Developers need to take IFRIC 15 seriously

In another step towards full convergence with the International Financial Reporting Standards (IFRS) in 2012, the Malaysian Accounting Standards Board (MASB) last week announced the issuance of three revised Financial Reporting Standards (FRSs), amendments to five existing FRSs and four new interpretations.

While the issuance and amendments of the FRSs and interpretations have been exposed, discussed and commented on in the past, the interpretation on the agreements for the construction of real estate or IFRIC 15 would have a major impact on the property development industry in Malaysia.

Under the present FRS 2012004, Property Development Activities, the revenue from property development activities is generally accounted for using the percentage of completion method, that is, revenue is recognised as the project progresses.

FRS 2012004 will be withdrawn with effect from July 1, 2010, when IFRIC 15 will be operational and becomes part of the applicable approved accounting standards in Malaysia.

Essentially IFRIC 15 clarifies the difference between a construction contract which should be accounted for under FRS 111, Construction Contracts, with a contract for the sales of goods which FRS 118, Revenue, will be applicable.

According to IFRIC 15, a construction contract is when the buyer is able to specify the major structural elements of the design of the real estate before construction begins or specify major structural changes once construction is in progress. Hence, FRS 111 shall apply.

In contrast, IFRIC 15 takes the view that an agreement for the construction of real estate in which buyers have only limited ability to influence the design of the real estate, for example to select a design from a range of options specified by the entity, or to specify only minor variations to the basic design, is an agreement for the sale of goods within the scope of FRS 118.

If the agreement or a component of the agreement has the elements of rendering of services, revenue may be recognised on the percentage of completion method. An indicator of a service agreement is when the entity is not required to acquire and supply construction materials.

On the other hand, if the contracting entity is responsible to provide construction services together with construction materials in order to deliver a completed real estate to the buyers, the agreement is for the sales of goods.

Here, whether or not revenue could be accounted for using the “percentage of” method depends on whether control and significant risks and rewards of ownership of the work in progress could be transferred to the buyers as construction progresses.

In the example accompanying IFRIC 15, when a property developer retains control and significant risks of ownership of the work in progress until completion, profit is recognised on the completion of the contract.

If most of our property development contracts fall under the sales of good category and revenue is only recognised at the completion of the contracts as developers still retain control and significant risks in the ownership of the uncompleted units, property developers in Malaysia may need to revise their accounting policy and their books accordingly.

In fact, MASB indicates that IFRIC 15 “may have a significant impact on the real estate industry, particularly those involved in multiple-unit developments, such as apartments and condominiums and sell the units before the construction is completed”.

IFRIC 15 requires the effect of the change in accounting policy to be applied retrospectively, meaning affected property developers shall adjust the opening balances of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied.

While the effective date of IFRIC 15 is still around six months away, property developers which are required to apply IFRIC 15 should consider the implications and start the required process of adoption.

Those which carry a significant number of outstanding projects before the cut-off date of  July 1 would need to start looking at the terms of the sales and purchase agreements and determine how revenue for those contracts should be determined when IFRIC 15 is operational.

It would also be interesting how the Inland Revenue Board would respond to the changes brought about by IFRIC 15. At the moment, property developers are taxed based on the percentage of completion method.

Are we heading towards a regime where the difference between accounting and taxable profit would be minimised to reduce compliance burden of Malaysian corporates? This is something that the business community will monitor as more FRSs are introduced or amended as the 2012 convergence dateline arrives.

Given the emphasis on high quality financial reporting and the potential change in the practice of how revenue from property development activities would be accounted for with IFRIC 15, listed property development companies need to take IFRIC 15 seriously.
Since there is some time for any initiative to cater for the possible change and the consequential business implications, any delay in responding would increase the challenge of implementation.

Nik Hasyudeen is the CEO and thought leader of Inovastra Sdn Bhd. He is also the former president of the Malaysian Institute of Accountants (MIA). He can be contacted at [email protected]

This article appeared in The Edge Financial Daily, Jan 12, 2010.