The countdown to the adoption of IFRIC 15 has begun. From July 1, developers are to recognise revenue only upon the completion of a project instead of the current percentage-of-completion method. Can IFRIC 15 work for Malaysia where most properties are sold off the plan? Ironically, the Inland Revenue Board will continue to tax developers based on the current accounting method. Should the implementation of IFRIC 15 be deferred until the picture is clearer?
The International Financial Reporting Interpretations Committee 15 or IFRIC 15, and its impact on the property industry, has been hotly debated since the Malaysian Accounting Standards Board (MASB) announced its adoption effective July 1, 2010.
IFRIC 15 is a guidance note issued by the International Accounting Standards Board (IASB) on the application of financial reporting standards (FRS) and sets out the criteria for the recognition of revenue for real estate developers.
The Real Estate and Housing Developers’ Association (Rehda) set up a task force early this month to deliberate IFRIC 15 after industry players and the investing public raised concerns about it.
With the July 1 deadline drawing close, the industry remains confused. A pertinent question that was raised but had not been answered at press time is whether IFRIC 15 necessitates the recognition of revenue based on the completion method alone or if there is another option. Under current accounting practices, developers recognise revenue based on the percentage-of-completion method.
“If you read IFRIC 15 from cover to cover, it actually allows developers to use the percentage-of-completion method, provided certain criteria are met,” says Tang Kin Kheong, the managing partner of accounting firm Mazars Malaysia. Mazars has been appointed by Rehda as consultant to its task force.
Tang believes Rehda has a strong argument for the revenue of developers to be recognised based on the percentage-of-completion method because the contractual relationship between the buyer and developer meets the criteria under IFRIC 15.
Contractual agreements differ from country to country. In some countries, a downpayment is collected but the sales and purchase agreement (SAP) is not signed until the property is 70% complete. Others adopt the build-then-sell concept.
For these countries, revenue should be recognised based on the completion method, but Malaysia is different, says Tang. As long as the buyer pays the 10% downpayment and differential sum and signs the SAP, the title is transferred to his name.
“In return for transferring the title, the developer gets an undertaking letter from the bank, assuring the developer that the progress billing will be paid out of the loan facility granted to the buyer. By virtue of signing the SAP, any risks and rewards relating to the ownership of the property belong to the buyer,” explains Tang.
An example of a significant reward of ownership is the capital appreciation of the property while it is under construction, which is a gain for the buyer once the SAP is signed, and not for the developer. Similarly, if the value drops, the loss belongs to the buyer.
“So, there is indeed a transfer of ownership at an early stage, and its risk and rewards. With that transfer of ownership under IFRIC 15, the developer is entitled to recognise revenue on the percentage-of-completion method,” reasons Tang.
This, he adds, is a matter of interpretation and is now a sticking point in the discussion between Rehda and the Malaysian Institute of Accountants (MIA).
Shivanandha Chellappah, a member of Rehda’s task force, feels that the accounting community has a very narrow interpretation of IFRIC 15 because they do not realise that the ownership of the property is transferred to the buyer at an early stage.
“We have also examined the law with the help of legal experts, and have established that the beneficial buyer becomes the owner of the property after the SPA is signed. Even in a situation where the developer goes bust, the buyer has the rights to the asset for which he has paid progressively although the balance is not settled yet,” says Shivanandha.
If Rehda is successful in its case, Malaysia will follow in the footsteps of Belgium and France, which have retained the percentage-of-completion method to recognise revenue and are still in compliance with IFRIC 15.
In these two countries, the law has two different schemes for the sale of a property under development:
• Forward sale, where the buyer agrees to buy a completed property and the transfer of title and payment occur only when the property is completed. Some developers require a deposit of up to 10%; and
• Continuous sale (Vente en I’Etat Futur d’Achevement — VEFA), where the buyer immediately buys the land and the existing construction. The legal title is passed to the buyer who makes payments as construction progresses.
The stakeholders, including auditors, standard setters, market regulators and property developers, in the two countries have agreed that a forward sale should be recorded when the property is completed while VEFA should be recorded according to the percentage of completion method. The latter is acceptable because it falls within the definition of a continuous sale as defined by IFRIC 15.
Commenting on IFRIC 15, president of Rehda Datuk Michael Yam says: “It’s not a one-size-fits-all situation. In the more developed countries, revenue recognition has been based on the completion method because of their delivery and funding system. So the practice is more acceptable.”
The percentage-of-completion method is more reflective of the state of the industry here as it matches the cost and profit components of progress billing, Yam tells City & Country.
Still waiting for word
On April 22, Rehda’s task force had presented a memorandum to the MASB and the MIA on its analysis of the application of IFRIC 15 in Malaysia. The task force has met the MASB and the MIA twice on the matter.
“We have not received any indication from the MASB or the MIA on when a decision [on IFRIC 15] will be reached. If the MIA is unable to make a decision by July 1, the best option would be for the MASB to defer the implementation date. Otherwise, there will be confusion among the property developers,” says Soo Chan Fai, chairman of the Rehda task force.
What the developers want to know is whether they should follow IFRIC 15 as set out by the MASB. “Accounts need to be prepared according to certain guidance, so how are property developers supposed to do that when there is no clear consensus?” asks Soo.
At the same time, Rehda does not want IFRIC 15 to be rolled back. “The authorities tend to flip flop too much. It’s not good for the country or the industry,” Soo tells City & Country.
When contacted, Rachel Chee of the MIA’s financial reporting standards implementation committee secretariat, says the matter is still being discussed and researched. She would not say when a decision will be made.
The recognition of revenue based only upon completion of a project will render the earnings of a listed developer volatile and even misleading. In fact, Soo does not discount a plunge in the earnings of some property companies, thus shocking investors.
Yeonzon Yeow, head of research at Kenanga Investment Bank, says this would be especially true of developers with few projects. Those with a number of projects will not be as badly affected, he comments.
Bernard Ching, ECM Libra Group’s head of research, concurs, saying that the earnings volatility will depend on the developer’s business profile.
“Not every company will be in the red. If a company is mainly a township developer with multiple launches and completion every year, its earnings will tend to be more stable than that of developers with niche developments, for example Sunrise Bhd,” he observes.
It is important to note that as developers will continue to receive payments, the cash flow of the companies will not be compromised and in theory, the delayed revenue recognition should not have any impact on them.
For listed developers that do not engage the investing public, their only mode of communication with the shareholders will be the quarterly financial statement.
“If the quarterly financial statements of these companies suddenly start to show losses, there is no way the investor will know if that is due to a change in the accounting method or problems at the company. Because of that, investor interest in the property company’s stock may wane,” reasons Ching.
As IFRIC 15 will only take effect from the accounting period beginning July, developers with a June financial year-end will be the first to implement the standard. Sunrise will be one of them.
“All eyes will be on developers like Sunrise whose financial year ends in June. The rest will still have time. Sunrise will be a test case. People will be waiting to see what happen to Sunrise when it announces its 1Q2010 results,” says Ching.
Sunrise, he adds, has already said it will provide a supplementary financial statement to ensure minimal impact on its share price.
From an operational standpoint, opines Yam of Rehda, providing supplementary financial statements or adding an explanatory note is additional and unproductive work.
Kenanga’s Yeow, on the other hand, feels that it will be in the best interests of the developers, market and authorities to educate the investors. “Come out in a big way to educate the investors and the public on what IFRIC 15 is all about and how it affects financial results. So far, we have not seen anything from these parties,” he remarks.
Soo agrees, saying that retail investors will need a lot of guidance.
City & Country spoke to several fund managers about IFRIC 15, only to find that most of them are either unaware of it or do not fully understand what it means.
Bharat Joshi, assistant investment manager at Aberdeen Asset Management Sdn Bhd, says it is difficult to gauge investors’ awareness of the issue. “We are aware of it because we meet property developers regularly for briefings.”
He does not believe property share prices will be badly affected if there is proper information from the developers. “If the developers are transparent about their earnings, for example like S P Setia, things will be fine. The problem is that the small developers are not as transparent as the major ones,” says Bharat.
Tan Teng Boo, CEO of Capital Dynamics Asset Management, does not rule out a knee-jerk reaction from investors, but says this does not necessarily mean the risk premium will rise as cash flow continues as before.
He feels that the recognition of revenue upon completion of a project will make performance forecasts and the job of an analyst more difficult.
“You come up with a ratio that says there are 70% sales now and estimate 100% sales in three years. So, in your forecast, do you take the 70% sales now or the 100% sales in three years?” he asks. Cash flow is going to be the guide for future profitability, he adds.
As for dividend payments, Soo says these can be distributed from retained earnings.
When contacted, a Bursa Malaysia Bhd official says: “We are monitoring the discussion on the interpretation of IFRIC 15 between Rehda and the MIA. If there are issues raised that may require additional disclosure to keep investors more informed, we will issue a directive to listed issuers involved in real estate developments to make the additional disclosure, if necessary.”
Another impact of IFRIC 15 on developers would be the need to keep two sets of accounts. This is because the Inland Revenue Board (IRB) will continue to tax developers on the percentage method.
“From what I understand, if the IRB taxes developers on the completed method, it will defer its tax revenue collection until the end of the project and I don’t think this will help in the national budget and cash flow projections,” explains Soo of Rehda.
Going forward, complications will arise when developers have to reconcile the two sets of books, especially for township developments where there are many phases, he observes. This is besides the added cost incurred from keeping two sets of accounts.
Yam estimates that the cost of manpower and auditing services will rise 50%, if not more.
“Why do we just comply without thinking of the implications and impact?” he asks.
Calling the rule “silly”, ECM Libra’s Ching agrees with Yam that IFRIC 15 is really about conforming to an international accounting standard set by the Westerners.
“As these developed countries mostly sell properties under the build-then-sell concept, it makes no difference to them, but it makes a lot of difference to us,” he comments.
According to Soo, it is not mandatory that IFRIC 15 be implemented by July 1 or even this year, although Malaysia has set Jan 1, 2012, as the deadline for full convergence with FRS.
“Even the Singapore authorities have not implemented IFRIC 15. They have said that even if they wish to do so, it will not be before Jan 1, 2011,” he points out.
However, both he and Shivanandha are optimistic that they have clarified concerns over ownership risks and rewards.
“The MIA seems to have understood the point we are making and it is now more open compared to the first time we met on this issue,” says Shivanandha.
Until a decision is made, it looks like a stay on the July 1 deadline is best. Otherwise, confusion will reign.
This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 812, June 28-July 4, 2010
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