Accounting for revenue in the real estate, property and construction industries involves many unique challenges - from dealing with complex bundles of interrelated goods and services, to vendor guarantees and financing. But recent activity by the IASB has put yet more obstacles in the path of accountancy teams.
In May 2014, the International Accounting Standards Board (IASB) publishedIFRS 15: Revenue from Contracts with Customers. IFRS 15 contains comprehensive guidance for accounting for revenue, some of which will have a notable impact within the global real estate sector. Its publication was shortly followed by IFRS 9, which outlined the new accounting requirements for financial instruments. And earlier this year, IFRS 16: Leases was released; this new standard requires lessees to recognise nearly all leases on the balance sheet that will reflect their right to use an asset for a period of time; and the associated liability for payments. This standard will improve a lessee’s EBITDA, but also involve significant judgement and debate as to; what is a lease? How long the lease is likely to last? It will also lead to complex accounting issues for determining what represents contingent rental payments and separating out the rental element from various service components of the lease.
Although IFRS 16 will become effective in 2019, a year after 9 and 15, these three IFRS publications should be viewed together as a ‘triple whammy’ that will put an innumerable strain on the accountancy world, particularly within the real estate and construction industries. Although due to be effective on different dates, IFRS 9, 15 and 16 should be tackled together so as to minimise the disruption period as far as is possible.
Nonetheless, the amount of work that will have to go into the adoption of each of the IFRS standards should not be underestimated. BDO Global’s IFRS experts view this triple whammy as perhaps the greatest change to real estate, property and construction accountancy in decades.
The adoption of IFRS 9 will impact several processes and systems, such as the impairment process system for loans and receivables. The new standard significantly relaxes the current rules on applying hedge accounting, so many entities in the sector will be evaluating their risk management strategies for FX, interest and commodity risk, together with the type of instruments they use to hedge these risks, with the use of options and swaptions likely to become much more prevalent. Accounting for loans, receivables and investments including accounting for impairment will also become more complex and alignment of key controls within the new processes will be required.
The most significant of all the anticipated changes as a result of IFRS 9 is the new impairment rule of calculating expected loss which will require evaluating available qualitative data, data processes used by risk teams, changes in the macro economic environment and the like. Although the proposed changes to hedge accounting may open the door to hedging opportunities, they will also cause disruption to existing processes. Globally, the revised approach to classification and measurement of financial instruments may change risk management strategies.
Within the construction industry, as well as the property management industry, IFRS 15 introduces complex rules about when revenue should be recognised and what distinct goods and services are being provided to the customer. Simply entering into separate contracts for different goods and services is not a solution to the problem with IFRS 15 requiring an assessment to be performed to determine whether a contract is distinct from an existing contract or not. For example, if a new contract provides the customer with additional goods or services, but is not “distinct” from an existing contract because the price of the goods and services in the new contract does not represent the standalone selling price of those goods or services, then this requires the application of new “modification” rules. This requires for accounting purposes the closing down of the existing contract, and then the creation of a new “merged” contract, amounting to the new contract and the uncompleted amount of the existing contract. Again, this will very likely change the pattern of revenue recognition, introducing significant complexity and will require changes to processes and systems including allowing the accounts team to be aware of such contract modifications.
Within the construction and the property management industries, further issues may arise on transition, where:
- revenue may be "lost" forever and never recorded in a company's financial report; or
- revenue may be double counted, allowing companies to “double dip” and record the same revenue in the 2017 financial report and the 2018 financial report.
There are a number of ways IFRS 15 may result in revenue being recognised earlier than under IAS 18 or IAS 11, these include:
- where a constructor of condominiums, which sells units off the plan, is required under the current requirements of Interpretation 15 to only recognise revenue when the customer takes possession of the unit. Adoption of IFRS 15 may allow revenue to be recognised using the percentage of completion method.
- where the construction contract includes an award bonus, under IAS 18 / 11 the recognition of revenue in respect of this bonus may be recognised when the bonus is actually achieved. Under IFRS 15, revenue will include the bonus award from the point that it is highly probable that the constructor will not fail to achieve the requirements to receive the award/bonus. This could lead to the bonus being factored into the contract from the outset and result in accelerated revenue recognition compared with IAS 18 or IAS 11.
Similarly, there are numerous instances where IFRS 15 will result in revenue being delayed. These include:
- having to link design services with construction services;
- having to recognise "free" goods and services given to the customer after work has been completed as separate performance obligations;
- having to be conservative when accounting for penalties or awards.
Additionally, IFRS 16 will mean that any company with a property lease will have to bring their property onto their balance sheets. This presents complications, such as how to define a lease: under the new standard, a lease is a contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration. To be a lease, a contract must convey the right to control the use of an identified asset, which could be a physically distinct portion of an asset such as a specific floor of a building.
For construction companies, this standard will likely cause a lot of disruption, given how much of their equipment is acquired via a lease. Similarly, the property industry will face a number of changes with regard to the ambiguity surrounding practices such as contingent rent or rent expense. The effects on the balance sheet are expected to be significant for companies with material off balance sheet leases, as well as resulting in a higher EBITDA and operating profit.
IFRS 9, 15 and 16 present myriad challenges to accountancy teams within the real estate and construction industries. Overcoming the combined obstacles will be a real feat of preparation and skill. Nonetheless, many have not yet taken the new standards into account. BDO Global would advise entities in the sector to consider the early adoption of IFRS 16 so as to mitigate disruption to accountancy processes.
In treating these three IFRS publications as a bundle, and implementing them sooner rather than later, real estate, property and construction accountancy teams can reduce the risk of unwanted consequences of adoption; such as underlining to stakeholders possible delays in revenue recognition, preparing stakeholders for materially different balance sheets and highlighting IFRS “sensitive” contracts that are likely to be impacted by these standards including remuneration models, borrowing covenants, bonus schemes and deferred payment arrangements.
In summary, act now and early adopt. If implementation is left until 2018 it is likely to be too late.