New era of financial reporting for developers
Impending adoption of real estate accounting standard will radically change revenue figures of property development companies
Managers of property developers should brace themselves for a change in the way revenue is recognised on projects, once the Malaysian Accounting Standards Board (MASB) adopts the International Financial Reporting Interpretation on how property developers should account for their real estate development.
The impact of the new standard on property developers in Malaysia would be more significant compared to those in developed countries where most property developments locally are conceptualised on buyers buy first, developers then build, as opposed to developers build first, buyers then buy in most developed countries.
Currently, property developers have been using a local standard developed for Malaysian property industry since the 1980’s. Under FRS 201 Property Development Activities, revenue from property development activities is recognised progressively based on the stage of completion. The new interpretation issued by International Financial Reporting Interpretations Committee (IFRIC), IFRIC 15 on real estate sales, however, sets out assessment criteria which will more likely require developers to change their accounting treatment from percentage of completion basis, to a completed basis. This is because most of the developments undertaken by the developers today would almost certainly fall under the category in which revenue can only be recognised once the property is completed and delivered to the customers.
Such a requirement would result in developers having to change their revenue recognition policy, where revenue will be deferred until a project is completed.\
Just why this radical change had come about had been in response to the criticisms from international investors and analysts that the current financial statements were too summarised and inconsistently presented, as well as being overly aggregated.
A large publicly listed property developer contacted had been using the percentage of completion method to satisfy both the reporting standard and Inland Revenue Board (IRB). The company said the current practice of progressive recognition of revenue does reflect the progress of work on the ground. A one-off recognition of revenue at the completion date not only failed to match the progress of work done but also will give rise to significant fluctuations in the company earnings. Bigger players which have a number of projects annually would not feel too big an impact but the smaller ones will suffer from wild fluctuations in earnings during the years of construction.
Given that this is an international standard and Malaysia’s commitment to converge, the listed company is prepared to comply but also hopes the IRB will be willing to adopt the same basis for company taxation, failing which developers will not only have to pay taxes first before recognising the revenue in the year of assessment, but also will have to prepare two sets of accounts.
Currently, the IRB had based their tax treatment on the percentage of completion method - a method which IRB assesses the developer based on their progressive profit estimation. IFRIC 15 principles, when adopted would create a conflict with the IRB Public Ruling of 13 March 2006 which stipulated that the percentage of completion method should be the only basis of profit recognition in all forms of property development and construction contract activities. Where a developer prepares his accounts on a completion of contract method, the Director General requires the property developer to compute his income tax liability for the year of assessment by using the percentage of completion method, or the progressive payments basis to determine and declare estimated profits annually. In other words, the deferment of profits until development is completed is not permissible. Any losses will only be given a relief when the project is completed and when the amount can be ascertained accurately.
It is clear that a major area which needs to be addressed before IFRIC 15 is adopted in Malaysia is the tax base used to compute the income tax liability for property developers. It would appear that developers would be open to the idea of adopting IFRIC 15 so long as the IRB would be prepared to change their position on the tax treatment.
Costs to developers are obvious, but the benefit seems questionable as the consequential change would merely change the timing in which the revenue would be recognised, and hence the tax implication.
At the moment, it remains to be seen how strong the reactions are from other developers to the new standard and whether a conclusive outcome with the IRB is in sight before the international standard is adopted in Malaysia. Judging by the wave of convergence worldwide, it appears that the property development industry in Malaysia will very likely embrace the new era of property development activities reporting but will have to bear with having 2 sets of accounts to satisfy different regulatory bodies for a while to come.
The writer, Dr. Nordin Zain is an Executive Director in Deloitte Malaysia. He specialises in advising companies on IFRS implementation and Islamic accounting standards. He can be contacted at firstname.lastname@example.org.