The construction of high rise office and residential condominium buildings has picked up over the last few years, spurred by the growth of business process outsourcing companies locating in the Philippines and OFWs investing in real estate in the country. In the financial statements, this shows up as higher revenues for real estate companies.

Presently, most companies recognize revenues from real estate development projects where sales are made prior to the completion of the project using the percentage of completion method. For instance, it is common to see units being sold before and during the construction of a residential condominium project (pre-completion sales). Typically, the buyer pays a deposit upon signing of the contract to sell and makes progress payments until the unit is completed and turned-over to the buyer. Under the percentage of completion method, revenue from pre-completion sales is recognized on basis of the completion of the physical proportion of the construction project. This means part of the revenue and the corresponding cost are being recognized in the profit and loss statement during the construction period, before the completion and turn-over of the units.

Under the new accounting interpretation, revenue from pre-completion sales will be recognized only when the unit is completed and delivered to the buyer.  This is a significant change from present the practice which could have a major impact on the financial statements of companies in the real estate industry.

The new accounting interpretation is called IFRIC Interpretation 15, Agreements for the Construction of Real Estate. IFRIC 15 has not yet been formally adopted by the Philippine standard setting body; however, the new standard will become part of Philippine Financial Reporting Standards before the end of the year.

As the name suggests, IFRIC 15 applies to agreements for the construction of real estate and not to all types of real estate sales. IFRIC 15 addresses the timing of recognition of revenue from the construction of real estate and provides guidance on when the percentage of completion method may be applied and when the general rule on revenue recognition as provided in Philippine Accounting Standard 18, Revenue, should be followed.

Under IFRIC 15, the percentage of completion method may be applied when the contract meets the definition of a construction contract in that the buyer is able to specify major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress. The percentage of completion is also applied for agreements in which the company transfers to the buyer control and significant risks and rewards of ownership of the work in progress in its current state as construction progresses (‘continuous transfer’).

The foregoing scenarios, in which the use of the percentage of completion method for recognizing revenue is allowed, may not be present in a typical residential condominium project. Generally, the buyer is in no position to specify major structural changes and the transfer of control and significant risks and rewards of ownership occurs upon the turn-over of the unit to the buyer. Accordingly, for a typical residential condominium project, revenues from sale of units can only be recognized when the project is completed.

IFRIC 15 is effective for annual periods beginning on or after January 1, 2009. Earlier application is permitted and the change in accounting policy shall be applied retrospectively.  For companies with interim reporting, the change in accounting policy will have to be applied to interim periods in 2009. For listed companies, this change in accounting policy will also require the restatement of December 31, 2006 balance sheet, the 2007 income statement and cash flow statement, and the 2008 financial statements.

IFRIC 15 changes the timing of revenue recognition only for financial reporting purposes. As such, there should be no change in the cash flows of a real estate company as a result of the change in accounting policy or in the tax reporting practices. Accordingly, from a shareholder value point of view, the change in accounting policy theoretically should have no impact on the value of a company.

IFRIC 15 however may have an effect on the ability of a company to maintain its dividend policy. The change in policy will likely result in a reduction in retained earnings and reduced retained earnings may result in reduced dividends.  It is also possible that the adjustment in retained earnings (as a result of the retrospective application of the change in accounting policy) could wipe out the company’s retained earnings or even result in a negative retained earnings or a deficit. 

In view of the possible adverse and significant effects of IFRIC 15 on the financial statements of real estate companies, on their revenues, their net income and their dividend policies, it would be prudent for the management of these companies to undertake a study as soon as possible to determine precisely the effects of the new policy on current and prior year financial statements. If business plans have already been prepared for 2009, the projected financial statements may have to be revised. Changes in monthly or quarterly management reporting may be also necessary. In addition, management incentive plans may also have to be revisited.


Published in the Philippine Star, July 22, 2008









(Jose T. Valencia is a Partner for Audit  Services of  Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or jvalencia@kpmg.com.)