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«IFRS Interpretations Agenda reference Committee Meeting March 2011 Date Staff Paper Tentative agenda decision Project IFRIC 15 Agreements for the ...»

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40. The staff’s assessment of the Interpretations Committee’s agenda criteria is as

follows:

(a) The issue is widespread and has practical relevance.

The issues described in this document are widespread and are of practical relevance in the off-plan sale of real estate industry. Geographical diversity extends from Asia to South America.

(b) The issue indicates that there are significantly divergent interpretations (either emerging or already existing in practice). The Committee will not add an item to its agenda if IFRSs are clear, with the result that divergent interpretations are not expected in practice.

There are currently differing views as to what ‘continuous transfer’ means and how it should be applied in practice.

(c) Financial reporting would be improved through elimination of the diverse reporting methods.

In off-plan sales of real estate, the revenue recognition pattern varies significantly depending on the assessment of the transfer of risks and rewards and control. The staff believe that providing guidance on the meaning of continuous transfer will help enhance comparability.

(d) The issue can be resolved efficiently within the confines of existing IFRSs and the Framework, and the demands of the interpretation process.

The issue is sufficiently narrow in order to be addressed by an interpretation of the IFRS Interpretations Committee.

(e) It is probable that the Committee will be able to reach a consensus on the issue on a timely basis.

Yes.

–  –  –

(f) If the issue relates to current or planned IASB project, is there a pressing need for guidance sooner than would be expected from the IASB project?

(The IFRIC will not add an item to its agenda if an IASB project is expected to resolve the issue in a shorter period than the IFRIC would require to complete its due process).

The Board is currently discussing the revenue recognition project with a view to finalise Revenue from Contracts with Customers by June 2011. The new standard will incorporate IFRIC 15 Agreements for the Construction of Real Estate and might not be effective before 2015.

Staff’s recommendations

41. Given the agenda criteria assessment above, the staff recommend that the Interpretations Committee should take the issue onto its agenda with the aim of providing further guidance in IFRIC 15 to help determine whether the transfer of control is on a continuous basis or at one specific point in time.

Questions to the Interpretations Committee

–  –  –

Appendix A - Text of the submission The text was rendered anonymous.

[Submitter] request the IFRS Interpretations Committee to address the following issue with respect to the application of IFRIC 15 Agreements for the Construction of Real Estate to off-plan sales of real estate.

Issue In July 2008 the IASB issued IFRIC 15 Agreements for the Construction of Real Estate.

This Interpretation addresses the questions (i) whether (a part of) an agreement is within the scope of IAS 11 or IAS 18 and (ii) to the extent the agreement is within the scope of IAS 18, whether it is for the rendering of services or for the sale of goods. This agenda item request is confined to agreements within the scope of IAS 18, for the sale of goods.

IFRIC 15 in par. 16 and BC23 notes that even though the seller has to perform certain services, the conditions referred to in par. 14 (Sale of Goods) of IAS 18 Revenue must be met for revenue to be recognised. Par. 17 and 18 of IFRIC 15 clarify that two of those conditions, i.e. (i) transfer of control to the buyer and (ii) transfer of risks and rewards of ownership to the buyer, may be met either (a) continuously as construction progresses or (b) only in its entirety at a single time (e.g. at completion, upon or after delivery).

Although the condition 'transfer of risks and rewards of ownership' is referred to in par. 14 of IAS 18, the notions 'transfer of control' or 'continuous transfer of control' are not. So there is little guidance in IAS 18 to fall back to when assessing when transfer of control takes place continuously or when it occurs in its entirety. IFRIC 15 does not contain such guidance either. In BC26 the Committee notes that agreements with 'continuous transfer' might not be encountered frequently, but neither the body of the interpretation nor the Basis provide indicators to assess when control transfers continuously. It is only in Illustrative Example 2 (IE6-IE8) that certain indicators are mentioned. However, since the two scenarios laid out in this example are extreme ends on a continuum, the judgement remains very difficult.

We realise that determining whether control transfers to the buyer continuously as construction progresses is a judgement call requiring careful analysis of all facts and circumstances, including legal documentation and an understanding of local law and rights and obligations of buyers and sellers of real estate in a particular jurisdiction. However, we have become aware of significant divergence in interpretation of the circumstances under which control and risks and rewards are deemed to have passed to the buyer continuously as construction progresses. These interpretations go beyond detailed interpretations of a contract or law. They are about the very nature of control. Since the outcome of this assessment has a significant effect on the timing of revenue recognition and therefore on the financial performance of real estate developers and construction companies we believe such a wide diversity of practice is hampering comparability of financial statements prepared under IFRS.





We are aware of the following potential interpretations, although this list is not necessarily

exhaustive:

A. Some would argue that continuous transfer of control to the buyer means that the buyer must have legal title to the work in progress. This is based on IE8 where the only variable that is changed from the fact pattern in IE6 is that the seller transfers ownership of the real estate in its current state of completion to the buyer immediately upon signing of the contract. Hence, any additional construction becomes the property of the buyer as construction progresses.

–  –  –

B. Others would argue that besides legal title there may be other ways in which a buyer can receive control over the work in progress while construction progresses. For example, if the agreement is terminated before construction is completed, the buyer retains the work in progress and the seller has the right to be paid for the work performed. This is based on the third sentence of IE8 and on the fact that legal title may just be one way of demonstrating control.

C. Some would go further and consider that as long as the protective rights of the buyer are such that control no longer rests with the seller, the criteria of continuous transfer are met. For example, if the seller would fail to meet its obligation, the buyer would not own the work in progress, but the state or some other agency would step in and decide the next steps. So it would not be necessary for control to be transferred to the buyer. As long as control does not entirely rest with the seller and there are sufficient protective rights of the buyer, the seller can claim it transfers control continuously while construction progresses.

D. Another view would be that continuous transfer can never take place in the case of individual units in a block of apartments since for technical reasons alone, the foundation and the first floor must be built before construction on the third Floor, for example, can even begin. The margin on the sale of units on the first floor may be significantly different from those on the 15th floor.

Continuous transfer would therefore mean that all agreements with all buyers are being considered as one unit of account which is inconsistent with IAS 18 as they are not negotiated as one contract.

To illustrate this diversity in practice we attach as an appendix the Accompanying Note on Application of INT FRS 115 issued by the Singapore Accounting Standards Council as part of their equivalent of IFRIC 15 (“Accompanying Note”). The interpretation in the Accompanying Note is different from practice we find in Europe and the Middle-East. Although this Accompanying Note was issued as part of Singapore GAAP, we understand there is an expectation in Singapore that there is no difference on this point between Singapore GAAP and IFRS. We have been made aware of several regulators weighing in on this issue. The interpretation of continuous transfer of control and risks and rewards is relevant in most jurisdictions; we are aware of recent discussions in Singapore, Malaysia, The Philippines, Korea and Brazil.

We are aware of the fact that the IASB is finalising a standard on revenue recognition (“Revenue ED”) which contains the notion of continuous transfer of control. Analogising to the Revenue ED seems inappropriate as it intends to apply one model to all sources of revenue, i.e. sale of goods and rendering of services. Continuous transfer of control would also apply to contracts that are currently dealt with in IAS 11. Percentage of completion accounting as required by IAS 11 provides the same result as continuous transfer would under IAS 18. This probably explains why the indicators of continuous transfer of control in the Revenue ED contains notions that go beyond the indicators in the illustrative example in IFRIC 15 and seem to be taken from IAS 11, for example whether the buyer has a significant say in the design of the asset. The problems encountered when applying IFRIC 15 may also surface when applying the final revenue recognition standard if issued on the basis of the Revenue ED. We also note that it may take a few years before that standard becomes mandatory.

We ask the Committee to clarify whether:

 continuous transfer of control means that (i) the buyer actually receives control over the asset in its partially completed state while construction takes place, or (ii) the seller loses control and buyer receives protective rights while actual transfer only takes place at a later date, e.g., completion of construction;

 control means that (i) the buyer has or takes legal or physical possession of work in progress while construction takes place, or (ii) it is sufficient that the seller is unable to sell the work in progress to anyone else; and

–  –  –

 the unit of account, for determining whether control transfers continuously while construction takes place is each individual apartment in a block of apartments or the entire block.

Reasons for the IFRS Interpretations Committee to address the issue:

(a) The issue is widespread and has practical relevance This issue is relevant in every sale of off-plan real estate in every jurisdiction and therefore widespread.

(b) The issue indicates that there are significantly divergent interpretations (either emerging or already existing in practice). The Committee will not add an item to its agenda if IFRSs are clear, with the result that divergent interpretations are not expected in practice.

As indicated above, there is evidence of significantly divergent interpretation emerging in practice.

(c) Financial reporting would be improved through elimination of the diverse reporting methods The assessment of whether control and risks and rewards are transferred continuously to the buyer as construction progresses determines the choice between two very different revenue recognition methods and therefore has a significant effect on the financial performance of companies in this sector. Divergence in practice would seriously hamper comparability of financial statements.

(d) The issue can be resolved efficiently within the confines of existing IFRSs and the Framework, and the demands of the interpretation process Yes, we believe IFRIC 15 can be clarified within the confines of IAS 18 and the Framework.

(e) It is probable that the Committee will be able to reach a consensus on the issue on a timely basis Yes, we believe the Committee will be able to clarify the wording of IFRIC 15 on a timely basis to limit divergence of practice.

(f) If the issue relates to a current or planned IASB project, there is a pressing need to provide guidance sooner than would be expected from the IASB’s activities. The Committee will not add an item to its agenda if an IASB project is expected to resolve the issue in a shorter period than the Committee requires to complete its due process.

We are aware of the fact that the Board is currently finalising its standard on Revenue Recognition which will absorb IFRIC 15. The effective date of this new standard, however, is not expected to be within the next few years. We therefore believe the Committee is able to help practice during the years IFRIC 15 is still applicable by clarifying the wording of IFRIC 15.

Literature

IAS 18 Revenue 14 Revenue from the sale of goods shall be recognised when all the following conditions have

been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

–  –  –

IFRIC 15 Agreements for the Construction of Real Estate The agreement is an agreement for the sale of goods 16 If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver the real estate to the buyer, the agreement is an agreement for the sale of goods and the criteria for recognition of revenue set out in paragraph 14 of IAS 18 apply.

17 The entity may transfer to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as construction progresses. In this case, if all the criteria in paragraph 14 of IAS 18 are met continuously as construction progresses, the entity shall recognise revenue by reference to the stage of completion using the percentage of completion method. The requirements of IAS 11 are generally applicable to the recognition of revenue and the associated expenses for such a transaction.



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