The article is published in the September issue of the ISCA Journal.
Will there be much change for developers and other companies active in the real estate market when they apply the principles of FRS 115 in their revenue process? We will briefly highlight the areas companies in the real estate sector should be watching out for with respect to the new accounting standard for revenues
Laws and regulations do affect timing of revenue recognition
Location, location, location - the three key value drivers for real estate are also important when it comes to revenue recognition. Local laws and regulations vary significantly, not just between countries but even between different types of real estate within the same country, such as residential and commercial properties. This is affecting revenue recognition in particular for developers.
One of the conditions that needs to be fulfilled in order to recognise revenue over the period of construction of a property is the "enforceable right to payment for performance completed to date" (FRS 115.35(c)) that the developer needs to have. What does that mean in practice?
In the Singapore context, "Standard Residential Sales & Purchase Agreements" (SPA) contain clauses that are interpreted as giving the developer such a right. Past legal cases also support that interpretation. Typically, both parties to the SPA are bound by the agreement and neither party has the right to early terminate the contract unilaterally. However, the right to payment for performance to date needs to be assessed against the background of a breach of contract by the buyer. SPAs governed by Housing & Development Board’s rules that require the buyers to qualify for the purchase of the property at TOP (Temporary Occupation Permit) when the property is handed over will not be able to recognise revenue over time.
The contingency that the rules introduce prevents the developer from having the right to payment for performance to date until the contingency is resolved upon handover of the property. For customised sale and purchase agreements, for example, for the construction of commercial properties, an analysis of the contract terms will be required in order to determine the appropriate timing for revenue recognition.
As most property developers are not only active in Singapore, but also across the region, separate assessments will be required for the various legal jurisdictions within which they develop properties. The result will likely be that revenue recognition will not be consistent across the region. For some of the development projects, revenue will likely be recognised over time, whereas for other projects, revenue will only be recognised upon completion.
Measurement of progress under FRS 115 and potential changes to existing accounting policies
Another aspect that should be considered is how progress is measured when revenue is recognised over time. The percentage of completion will drive revenue recognition and in particular, the reported profit. FRS 115 does contain some guidance on how to measure progress, and companies should carefully assess whether any changes to their current accounting policies are required.
Uninstalled materials and equipment, for example, an elevator delivered to the construction site but not yet installed, should not be taken into consideration when assessing the stage of completion. As for land, given its high cost in Singapore, the most significant aspect will be how to include the cost of land in the determination of the percentage of completion and whether any change to the currently applied methodology is required. There are mixed views on this matter of land cost and this issue has been raised to the IASB-FASB Joint Transition Resource Group for Revenue Recognition for clarification.
The article is contributed by Mr Reinhard Klemmer, partner at KPMG in Singapore. The views expressed are his own.