Impact of IFRIC 15 on property stocks

If you have any property stock in your portfolio, or you plan to buy any property stock, I have a very important message to share with you.

 

Malaysia will implement a new accounting standard named as IFRIC 15, an interpretation issued by the International Financial Reporting Interpretations Committee (IFRIC) effective 1 July 2010. IFRIC has named this interpretation "Agreements for the Construction of Real Estate", which, what you guess is correct -- it will affect the accounting system of all the property developers.

 

This radical change was made in response to criticisms from international investors and analysts that the current financial statements were inconsistently presented as well as being overly aggregated.

 

Currently, it is a normal practice that property developer charge for progressive payments based on percentage of completion of the project, and once the developer received the payment (normally from the bank which the buyer financed for the property, or directly from the buyer if the property is bought in cash without financing), the amount of money will be booked into the accounting system of the developer as revenue received. For public listing property stocks, this revenue will be reported in their Quarterly Report, and is used to calculated their profit & loss.

 

Under IFRIC 15, there is possibility that the property developer can only recognise this revenue at a lump-sum after the property is 100% completed and handed over to the buyer.

 

Although IFRIC 15 clarifies that there is possibility for the "percentage of completion method" can be applied, it is unlikely in many jurisdictions that many agrrangements will meet the necessary criteria. Therefore, such arrangements will result in "deferring recognision of revenue until construction is complete", which affect the profit/loss booking in accounting.

 

The greatest impact to property developers from this deferred recognision of revenue is that, we would see zero revenue generated in a project before its completion, and there are cost - labour, materials, project management, sales & marketing, etc. incurred during construction period. With zero revenue recorded but all the cost recorded, the P&L statement will show a red figure of lost.

Then, when the property is completed and handed over, there will be a surge in revenue. By that time, the cost is also minimal as the construction has already completed. We will probably see a sudden big gain in the P&L then.

Although this is a drastic change in accounting, bear in mind that there is nothing change in the fundamental of the business, as well as the cash flow of the company. This might cause confusion to investors if not handled properly.

We can foresee that in case this happened:

• Property developers who focus on highrise building (which normally development period is 3 years) are more affected than property developers who focus more on landed property (which normally the development period is 2 years).
• Property developers who have large landbanks and a lot of development projects concurrently ongoing, are less affected than those with only a few projects running, as they can strategically schedule the development completion time more effectively.
• Property stocks who also have other type of business (such as property management, plantation, mining, etc.) are less affected than those who only involved in property development.

It is reported that the Real Estate and Housing Developers' Association (REHDA) of Malaysia has set up a task force to address and minimize issues arising from Malaysia's adoption of this IFRIC 15.