This article first appeared in Forum, The Edge Malaysia Weekly on December 11, 2017 - December 17, 2017

Revenue is one of the most important barometers for any business and the new revenue recognition standard developed to improve this area of financial reporting is set to bring significant changes to the current accounting landscape and prevailing industry practice.

Effective Jan 1, 2018, FRS 2012004 Property Development Activities (FRS 201) will be replaced by MFRS 15 Revenue from Contracts with Customers (MFRS 15), the equivalent of IFRS 15. How will this affect property developers in Malaysia?

Timing of revenue recognition

One of the key concerns which may arise in the adoption of the new revenue standard is the timing of revenue recognition — whether revenue should be recognised over the period of the contract, or upon completion of the contract. To determine this, property developers will need to assess if they have an alternative use for the assets they are constructing and whether they have an enforceable right to be paid for work completed to date. Revenue in respect of property development activities can only be recognised over the period of the contract if both tests are met.

In Malaysia, properties sold to customers are uniquely identified by plot and unit numbers in the sales and purchase agreement (SPA), and hence property developers are legally prohibited from substituting the properties sold with other properties (“alternative use test” is met).

The “enforceable right test” requires property developers to determine whether the practices in the legal jurisdiction indicate that they have an enforceable right to payments for work completed to date. Such enforceable right is established for the development of residential properties governed under the Housing Development Act (HDA) in Malaysia. However, property developers will need to determine whether the practices in the legal jurisdiction in Malaysia provide them with the right to payments for work completed to date for the development of commercial properties in Malaysia, which are not governed under the HDA.

The aforementioned assessments will also be applicable to property development activities outside Malaysia and such assessments will have to be made based on the practices in the legal jurisdiction of the respective countries.

Different payment schemes

Property developers may offer different payment schemes to their customers. For example, some property developers may only require payment of 90% of the purchase price to be made on completion of the property units (10:90 scheme). Such payment schemes are often viewed as a form of financing provided by the property developers to their customers.

Under the new revenue standard, such financing arrangements are required to be separately recognised in the income statement. Accordingly, the revenue in respect of property development activities with such payment schemes will be reduced by the amount of interest income. Key financial measures and ratios such as revenue and Ebitda may also be affected.

Free goods and services provided to customers

Certain property developers may offer free goods and services to their customers, such as free maintenance fees and furniture. These goods and services are capable of being separated even though they may be negotiated as a package under a single contract. The new revenue standard requires these goods and services to be accounted for separately from the property units. Consequently, the timing and amount of revenue to be recognised may therefore change (see charts).

Some developers may also offer to reimburse their customers’ legal fees and stamp duties for the property units purchased. Such reimbursement is effectively a “consideration payable by the property developers to the customers”. Under the new revenue standard, such consideration payable to the customer needs to be deducted from the revenue.

With the advent of the new revenue standard, it is important for property developers to evaluate their contractual terms and customary business practices to identify all the goods and services in a contract as these may have an impact on their annual key financial measures and ratios.

Hoh Yoon Hoong is a partner and the Malaysia real estate leader of Ernst & Young. The views in this article are those of the author and do not necessarily reflect the views of the global EY organisation or its member firms. This is the first of a two-part series on the accounting disruptions to property developers.

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