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City & Country: Volatile earnings under new accounting rules

The Malaysian Accounting Standards Board (MASB) has decided to adopt what is called IFRIC 15 — agreements for the construction of real estate.

Under the new rules, which will become applicable for the accounting period commencing July 1, property developers are to recognise revenue based on the completion method instead of the percentage-of-completion method in current practice.

Revenue from progress billings will only be recognised upon completion of a project, and not progressively as is now the case for projects that are sold off the plan.

Should this happen, expect a “plunge” in the earnings of all listed property developers in the months to come since revenue and the proportionate cost will no longer be recognised progressively.

Even after a period of adjustment, developers’ earnings, especially that of the smaller  players with few projects, will continue to stay volatile.  Depending on the timing of a project launch and number of existing projects, the “drop” in earnings can be drastic, before it reverses upon completion of the project.

So, as listed developers migrate to the new accounting rules, the price earnings (PE) valuation method will be meaningless in assessing their worth.

The turnover of a property developer reflects the success of its launch or launches. In the absence of such information, the investing community will have a problem sizing up a company unless additional information in notes to its accounts is made readily available.

Irony of ironies
The merits and demerits of the new accounting treatment aside, as at press time,  the government has remained silent on the tax treatment of developers’ earnings from progress billings. Industry players take this to mean that there will be no deferment of taxes on profits from progress billings, IFRIC 15 or otherwise.

Developers, therefore, will need to make adjustments to the new accounting treatment specially for taxation purposes.  This makes it  necessary to maintain two sets of accounts — one for the Inland Revenue Department and the other to comply with IFRIC 15. 

Still, how does a company compute tax payment for earnings that have not been recognised?  And how does a company pay dividend from unrecognised earnings?

Needless to say,  additional administrative costs will be incurred. Guess who will have to pick up the tab?
Developers,  understandably,  are against the implementation of IFRIC 15, aimed at streamlining accounting standards worldwide.

While IFRIC 15 has been adopted by most countries in the West, the property development fraternity in France and Belgium are believed to have successfully resisted the move. Closer to home, there is no news yet as to when Singapore will embrace the new ruling. It is the same in Indonesia and Thailand.

The glaring differences between the property development landscape and related laws in Malaysia and in the West cannot and should not be ignored.

Primarily, the build-then-sell concept is common in the West but only a handful of projects in Malaysia are marketed in this manner, although the government is keen to see more developers adopt this practice.

Here,  like it or not, the sell-then-build concept is driving the market, with financial institutions being a party to the deal by extending end-financing following the signing of a sale and purchase agreement (S&P) between the buyer and developer.

Some quarters, meanwhile, argue that the legality of the S&P in fact “supports” IFRIC 15 as the purchaser can technically cancel or reverse the deal provided the property has not been physically handed over.

A lawyer confirms that the Housing Development Act (HDA) does provide for termination of the S&P and that the developer can forfeit 10% to 20% of money paid thus far, depending on the work completed and billed for.

A developer however explains that this will only apply to a buyer who pays in cash because in such a case, the title to the property is retained by the developer until the project is completed.

An important point is that laws in Malaysia allow for property development to be sold off the plan. So, should these laws be made subservient to IFRIC 15?

While globalisalisation is a step in the right direction, it should never give rise to a burden that will be ultimately passed on to,  in this case, property buyers as well as those who invest in the shares of property companies.


Au Foong Yee is editor of City & Country, theedgeproperty.com and haven, a bi-monthly design and garden magazine published by The Edge Malaysia.




This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 795, Mar 1-7, 2010.

 

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