilities and amortize them on a straight-line basis as an increase to real estate rental revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, we accelerate the amortization of the unamortized portion of the tenant origination cost, leasing commissions, absorption costs and net lease intangible associated with that lease, over its new, shorter term.

Balances, net of accumulated depreciation or amortization, as appropriate, of the components of the fair value of in-place leases at December 31, 2012 and 2011 were as follows (in thousands):
 
December 31,
 
2012
 
2011
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Tenant origination costs
$
58,444

 
$
32,839

 
$
25,605

 
$
55,640

 
$
25,479

 
$
30,161

Leasing commissions/absorption costs
90,327

 
48,163

 
42,164

 
86,705

 
34,738

 
51,967

Net lease intangible assets
14,794

 
7,665

 
7,129

 
14,422

 
5,679

 
8,743

Net lease intangible liabilities
32,093

 
22,336

 
9,757

 
31,991

 
19,293

 
12,698

Below-market ground lease intangible asset
12,080

 
956

 
11,124

 
12,080

 
766

 
11,314


Amortization of these combined components from continuing operations for the three years ended December 31, 2012 were as follows (in thousands):
 
Year Ended December 31,
 
2012
 
2011
 
2010
Amortization
$
20,636

 
$
15,360

 
$
7,643


Amortization of these combined components from continuing operations over the next five years is projected to be as follows (in thousands):
2013
$
17,382

2014
14,837

2015
12,228

2016
8,984

2017
5,548


Discontinued Operations
We classify properties as held for sale when they meet the necessary criteria, which include: (a) senior management commits to and actively embarks upon a plan to sell the assets, (b) the sale is expected to be completed within one year under terms usual and customary for such sales and (c) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We generally consider that a property has met these criteria when a sale of the property has been approved by the Board of Trustees, or a committee with authorization from the Board, there are no known significant contingencies related to the sale and management believes it is probable that the sale will be completed within one year. Depreciation on these properties is discontinued at the time they are classified as held for sale, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale.
Revenues and expenses of properties that are either sold or classified as held for sale are presented as discontinued operations for all periods presented in the consolidated statements of income. Interest on debt that can be identified as specifically attributed to these properties is included in discontinued operations. We do not have significant continuing involvement in the operations of any of our disposed properties.
Segments
We evaluate performance based upon operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. GAAP requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing segments’ performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as segment real estate rental revenue less segment real estate expenses.
Cash and Cash Equivalents
Cash and cash equivalents include investments readily convertible to known amounts of cash with original maturities of 90 days or less.
Restricted Cash

Restricted cash includes funds escrowed for tenant security deposits, real estate tax, insurance and mortgage escrows and escrow deposits required by lenders on certain of our properties to be used for future building renovations or tenant improvements.

Earnings Per Common Share

We determine “Basic earnings per share” using the two-class method as our unvested restricted share awards and units have non-forfeitable rights to dividends, and are therefore considered participating securities. We compute basic earnings per share by dividing net income attributable to the controlling interest less the allocation of undistributed earnings to unvested restricted share awards and units by the weighted-average number of common shares outstanding for the period.

We also determine “Diluted earnings per share” under the two-class method with respect to the unvested restricted share awards. We further evaluate any other potentially dilutive securities at the end of the period and adjust the basic earnings per share calculation for the impact of those securities that are dilutive. Our dilutive earnings per share calculation includes the dilutive impact of employee stock options based on the treasury stock method and our performance share units under the contingently issuable method. The dilutive earnings per share calculation also considers our operating partnership units.

Stock Based Compensation
We currently maintain equity based compensation plans for trustees, officers and employees and previously maintained option plans for trustees, officers and employees.
We recognize compensation expense for service-based share awards ratably over the period from the service inception date through the vesting period based on the fair market value of the shares on the date of grant. We initially measure compensation expense for awards with performance conditions at fair value at the service inception date based on probability of payout, and we remeasure compensation expense at subsequent reporting dates until all of the award’s key terms and conditions are known and the grant date is established. We amortize awards with performance conditions over the performance period using the graded expense method. We measure compensation expense for awards with market conditions based on the grant date fair value, as determined using a Monte Carlo simulation, and we amortize the expense ratably over the requisite service period, regardless of whether the market conditions are achieved and the awards ultimately vest. Compensation expense for the trustee grants, which fully vest immediately, is fully recognized upon issuance based upon the fair market value of the shares on the date of grant.
Accounting for Uncertainty in Income Taxes
We can recognize a tax benefit only if it is “more likely than not” that a particular tax position will be sustained upon examination or audit. To the extent that the “more likely than not” standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being recognized upon settlement.
We are subject to U.S. federal income tax as well as income tax of the states of Maryland and Virginia, and the District of Columbia. However, as a REIT, we generally are not subject to income tax on our net income distributed as dividends to our shareholders.
Tax returns filed for 2008 through 2012 tax years are subject to examination by taxing authorities. We classify interest and penalties related to uncertain tax positions, if any, in our financial statements as a component of general and administrative expense.
Derivatives
We enter into interest rate swaps from time to time to manage our exposure to variable interest rate risk. We do not purchase derivatives for speculation. In February 2008, we entered into an interest rate swap that expired in February 2010. In May 2009, we entered into a forward interest rate swap that expired in November 2011. Both interest rate swaps qualified as cash flow hedges. Our cash flow hedges were recorded at fair value based on discounted cash flow methodologies and observable inputs. We recorded the effective portion of changes in fair value of cash flow hedges in other comprehensive income. The change in fair value of cash flow hedges was the only activity in other comprehensive income (loss) during periods presented in our consolidated financial statements. We assessed the effectiveness of our cash flow hedges both at inception and on an ongoing basis. We deemed the hedges to be effective for the year ended December 31, 2010 and for subsequent periods prior to expiration in 2011. We had no derivative instruments outstanding as of December 31, 2012 and 2011.
Reclassifications
During the second quarter of 2012, we identified certain immaterial classification errors in our 2011 and 2010 consolidated statements of income and have determined that in this Annual Report on Form 10-K and future periodic reports we will correct these reclassification errors by including within the subtotal “real estate operating income” impairment charges and acquisition costs, which had previously been included in “other income (expense).” These reclassifications totaled $18.1 million and $1.2 million for the years ended December 31, 2011 and 2010, respectively. These reclassifications decrease “real estate operating income” and increase “other income (expense)” by an equal and offsetting amount. As a result, these reclassifications do not change income from continuing operations, net income, cash flows or any other operating measure for the periods affected.
In addition, certain prior year amounts have been reclassified from continuing operations to discontinued operations to conform to the current year presentation (see note 3).