Audit | Tax | Advisory

Crowe Horwath AF 1018

Member Crowe Horwath International




Will our Property Developers be affected by the
Exposure Draft Revenue Accounting Standards
(ED IAS 18)
December E-Newsletter | 18 December 2012

Introduction

The Financial Accounting Standards Board
(FASB) and International Accounting Standards
Board (IASB) (collectively known as the Boards)
released a revised exposure draft IAS 18
Revenue from Contracts with Customers in
November 2011 (ED IAS 18). The ED IAS 18 is
aimed to combine all related interpretations on
revenue accounting that were issued over the
years to deal with areas and emerging issues not
specifically addressed in IAS 18. The affected
standards include IFRIC 15 Agreements for the
Construction of Real Estate, which is identical to
our IC Interpretation 15 that has been hotly
debated by the Malaysian property industry since
MASB set a deadline of 1 July 2010 for its
adoption.

Since the issuance of the ED IAS 18, the Boards
have received enquiries seeking clarification on
the exposure drafts application. . Consequently,
the Boards have not decided on the effective date
of the ED IAS 18 currently but have said that it will
not be effective earlier than 1 January 2015.

This article attempts to summarise the differences
between ED IAS 18 and the present standards
governing revenue recognition for property
development contracts.
Current Revenue Recognition Principles

Under IAS 18

IAS 18 deals with the revenue recognition of sales
of goods and rendering of services.

In general, revenue from sales of goods is
recognised when the following conditions are
met:-
when significant risks and rewards of the
goods sold have been transferred to the
customers;
the economic benefits inflow is probable; and
the amount of revenue can be measured
reliably.

Revenue from services rendered is recognised
when the services have been performed.

The criteria for the transfer of risks and rewards
tend to focus on the transfer of legal title or
physical possession. For the sale of goods, this
can be established easily as the transfer happens
at a single point in time, for example when goods
are physically passed to the customer. However,
it is difficult to apply this principle to property
development contracts as under property
development, the risks and rewards are
transferred in stages or progressively.


Under FRS in Malaysia

Malaysian property developers are currently
applying a local accounting standard, namely FRS
201 Property Development Activities (FRS 201).
FRS 201 only allows the use of percentage-of-
completion method in recognising the revenue
from property development activities i.e. revenue
is recognised when the property development
activities progress.











Audit | Tax | Advisory


Crowe Horwath AF 1018
Member Crowe Horwath International
Under IFRIC 15

IFRIC 15 provides guidance on property
development revenue recognition and aimed to
standardise accounting practice in this area
across different jurisdictions.

The fundamental issue is whether the property
developer is selling a product (goods) the
completed property or is selling a service a
construction service as a contractor engaged by
the property buyer. Revenue from selling products
is normally recognised upon the delivery of goods
(i.e. when control is transferred) while the revenue
from rendering services is normally recognised
using the percentage-of-completion method as
construction progresses.

IFRIC 15 is critical because it determines
whether the developers in Malaysia
should abandon the long-standing
practice of reporting revenue based on
the percentage-of-completion method
and switch over to recognising revenue at
a single time at completion upon or after
the delivery (commonly known as the
completed method).

IFRIC 15 also introduces a new concept of
continuous transfer of control, but does not define
it or provide the indicators of continuous transfer
other than the limited guidance in the illustrative
examples.


Revenue Recognition Principles under the
Exposure Draft

General

The ED IAS 18 is a contract-based model, which
means that the revenue recognition principles
apply only when there is a contract with
customers. A contract can be written, oral, or
implied by an entity's customary business
practice.

The Boards have proposed that revenue is
recognised upon the satisfaction of a contractors
performance obligations, which occurs when
control of an asset (good or service) transfers to
the customer. Control can transfer either at a
point in time or continuously over the contract
period.


Control of a good or service is defined as ones
ability to direct the use of, and receive the
benefits from, a good or service. Indicators that a
customer has obtained control of a good or
service include the following:-

(a) The customer has an unconditional
obligation to pay.
(b) The customer has legal title.
(c) The customer has physical possession.
(d) The design or function of the good or service
is customer-specific.

The ED IAS 18 clarifies that not one of the above
indicators determines by itself whether a customer
has obtained control of the good or service. As a
result, an entity would need to apply judgment to
determine when control has passed, by
considering the facts and circumstances of the
arrangement.

In a straightforward sale of retail goods, the
application of these requirements to a single
performance would not pose any practical
problem. However, these principles would be
difficult to be applied by some industries, for
example construction and property
development.

Introduction of New Concept - Performance
Obligations Satisfied Over Time Principle

It is proposed that revenue is to be recognised on
the satisfaction of performance obligations, which
occurs when control of the good or service
transfers to the customer. As mentioned earlier,
control can be transferred at a point in time or,
perhaps most important for the property
development industry, continuously over the
contract period.

Under this new concept, when an entity transfers
control of a good or service over time it shall
recognise revenue progressively. (Pease take
note that this new concept of transfer over time
replaces the concept of continuous transfer used
in IFRIC 15).

Under the IFRS Conceptual Framework,
control of an asset refers to ones ability
to direct the use of, and receive the
benefits from, the asset. The ED IAS 18
gives a few illustrations on this interpretation.












Audit | Tax | Advisory


Crowe Horwath AF 1018
Member Crowe Horwath International
One of the illustrations given is that when a
customer could pledge an asset to secure for a
loan, it is presumed that control of the asset has
been transferred.

Thus, in a contract to sell and build an apartment
or a housing unit, the customer obtains control of
the asset as it is being developed. This is
because the customer obtains substantially all of
the potential cash flows from that specified
property, including pledging the asset in its
current uncompleted stage to secure a housing
loan. As such, the arrangement meets the new
concept.

Example 7 of the Illustrative Examples to the ED
IAS 18 is of particular significance to property
developers in Malaysia, and it is reproduced here
to illustrate how a property developer should
assess the Performance Obligations Satisfied
Over Time principle.





































Conclusion

In general, the new concept of the revenue
recognition under the ED IAS 18 allows the
property developers in Malaysia to continue using
the percentage-of-completion method to
recognise property development revenue.
However, the developers need to consider the
terms of the contract and the related facts and
circumstances of the arrangement when applying
the performance obligations satisfied over time
principle under the ED IAS 18.

As a result, we do not expect our current practice
in the property development industry to be
significantly affected by the proposals of the ED
IAS 18. However, these proposals are subject to
change at any time until a final standard is issued
later.


This article is written by
James Chan
Audit Partner
Crowe Horwath, Kuala Lumpur


Example 7: Determining whether an asset has an
alternative use to the entity

An entity is developing residential real estate and starts
marketing individual units (apartments). The entity has
entered into the minimum number of contracts that are
needed to begin construction.

A customer enters into a binding sales contract for a
specified unit that is not yet ready for occupancy. The
customer pays a non-refundable deposit at inception of the
contract and also promises to make payments throughout the
contract. Those payments are intended to at least
compensate the entity for performance completed to date
and are refundable only if the entity fails to deliver the
completed unit. The entity receives the final payment only on
completion of the contract (ie when the customer obtains
possession of the unit).

To finance the payments, the customer borrows from a
financial institution that makes the payments directly to the
entity on behalf of the customer. The lender has full recourse
against the customer. The customer can sell his or her
interest in the partially completed unit, which would require
approval of the lender but not the entity. The customer is able
to specify minor variations to the basic design but cannot
specify or alter major structural elements of the units design.
The contract precludes the entity from transferring the
specified unit to another customer.

The entity concludes that it has a right to payment for
performance completed to date because the customer is
obliged to compensate the entity for its performance rather
than only a loss of profit if the contract is terminated. In
addition, the entity expects to fulfil the contract as promised.
Therefore, the terms of the contract and the surrounding
facts and circumstances indicate that the entity has a
performance obligation that it satisfies over time.

To recognise revenue for that performance obligation
satisfied over time, the entity would measure its progress
towards completion in accordance with paragraphs 3848.