IFRS accounting for Thai developers. A new era of accountability

[Admin]

IFRS accounting for Thai developers  
Bangkok Post: 10 Apr 2011

A new era of accountability

Adoption of international accounting standards in Thailand has major implications for real estate owners and developers

SET-listed companies will soon begin reporting their first quarterly financial statements under new accounting standards. What might this mean to companies and investors? Will consistency really be improved, as promised? Or will some companies find ways to delay the pain?

International Financial Reporting Standards, or IFRS, are well known within the accounting profession but as they are adopted in Thailand, their impact will be felt across other areas of business. Here we will look at the effect on property owners and operators.

IFRS are intended to be a globally accepted set of accounting principles that better reflect a company's true financial performance. Because the standard is global, companies and investors can compare performance against a company's peer group, both domestically and internationally.

Financial statements in Thailand have historically followed Thai Generally Accepted Accounting Principles, which refer to standards issued by the Federation of Accounting Professions. However, from Jan 1 this year, the Securities and Exchange Commission requires listed companies to prepare and report statements in accordance with Thai standards based on IFRS, with full compliance from Jan 1, 2013.

PROPERTY-RELATED IFRS/IAS

The title IFRS applies to new standards issued after 2001. Those issued prior to this are called international accounting standards (IAS) and retain their old title. Three standards relate directly to property assets. For operational, owner-occupied property, these are IAS 16 (Property, Plant and Equipment) and IAS 17 (Leases). For investment property, IAS 40 (Investment Property) applies. There are other IAS that cover inventories, income taxes, revenue, impairment of assets, business combinations, and non-current assets held for sale and discontinued operations.

Out of the 50 or so IFRS, the property-related standards are among the trickiest to apply and could have the greatest impact on financial statements.

OPERATIONAL, OWNER-OCCUPIED PROPERTY

Companies have the choice of carrying existing freehold property or assets on their balance sheets at historic (original) cost or they may revalue to fair (current) value, less depreciation and impairment. Under the historic cost model, the company is not required to disclose the fair value of the asset, but this is encouraged (especially when the two figures are materially different). Once an entity has adopted a particular model, all assets with the same classification must be accounted for using this model.

IFRS also complicates the calculation of depreciation as it introduces the concept of component depreciation. This is where a property is broken down into its significant separate components, each with a differing useful life _ structure and building services, for example _ which are depreciated separately.

Where a property is "multipurpose" (used both operationally and partially income-generating) and it is possible for portions to be sold or leased separately under a finance lease, IAS 16 and IAS 40 should be applied. The entire property is treated as an investment property only if an insignificant portion is used operationally.

Upon acquisition of a company, the properties must initially be included in the purchaser's financial statements at fair value.

LEASED PROPERTY

In a lease of land and buildings, each element must be treated separately and classified as either an operating or a finance lease.

Broadly speaking, the assessment of each element depends on whether the economic risks and rewards of ownership are transferred to the lessee or remain with the lessor. For this reason, land tends to be classified as an operational lease. Buildings can either be classified as operating or finance leases, with a significant factor being the remaining useful economic life of the building upon the expiry of the lease. Where this is limited, the element is more likely to be classified as a finance lease, which will be treated as property of the lessee (and as a disposal of the property by the lessor).

Currently, with an operating lease, no asset liability is recorded on the balance sheet. A finance lease is recorded as both an asset and a liability (the present value of the committed rental payments). An apportionment of the rent payable under a lease must therefore be made for each element or, where a capital payment is made in lieu of rent, this needs be amortised appropriately.

INVESTMENT PROPERTY

Property is classified as an investment if it is held for capital appreciation or to receive rental income, or both, and includes land held for future undecided use. Initially, the carrying amount stated in the balance sheet is the cost of the property plus any transaction costs and transfer fees. Thereafter, the fair value or the historic cost models (provided fair value is also disclosed) are applied. The exception is leasehold investment property, which must be stated at fair value. In this case, there is no requirement to apportion the rent between the land and building elements. As expected in a sector focused on asset values, most companies choose the fair value model.

Fair value for investment properties should reflect market conditions at the end of the reporting period, which implies annual revaluations by an independent professionally qualified valuer.

PROPERTY DEVELOPMENT

Historically, Thai accounting standards allowed property developers to book revenues on a "percentage of completion" basis. IFRS only permits revenue to be recognised once the risks and rewards of ownership are transferred to the buyer, which usually occurs upon legal transfer of the completed property.

This is particularly relevant to residential project developers , where significant revenues are achieved from presales contracts. Some major developers in Thailand have adopted this approach but for those that have not, the impact may be felt in this quarter's results. (For example, an early adopter, LPN. Development Plc, reported first-quarter 2010 results lower than in the first quarter of 2009 and attributed this to accounting system adjustments to follow the standard.)

From the above brief review we can draw the following conclusions:

- IFRS is not just an accounting issue _ it will affect your whole business.

- You will have to book some properties at fair value, not cost.

- Opting to adopt the fair value model can improve but also increase the volatility of earnings.

- IFRS will affect your financial ratios _you will need to reconcile changes transparently and manage expectations.

- IFRS rules on leases can have a major impact on your balance sheet.

- Depreciation rules will require separate calculations.

- Developers are being affected by the revenue recognition requirements.

My experience from the UK is that in the early stages of IFRS adoption, application of the standards can be inconsistent from one company to the next. Also, companies will prepare statements in accordance with IFRS but may choose to highlight adjusted numbers in their presentations to investors, in much the same way as previous years. Therefore, "full and frank" adoption of IFRS is only likely to occur as companies realise the benefits of improved corporate governance, which has a knock-on effect on their ability to raise capital as their market perception improves.

In any case, interpreting the standards can be complicated and should be reviewed on a case-by-case basis, so it is important to seek expert advice.


Nicholas Brown is a member of the Royal Institution of Chartered Surveyors and head of valuation at Colliers International Thailand. Before moving to Thailand, he was based in London and provided advice on valuation and management of corporate properties.
http://www.bangkokpost.com/news/investigation/231258/a-new-era-of-accountability