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Property Sector
IFRIC 15
“If it isn’t broken, don’t fix it”
IFRIC 15 interpretations unresolved. We recently hos ted an IFRIC 15 seminar, conducted by Pascal Jauffret, Head of Mazars IFRS, Asia Pacific, to better understand the matter. It has been unsettling for investors as the interpretation of IFRIC 15 remains unresolved as we have passed the MASB adoption dateline of 1 July 2010. Mazars Malaysia has been appointed by REHDA to advice on what was permitted by IFRIC 15 in the France and Belgium context; both countries has successfully adopted IFRIC 15 but still continue to permit ‘percentage -o f-completion’ (PoC) method.
The issue of IFRIC 15 in Malaysia. Most, if not all Malaysian developers prefer to maintain the PoC method. They believe property development revenue recognition ‘at a single point in time upon completion’ (a.k.a. completion method) is not reflective of the prevailing business model of a Sell -Than-Build basis.
‘Completion method’ could end up confusing investors . Besides lumpy earnings, volatile balance sheets and mismatching cashflow to earnings, investors will only be left with RNAV and P/CF as comparative metrics; as it is RNAVs are extremely subjective.
Implementation of IFRIC 15 still in discussion. Dialogues are currently taking place between respective parties (e.g. REHDA, MASB, MIA). SC and Bursa areobserving this matter closely due to concerns of potential adverse reaction from investors, particularly as the property sector is one of the cornerstones of the Malaysian economy which facilitates the multiplier effect. Potential sell downs may prevent developers from raising financing from both equity and banks. Many smaller/niche developers with weak balance sheet will be out of the game, disrupting supply and healthy competition. There is a possibility that the implementation dateline may be deferred given no resolution from dialogues yet.
IFRIC 15 = ‘completion method’ is a misconception. Rather, it is about who has ownership i.e. control and risk/reward of the acquired property base on the law of the Malaysian jurisdiction.
Control, risks and rewards with developers or buyers? Under the Malaysian Sales and Purchase Agreement (SPA) for real estate, buyers are allowed to transfer or pledge his/her acquired real-estate while it is under construction, meaning the risk/rewards of the acquisition has been fully transferred from developer to buyer. Hence, the criteria for continuous sale are met, implying the PoC method is still applicable under IFRIC 15.
We strongly opine it is in the sector’s best interest to continue using PoC method as it best reflects the Malaysian developers’ business model. The sector has lost its luster after the exclusion of large developers from the new KLCI index (e.g. SP Setia) , possibility of higher RPGT, and should the ‘completion method’ be adopted across the board for all property companies.
We think the PoC method will prevail. There is little benefit from to adopt a completion method of accounting when the actual practice is sale by percentage of completion. The adoption forces the mismatched in income recognition which goes again the root principle of accounting that is to reflect a true and fair view. If Malaysia reverts to ‘completion method’, real -estate SPA will need to be changed to address the issue of ownership. This we believe is more arduous. Like the saying goes, “if it isn’t broken, don’t fix it”.
Key Points
IFRIC 15 interpretations unresolved. We recently hosted an IFRIC 15 seminar, conducted by Pascal Jauffret, Head of Mazars IFRS, Asia Pacific, to better understand the matter . It has been unsettling for investors as the interpretation of IFRIC 15 remains unresolved as we have passed the MASB adoption dateline of 1 July 2010. Mazars Malaysia has been appointed by REHDA to advice on what was permitted by IFRIC 15 in the France and Belgium context; both countries has successfully adopted IFRIC 15 but still continue to permit ‘percentage -of-completion’ method.
The issue of IFRIC 15 in Malaysia. Most, if not all, Malaysian developers are opposing property development revenue recognition ‘at a single point in time upon completion’ (a.k.a. completion method) method. In the Malaysian context, majority of property sales is based on a Sell -Than-Build (STB) basis, rather than the Build-Then-Sell (BTS) basis (e.g. Australia) . Malaysian developers strongly believe the conventional ‘percentage-of-completion’ (PoC) method best reflects their business models.
Developers could end up with extremely lumpy earnings and volatile balance
sheets based on the ‘completion method’. Ironically, it goes against the grain of the IFRS goal of increasing reporting transparency. PER, PBV and PEG will no longer be relevant as valuation and comparable metrics and investors will only be left with RNAV and P/CF; it leaves very little room for analysis as RNAVs are subjective. There will also be mismatches of cash flow vs. earnings as collections of housing payments are still on a progressive basis; this is not reflective of true sales and real billings (e.g. collections lag behind actual billings), making investors’ assessment of developers much tougher. We understand developers will need to maintain two sets of financials; one for reporting purposes and the other for tax reasons. As a result, more accountants are needed and hence, higher cost.
Implementation of IFRIC 15 still in discussion. Dialogues are currently taking place between the Malaysian Accounting Standards Board (MASB), Malaysia Institute of Accountants (MIA) and REHDA (representing developers). Admittedly, the discussion of implementations with FRSIC * should have taken place 12-18 months ago to allow for smooth implementati on. Hence there is possibility of deferring the IFRIC 15 implementation.
* FRSIC or Financial Reporting Standards Implementation Committee is meant to provide guidance to MIA members on how accounting standards should be implemented.
We also understand that the governing body of MASB or Financial Reporting Foundation (FRF) which includes members of the SC, Bursa, Khazanah and IJM Corporation; are concern about potential adverse reaction from investors’, particularly as the property sector is one of the cornerstones of the Malaysian economy while the recent Budget expects the private sector to lead economic recovery.
Implications of ‘completion method’. There are grounds to be concern about investors’ perception of the sector, even though ‘completion method’ under IFRIC 15 will leave developer’s cash flow unchanged. Smaller or niche developers which do not have steady ‘bread-and-butter’ earnings from townships may be subjected to yearly or quarterly losses as overheads and finance cost continues. It may cause sell-downs as investors are unable to ascertain true financial health of the companies. We believe the authorities like SC and Bursa are also concern about the ramifications of the adoption of this standard.
The sell downs may prevent developers from raising financing from both equity and banks. Ultimately, the resulting will eliminate many smaller/niche developers, which reduces supply and hence, less competitive pricings in the market. We think it is unlikely to see larger developers moving towards a BTS business model if the ‘completion method’ is implemented as developers are still allowed to progressively bill buyers.
IFRIC 15 = ‘completion method’ is a misconception. Rather, it is about who has ownership i.e. control and risk/reward of the acquired property base on the law of the Malaysian jurisdiction. According to the IFRS Foundation, the interpretation of IFRIC 15 is meant to provide guidance on how to determine whether an agreement for the construction of real estate is within the scope of IAS 11 Construction Contracts or IAS 18 Revenue and when revenue from the construction should be recognized. (Refer to appendix for IAS11 and IAS18 standards to account for revenue from the construction of real estate). The flow chart below accompanies the Interpretation of IFRIC 15, providing room for Malaysian developers to argue for PoC method.
Control, ri ks and rewards with developers or buyers? Under the Malaysian
Sales and Purchase Agreement (SPA) for real estate, buyers are allowed to transfer or pledge his/her acquired real-estate while it is under construction, meaning the risk/rewards of the acquisition has been fully transferred from developer to buyer. Hence, the criteria for continuous sale are met, implying the PoC method is still applicable under IFRIC 15. Also, on a legal front, buyers become the beneficial owner of the property very soon after the SPA are signed. In our Appendix, we have attached a table used by REHDA to ascertain where the risk/reward and control of an acquired p roperty still under construction lies.
Differentiating between business and buyers risks. One might argue that under a STB, a buyer who buys on launch has locked-in prices at his/her sale price and developers bear the volatility risks of building material costs. However, this would be deem as a business risks like any other, which is seen in other businesses e.g.
OEM sales where price is determined at the start of the contract and the manufacturer bears risk of its raw material costs. France has successfully adopted IFRIC 15 but still continue to permit PoC method based on IFRIC 15 because of the features of their real estate contracts or VEFA contracts (see Appendix for further details). According to Mazars, risks and rewards lie with the buyer under VEFA contracts since;
What will likely happen if there is still no resolution? Developers with FYE 30 June 11 (e.g. Sunrise and Hunza Properties) will be the first to be impacted. However, if there is still no resolution, we believe these developers will continue with the conventional reporting standard i.e. PoC.
We strongly opine it is in the sector’s best interest to continue using PoC method as it best reflects the Malaysian developers’ business model. The sector has lost its luster post the exclusion of key pure developers from the new KLCI index (e.g. S P Setia) and threats of higher RPGT, and will be more worse off if we employ the ‘completion method’.
We think the PoC method will prevail. It will cause too much confusion amongst investors and reduce interest in the sector as a whole. It also means additional non-value add work and costs for developers. If Malaysia reverts to ‘completion method’, real-estate SPA will need to change to address the issue of ownership; this we believe is more arduous than keeping to our conventional PoC method. Like the saying goes , “if it isn’t broken, don’t fix it”.
Appendix
France’s VEFA contracts are recognized using the PoC method under IFRIC 15. Main features of VEFA (Vente en l’Etat Futur d’Achèvement, Sale of a real estate to be terminated are defined by the French Code Civil (art. 1601-03) contracts are as followed;
IFRIC 15
“If it isn’t broken, don’t fix it”
IFRIC 15 interpretations unresolved. We recently hos ted an IFRIC 15 seminar, conducted by Pascal Jauffret, Head of Mazars IFRS, Asia Pacific, to better understand the matter. It has been unsettling for investors as the interpretation of IFRIC 15 remains unresolved as we have passed the MASB adoption dateline of 1 July 2010. Mazars Malaysia has been appointed by REHDA to advice on what was permitted by IFRIC 15 in the France and Belgium context; both countries has successfully adopted IFRIC 15 but still continue to permit ‘percentage -o f-completion’ (PoC) method.
The issue of IFRIC 15 in Malaysia. Most, if not all Malaysian developers prefer to maintain the PoC method. They believe property development revenue recognition ‘at a single point in time upon completion’ (a.k.a. completion method) is not reflective of the prevailing business model of a Sell -Than-Build basis.
‘Completion method’ could end up confusing investors . Besides lumpy earnings, volatile balance sheets and mismatching cashflow to earnings, investors will only be left with RNAV and P/CF as comparative metrics; as it is RNAVs are extremely subjective.
Implementation of IFRIC 15 still in discussion. Dialogues are currently taking place between respective parties (e.g. REHDA, MASB, MIA). SC and Bursa areobserving this matter closely due to concerns of potential adverse reaction from investors, particularly as the property sector is one of the cornerstones of the Malaysian economy which facilitates the multiplier effect. Potential sell downs may prevent developers from raising financing from both equity and banks. Many smaller/niche developers with weak balance sheet will be out of the game, disrupting supply and healthy competition. There is a possibility that the implementation dateline may be deferred given no resolution from dialogues yet.
IFRIC 15 = ‘completion method’ is a misconception. Rather, it is about who has ownership i.e. control and risk/reward of the acquired property base on the law of the Malaysian jurisdiction.
Control, risks and rewards with developers or buyers? Under the Malaysian Sales and Purchase Agreement (SPA) for real estate, buyers are allowed to transfer or pledge his/her acquired real-estate while it is under construction, meaning the risk/rewards of the acquisition has been fully transferred from developer to buyer. Hence, the criteria for continuous sale are met, implying the PoC method is still applicable under IFRIC 15.
We strongly opine it is in the sector’s best interest to continue using PoC method as it best reflects the Malaysian developers’ business model. The sector has lost its luster after the exclusion of large developers from the new KLCI index (e.g. SP Setia) , possibility of higher RPGT, and should the ‘completion method’ be adopted across the board for all property companies.
We think the PoC method will prevail. There is little benefit from to adopt a completion method of accounting when the actual practice is sale by percentage of completion. The adoption forces the mismatched in income recognition which goes again the root principle of accounting that is to reflect a true and fair view. If Malaysia reverts to ‘completion method’, real -estate SPA will need to be changed to address the issue of ownership. This we believe is more arduous. Like the saying goes, “if it isn’t broken, don’t fix it”.
Key Points
IFRIC 15 interpretations unresolved. We recently hosted an IFRIC 15 seminar, conducted by Pascal Jauffret, Head of Mazars IFRS, Asia Pacific, to better understand the matter . It has been unsettling for investors as the interpretation of IFRIC 15 remains unresolved as we have passed the MASB adoption dateline of 1 July 2010. Mazars Malaysia has been appointed by REHDA to advice on what was permitted by IFRIC 15 in the France and Belgium context; both countries has successfully adopted IFRIC 15 but still continue to permit ‘percentage -of-completion’ method.
The issue of IFRIC 15 in Malaysia. Most, if not all, Malaysian developers are opposing property development revenue recognition ‘at a single point in time upon completion’ (a.k.a. completion method) method. In the Malaysian context, majority of property sales is based on a Sell -Than-Build (STB) basis, rather than the Build-Then-Sell (BTS) basis (e.g. Australia) . Malaysian developers strongly believe the conventional ‘percentage-of-completion’ (PoC) method best reflects their business models.
Developers could end up with extremely lumpy earnings and volatile balance
sheets based on the ‘completion method’. Ironically, it goes against the grain of the IFRS goal of increasing reporting transparency. PER, PBV and PEG will no longer be relevant as valuation and comparable metrics and investors will only be left with RNAV and P/CF; it leaves very little room for analysis as RNAVs are subjective. There will also be mismatches of cash flow vs. earnings as collections of housing payments are still on a progressive basis; this is not reflective of true sales and real billings (e.g. collections lag behind actual billings), making investors’ assessment of developers much tougher. We understand developers will need to maintain two sets of financials; one for reporting purposes and the other for tax reasons. As a result, more accountants are needed and hence, higher cost.
Implementation of IFRIC 15 still in discussion. Dialogues are currently taking place between the Malaysian Accounting Standards Board (MASB), Malaysia Institute of Accountants (MIA) and REHDA (representing developers). Admittedly, the discussion of implementations with FRSIC * should have taken place 12-18 months ago to allow for smooth implementati on. Hence there is possibility of deferring the IFRIC 15 implementation.
* FRSIC or Financial Reporting Standards Implementation Committee is meant to provide guidance to MIA members on how accounting standards should be implemented.
We also understand that the governing body of MASB or Financial Reporting Foundation (FRF) which includes members of the SC, Bursa, Khazanah and IJM Corporation; are concern about potential adverse reaction from investors’, particularly as the property sector is one of the cornerstones of the Malaysian economy while the recent Budget expects the private sector to lead economic recovery.
Implications of ‘completion method’. There are grounds to be concern about investors’ perception of the sector, even though ‘completion method’ under IFRIC 15 will leave developer’s cash flow unchanged. Smaller or niche developers which do not have steady ‘bread-and-butter’ earnings from townships may be subjected to yearly or quarterly losses as overheads and finance cost continues. It may cause sell-downs as investors are unable to ascertain true financial health of the companies. We believe the authorities like SC and Bursa are also concern about the ramifications of the adoption of this standard.
The sell downs may prevent developers from raising financing from both equity and banks. Ultimately, the resulting will eliminate many smaller/niche developers, which reduces supply and hence, less competitive pricings in the market. We think it is unlikely to see larger developers moving towards a BTS business model if the ‘completion method’ is implemented as developers are still allowed to progressively bill buyers.
IFRIC 15 = ‘completion method’ is a misconception. Rather, it is about who has ownership i.e. control and risk/reward of the acquired property base on the law of the Malaysian jurisdiction. According to the IFRS Foundation, the interpretation of IFRIC 15 is meant to provide guidance on how to determine whether an agreement for the construction of real estate is within the scope of IAS 11 Construction Contracts or IAS 18 Revenue and when revenue from the construction should be recognized. (Refer to appendix for IAS11 and IAS18 standards to account for revenue from the construction of real estate). The flow chart below accompanies the Interpretation of IFRIC 15, providing room for Malaysian developers to argue for PoC method.
Control, ri ks and rewards with developers or buyers? Under the Malaysian
Sales and Purchase Agreement (SPA) for real estate, buyers are allowed to transfer or pledge his/her acquired real-estate while it is under construction, meaning the risk/rewards of the acquisition has been fully transferred from developer to buyer. Hence, the criteria for continuous sale are met, implying the PoC method is still applicable under IFRIC 15. Also, on a legal front, buyers become the beneficial owner of the property very soon after the SPA are signed. In our Appendix, we have attached a table used by REHDA to ascertain where the risk/reward and control of an acquired p roperty still under construction lies.
Differentiating between business and buyers risks. One might argue that under a STB, a buyer who buys on launch has locked-in prices at his/her sale price and developers bear the volatility risks of building material costs. However, this would be deem as a business risks like any other, which is seen in other businesses e.g.
OEM sales where price is determined at the start of the contract and the manufacturer bears risk of its raw material costs. France has successfully adopted IFRIC 15 but still continue to permit PoC method based on IFRIC 15 because of the features of their real estate contracts or VEFA contracts (see Appendix for further details). According to Mazars, risks and rewards lie with the buyer under VEFA contracts since;
- French law outlines the buyer having complete exposure to changes in market value of the property under construction;
- The buyer is able to sell or pledge its property while under construction, hence benefiting the buyer;
- The buyer is able to hire another contractor if the current developer fails to complete the project. Hence, developers in France tend to offer bank guarantees.
What will likely happen if there is still no resolution? Developers with FYE 30 June 11 (e.g. Sunrise and Hunza Properties) will be the first to be impacted. However, if there is still no resolution, we believe these developers will continue with the conventional reporting standard i.e. PoC.
We strongly opine it is in the sector’s best interest to continue using PoC method as it best reflects the Malaysian developers’ business model. The sector has lost its luster post the exclusion of key pure developers from the new KLCI index (e.g. S P Setia) and threats of higher RPGT, and will be more worse off if we employ the ‘completion method’.
We think the PoC method will prevail. It will cause too much confusion amongst investors and reduce interest in the sector as a whole. It also means additional non-value add work and costs for developers. If Malaysia reverts to ‘completion method’, real-estate SPA will need to change to address the issue of ownership; this we believe is more arduous than keeping to our conventional PoC method. Like the saying goes , “if it isn’t broken, don’t fix it”.
Appendix
France’s VEFA contracts are recognized using the PoC method under IFRIC 15. Main features of VEFA (Vente en l’Etat Futur d’Achèvement, Sale of a real estate to be terminated are defined by the French Code Civil (art. 1601-03) contracts are as followed;
- The developer enters into a continuous sale with a buyer;
- The ownership of the land is transferred to the buyer when the contract is signed;
- The ownership of the property is transferred to the buyer as the building is being built up. There is a continuous transfer of proper ty ;
- The buyer can sell or pledge the land before the construction of the building is completed;
- The right of the buyer on the existing building under construction and over the future building (eg once finished) can be sold or pledged by the buyer. (Excerpts from Mazar’s presentation)
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