Note 2 – Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements of Agree Realty Corporation include the accounts of the Company, the Operating Partnership and its wholly-owned subsidiaries. The Company, as the sole general partner, held 99.1% and 98.8% of the Operating Partnership as of December 31, 2018 and 2017, respectively. All material intercompany accounts and transactions are eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of (1) assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and (2) revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications of prior period amounts have been made in the consolidated financial statements and footnotes in order to conform to the current presentation. Income tax expense is presented in Other (Expense) Income on the Consolidated Statements of Operations and Comprehensive Income. In financial statements filed prior to March 2018, income tax expense was included in general and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

Segment Reporting

The Company is primarily in the business of acquiring, developing and managing retail real estate which is considered to be one reporting segment. The Company has no other reportable segments.

Real Estate Investments

The Company records the acquisition of real estate at cost, including acquisition and closing costs. For properties developed by the Company, all direct and indirect costs related to planning, development and construction, including interest, real estate taxes and other miscellaneous costs incurred during the construction period, are capitalized for financial reporting purposes and recorded as property under development until construction has been completed. Assets are classified as Held for Sale based on specific criteria as outlined in Accounting Standards Codification (“ASC”) 360, Property, Plant & Equipment. Properties classified as Held for sale are recorded at the lower of their carrying value or their fair value, less anticipated selling costs. Assets are generally classified as Held for Sale once management has actively engaged in marketing the asset and has received a firm purchase commitment that is expected to close within one year. Real estate held for sale consisted of the following as of December 31, 2018 and December 31, 2017 (in thousands):


	December 31, 2018		December 31, 2017

Land	$	-	$	393
Buildings		-		1,857
Lease Intangibles (Asset)		-		557
		-		2,807
Accumulated depreciation and amortization		-		(387)
Total Real Estate Held for Sale, net	$	-	$	2,420

Accounting for Acquisitions of Real Estate

The acquisition of property for investment purposes is typically accounted for as an asset acquisition. The Company allocates the purchase price to land, buildings and identified intangible assets and liabilities, based in each case on their relative estimated fair values and without giving rise to goodwill. Intangible assets and liabilities represent the value of in-place leases and above- or below-market leases. In making estimates of fair values, the Company may use a number of sources, including data provided by independent third parties, as well as information obtained by the Company as a result of its due diligence, including expected future cash flows of the property and various characteristics of the markets where the property is located.

In allocating the fair value of the identified intangible assets and liabilities of an acquired property, in-place lease intangibles are valued based on the Company’s estimates of costs related to tenant acquisition and the carrying costs that would be incurred during the time it would take to locate a tenant if the property were vacant, considering current market conditions and costs to execute similar leases at the time of the acquisition. Above- and below-market lease intangibles are recorded based on the present value of the difference between the contractual amounts to be paid pursuant to the leases at the time of acquisition and the Company’s estimate of current market lease rates for the property. The capitalized above- and below-market lease intangibles are amortized over the non-cancelable term of the lease unless the Company believes it is reasonably certain that the tenant will renew the lease for an option term whereby the Company amortizes the value attributable to the renewal over the renewal period. In the case of sale-leaseback transactions, it is typically assumed that the lease is not in-place prior to the close of the transaction.

The fair value of identified intangible assets and liabilities acquired is amortized to depreciation and amortization over the remaining term of the related leases.

Depreciation

The Company’s real estate portfolio is depreciated using the straight-line method over the estimated remaining useful life of the properties, which are generally 40 years for buildings and 10 to 20 years for improvements. Properties classified as held for sale and properties under development are not depreciated.

Impairments

The Company reviews long-lived assets, including intangible assets, for possible impairment when certain events or changes in circumstances indicates that the carrying amount of the asset may not be recoverable though operations. Events or changes in circumstances that may occur include, but are not limited to, significant changes in real estate market conditions and an expectation to sell assets before the end of the previously estimated life. Impairments are measured to the extent the current book value exceeds the estimated fair value of the asset less disposition costs for any assets classified as held for sale.

The valuation of impaired assets is determined using valuation techniques including discounted cash flow analysis, analysis of recent comparable sales transactions, and purchase offers received from third parties, which are Level 3 inputs. The Company may consider a single valuation technique or multiple valuation techniques, as appropriate, when estimating the fair value of its real estate.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents consist of cash and money market accounts. The account balances periodically exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance coverage, and as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. We had $52.7 million and $57.5 million in cash and cash held in escrow as of December 31, 2018 and December 31, 2017, respectively, in excess of the FDIC insured limit.

Accounts Receivable – Tenants

The Company reviews its rent receivables for collectability on a regular basis, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located. In the event that the collectability of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific receivable will be made. For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions.

The Company’s leases provide for reimbursement from tenants for common area maintenance (“CAM”), insurance, real estate taxes and other operating expenses ("Operating Cost Reimbursement"). A portion of our Operating Cost Reimbursement Revenue is estimated each period and is recognized as revenue in the period the recoverable costs are incurred and accrued. Receivables from Operating Cost Reimbursement Revenue are included in our Accounts Receivable - Tenants line item in our Consolidated Balance Sheets. The balance of unbilled Operating Cost Reimbursement Receivable at December 31, 2018 and December 31, 2017 was $3.3 million and $1.4 million, respectively.

In addition, many of the Company’s leases contain rent escalations for which we recognize revenue on a straight-line basis over the non-cancelable lease term. This method results in rental revenue in the early years of a lease being higher than actual cash received, creating a straight-line rent receivable asset which is included in the Accounts Receivable - Tenants line item in our Consolidated Balance Sheets. The balance of straight-line rent receivables at December 31, 2018 and December 31, 2017 was $16.7 million and $12.9 million, respectively. To the extent any of the tenants under these leases become unable to pay their contractual cash rents, the Company may be required to write down the straight-line rent receivable from those tenants, which would reduce operating income.

Sales Tax

The Company collects various taxes from tenants and remits these amounts, on a net basis, to the applicable taxing authorities.

Unamortized Deferred Expenses

Deferred expenses include debt financing costs related to the Company’s revolving credit facility, leasing costs and lease intangibles, and are amortized as follows: (i) debt financing costs related to the line of credit on a straight-line basis to interest expense over the term of the related loan, which approximates the effective interest method; (ii) leasing costs on a straight-line basis to amortization over the term of the related lease entered into; and (iii) lease intangibles on a straight-line basis to amortization over the remaining term of the related lease acquired.

The following schedule summarizes the Company’s amortization of deferred expenses for the years ended December 31, 2018, 2017 and 2016, respectively (in thousands):


	For the Year Ended December 31,
	2018		2017		2016

Credit Facility Financing Costs	$	477	$	405	$	228
Leasing Costs		243		161		124
Lease Intangibles (Asset)		22,650		16,060		11,093
Lease Intangibles (Liability)		(4,228)		(4,275)		(3,083)
Total	$	19,142	$	12,351	$	8,362

The following schedule represents estimated future amortization of deferred expenses as of December 31, 2018 (in thousands):



Year Ending December 31,	2019		2020		2021		2022		2023		Thereafter		Total

Credit Facility Financing Costs	$	556	$	542	$	28	$	—	$	—	$	—	$	1,126
Leasing Costs		290		315		306		298		312		1,131		2,652
Lease Intangibles (Asset)		25,690		25,202		24,517		23,439		22,080		159,225		280,153
Lease Intangibles (Liability)		(4,413)		(4,313)		(4,028)		(3,129)		(2,567)		(8,768)		(27,218)
Total	$	22,123	$	21,746	$	20,823	$	20,608	$	19,825	$	151,588	$	256,713

Revenue Recognition

The Company leases real estate to its tenants under long-term net leases which we account for as operating leases. Under this method, leases that have fixed and determinable rent increases are recognized on a straight-line basis over the lease term. Rental increases based upon changes in the consumer price indexes, or other variable factors, are recognized only after changes in such factors have occurred and are then applied according to the lease agreements. Certain leases also provide for additional rent based on tenants’ sales volumes. These rents are recognized when determinable after the tenant exceeds a sales breakpoint. Contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses are generally included in operating costs reimbursement in the period when such expenses are incurred.

Earnings per Share

Earnings per share have been computed by dividing the net income less net income attributable to unvested restricted shares by the weighted average number of common shares outstanding less unvested restricted shares. Diluted earnings per share is computed by dividing net income by the weighted average common shares and potentially dilutive common shares outstanding in accordance with the treasury stock method.

The following is a reconciliation of basic net earnings per common share computation to the denominator of the diluted net earnings per common share computation for each of the periods presented:


		Year Ended December 31,
		2018		2017		2016
Net income attributable to Agree Realty Corporation	$	58,172	$	58,112	$	45,118
Less: Income attributable to unvested restricted shares		(370)		(454)		(424)
Net income used in basic and diluted earnings per share	$	57,802	$	57,658	$	44,694

Weighted average number of common shares outstanding		32,281,273		27,852,231		23,096,267
Less: Unvested restricted stock		(211,018)		(227,129)		(227,531)
Weighted average number of common shares outstanding used in basic earnings per share		32,070,255		27,625,102		22,868,736

Weighted average number of common shares outstanding used in basic earnings per share		32,070,255		27,625,102		22,868,736
Effect of dilutive securities: Restricted stock		69,136		75,245		91,063
Effect of dilutive securities: March 2018 forward equity offering		198,786		—		—
Effect of dilutive securities: September 2018 forward equity offering		62,945		—		—
Weighted average number of common shares outstanding used in diluted earnings per share		32,401,122		27,700,347		22,959,799

Operating Partnership Units ("OP Units")		347,619		347,619		347,619
Weighted average number of common shares and OP Units outstanding used in diluted earnings per share		32,748,741		28,047,966		23,307,418

Forward Equity Sales

In March 2018, the Company completed a forward sale agreement to sell an aggregate of 3,450,000 shares of our common stock, which included the underwriters option to purchase an additional 450,000 shares of common stock, at a public offering price of $48.00 per share, before underwriting discounts. In September 2018, the Company settled, in its entirety, the forward sale agreement and received proceeds of $160.2 million, net of underwriting discounts, fees and expenses.

In September 2018, the Company entered into a forward sale agreement to sell an aggregate of 3,500,000 shares of our common stock at a public offering price of $55.20 per share, before underwriting discounts. The Company is obligated to settle the forward sale agreement no later than September 3, 2019.

To account for the forward sale agreements, the Company considered the accounting guidance governing financial instruments and derivatives and concluded that our forward sale agreement was not a liability as it did not embody obligations to repurchase our shares nor did it embody obligations to issue a variable number of shares for which the monetary value was predominantly fixed, varying with something other than the fair value of the shares, or varying inversely in relation to our shares. We then evaluated whether the agreement met the derivatives and hedging guidance scope exception to be accounted for as an equity instrument, and concluded that the agreement can be classified as an equity contract based on the following assessment: (i) none of the agreement’s exercise contingencies was based on observable markets or indices besides those related to the market for our own stock price and operations; and (ii) none of the settlement provisions precluded the agreement from being indexed to our own stock.

The Company also considered the potential dilution resulting from the forward sale agreement on the earnings per share calculations. The Company used the treasury stock method to determine the dilution resulting from the forward sale agreement during the period of time prior to settlement. The impact to our weighted-average number of common shares – diluted for the year ended December 31, 2018, was 261,731 weighted-average incremental shares.

Income Taxes

The Company has made an election to be taxed as a REIT under Sections 856 through 860 of the Code and related regulations. The Company generally will not be subject to federal income taxes on amounts distributed to stockholders, providing it distributes 100% of its REIT taxable income and meets certain other requirements for qualifying as a REIT. For each of the years in the three-year period ended December 31, 2018, the Company believes it has qualified as a REIT. Notwithstanding the Company’s qualification for taxation as a REIT, the Company is subject to certain state taxes on its income and real estate.

The Company and its taxable REIT subsidiaries (“TRS”) have made a timely TRS election pursuant to the provisions of the REIT Modernization Act. A TRS is able to engage in activities resulting in income that previously would have been disqualified from being eligible REIT income under the federal income tax regulations. As a result, certain activities of the Company which occur within its TRS entity are subject to federal and state income taxes (See Note 7). All provisions for federal income taxes in the accompanying consolidated financial statements are attributable to the Company’s TRS.

Fair Values of Financial Instruments

The Company’s estimates of fair value of financial and non-financial assets and liabilities are based on the framework established in the fair value accounting guidance. The framework specifies a hierarchy of valuation inputs which was established to increase consistency, clarity and comparability in fair value measurements and related disclosures. The guidance describes a fair value hierarchy based upon three levels of inputs that may be used to measure fair value, two of which are considered observable and one that is considered unobservable. The following describes the three levels:


Level 1 –	Valuation is based upon quoted prices in active markets for identical assets or liabilities.

Level 2 –	Valuation is based upon inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 –	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include option pricing models, discounted cash flow models and similar techniques.

Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). These amendments modify the disclosure requirements in Topic 820 on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty. ASU 2018-13 will be effective for all entities for fiscal years beginning after December 15, 2019, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company is in the process of determining the impact that the implementation of ASU 2018-13 and does not believe it will have a material effect on the Company’s financial statements.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”). These amendments expand the scope of Topic 718, Compensation—Stock Compensation, which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned, and the ASU supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. ASU 2018-07 will be effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2017, the FASB issued ASU No. 2017‑12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities” (“ASU 2017‑12”). The objective of ASU 2017‑12 is to expand hedge accounting for both financial (interest rate) and commodity risks, and create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes. ASU 2017‑12 will be effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods in the year of adoption. Early adoption is permitted for any interim or annual period. The Company has evaluated the impact of the implementation of ASU 2017‑12 and does not believe it will have a material effect on the Company’s financial statements.

In February 2016, the FASB issued ASU No. 2016-02 “Leases” (“ASU 2016-02”). The new standard creates Topic 842, Leases, in FASB Accounting Standards Codification (“FASB ASC”) and supersedes FASB ASC 840, Leases. ASU 2016-02 requires a lessee to recognize the assets and liabilities that arise from leases (operating and finance). ASU 2016-02 is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2018. The main difference between the existing guidance on accounting for leases and the new standard is that operating leases for lessees will now be recorded in the statement of financial position as right of use assets and lease liabilities on the lessee’s balance sheet. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases and operating leases. As part of ASU 2018-01, the FASB provided an optional transition method, allowing entities to not evaluate under ASC 842 land easements that existed or expired before the adoption of ASC 842 and that were not previously accounted for as leases under ASC 840. The Company will apply this practical expedient upon adoption of Topic 842. In July 2018, the FASB issued ASU 2018-11, which provides a practical expedient for lessors by class of underlying assets to not separate non-lease components from the lease component. The Company will apply the practical expedient to not separate lease and nonlease components in a contract if the timing and pattern of transfer for the lease components and nonlease components are the same and if the lease component is classified as an operating lease. As part of ASU 2018-11, the FASB provided an additional (and optional) transition method that allows entities to initially apply Topic 842 at the adoption date (January 1, 2019) and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company will apply this practical expedient upon adoption of Topic 842. Based on its anticipated election of practical expedients, the Company anticipates that its retail leases, where it is the lessor, will continue to be accounted for as operating leases under the new standard. As part of ASU 2018-20, the FASB provided guidance requiring lessors to exclude from variable payments, lessor costs paid by lessees directly to third parties. The ASU also requires lessors to account for costs excluded from the consideration of a contract that are paid by the lessor and reimbursed by the lessee as variable payments. The Company evaluated the recognition of reimbursed costs received from the lessee and have concluded that there will be no change in current presentation based on this ASU. The Company is also the lessee under various land lease arrangements. The Company will not reassess the classification of existing land leases where it is the lessee and therefore these leases will continue to be accounted for as operating leases. Therefore, as of January 1, 2019, the Company does not currently anticipate significant changes in the accounting for its lease revenues as lessor, but does anticipate the recognition of right of use assets and related lease liabilities on its consolidated balance sheets related to land leases as lessee of less than 1.0% of total assets. In addition the Company will include the required disclosures related to the adoption of this standard. In the event the Company modifies existing land leases or enters into new land leases after adoption of the new standard, such leases may be classified as finance leases. The Company will continue to evaluate the impact of adopting the new leases standard on its consolidated statements of income and comprehensive income, consolidated balance sheets and related internal controls over financial reporting.