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How is the Progress on IFRS Convergence in Malaysia now?

July E-Newsletter | 31 May 2012 Malaysian accounting standards have gone through a
good amount of refreshing in recent years. Previously, Malaysia had adopted the Financial Reporting Standards (FRS) which was largely based on the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). From 1 January 2012, Malaysia undertook a full convergence of Malaysian accounting standards to IFRS. However, the adoption of two new accounting standards was deferred until a later date. These were MFRS 141 Agriculture (IAS 41) and IC Interpretation 15 Agreements for the Construction of Real Estate (IFRIC 15). The convergence with IFRS takes the form of the Malaysian Financial Reporting Standards (MFRS), which is the name of the accounting standards in Malaysia. This new accounting framework applies to all entities other than the following:1. private entities; and 2. those engaged in the agriculture and real estate industries, including their parents, significant investors and venturers (Transitioning Entities).These entities can defer the adoption of MFRS for one year, i.e. adoption for annual periods beginning on or after 1 January 2013. Most of the public listed companies had published their first set of MFRS-based quarterly reports by end of May 2012. Interestingly, not much financial impact was observed upon the transitioning to MFRS because our FRS is identical to IFRS in all major aspects. This article discusses the development of IAS 41 and IFRIC 15 and their potential implications to companies in the agriculture and property development industries.

IAS 41
Impact on financial statements and their users
IAS 41 sets out the accounting principles relating to agricultural activities such as the measurement of biological assets, which are assets that are used to produce the agricultural products. An example of a biological asset is oil palm trees. This standard introduces the fair value concept which replaces the historical cost convention. The fair value concept requires the biological assets to be marked to their fair value at each reporting date. The changes in fair value are taken to the income statement. In Malaysia, IAS 41 will affect mainly plantation companies. Presently most plantation companies record their biological assets at historical costs. Maintenance costs of the plantations are charged to the income statement. As an example, an oil palm plantation company would capitalize costs incurred in planting its oil palm trees up to maturity. Subsequent costs are charged to income statement. Revenue from sale of fresh fruit bunches less cost incurred to run the plantation represents the plantation companys net profit. Under IAS 41, the income producing assets of a plantation company is defined as biological assets. In the same example above, the palm trees are considered biological assets. IAS 41 requires that biological assets be carried in the financial statements at their fair values.

From 1 January 2012, Malaysia undertook a full convergence of Malaysian accounting standards to IFRS.
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As a result, there would be two factors affecting the results of a plantation company. Firstly, the

The Real Estate Industry

Impact on the financial statements and their users
In the past, property developers recognized profits progressively. This has been accepted as reflective of the progress of work that is being carried out. IFRIC 15 requires property developers to account for profits only when a project is completed, if the properties are homogeneous. Exception allowed by IFRIC 15 applies only when the properties are customized, for example, properties which the buyers dictate the design and materials to be used. As most properties developed in Malaysia are homogeneous, IFRIC 15 will affect most if not all developers. The thinking behind IFRIC 15 is that in the case of homogeneous properties, the developer is selling a product as opposed to providing a service. Hence, profit can only be recognized upon the transfer of risks and rewards to the customers i.e. upon completion and handover of the properties. This is a departure from our present practice of recognizing profit as construction progresses.

operational results from the running of the plantation. Secondly, the fair value changes of the biological assets.

The issues which we foresee from the implementation of IAS 41 are as follows:1. The fair value changes in the biological assets do not have any cash flow impact as it is merely an accounting adjustment to report the biological assets at their fair values. As a result, it remains to be seen whether financial statements users, such as analysts, will take the fair value changes in assessing the value of plantation companies; 2. The results may not reflect the profitability of the plantation companies operations. In extreme cases, where prices of commodities are volatile, such accounting treatment may mask an unprofitable operation; and 3. The costs of valuation.

Status of implementation
The Malaysian Accounting Standards Board (MASB), the accounting standards setting body in Malaysia, believes the existing IAS 41 is outdated. It is not surprising as since 2008, MASB together with several other standard setters have been in discussion with the IASB to revise IAS 41. This proposal had been added to the 2011 IASB project agenda. It is because of this that MASB has provided the one year transition period to implement IAS 41. However, it is still uncertain whether all the proposals in the 2011 IASB project agenda will be accepted. Obviously, this uncertainty is not ideal for the agricultural industry players. In our view, this change in the fundamental accounting concept may not be completed by end 2012. It may take a longer time for IASB to re-visit IAS 41. In the meantime, the jury is still out there as to whether MASB will defer the adoption of IAS 41 for another year.

IFRIC 15 requires property developers to account for profits only when a project is completed, if the properties are homogeneous.
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Audit | Tax | Advisory

2012 Crowe Horwath AF1018

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Member Crowe Horwath International

The implications of IFRIC 15 are significant to the property industry and can be summarized as follows:1. Volatility in earnings as profit is recognized only upon completion of projects which can span 3 years, there will be reporting periods when a property developer does not report any profit. On the other hand, it will report bumper profit in the year the project is completed; 2. Valuation of property counter this will be made more difficult and subjective, as results cannot be used as a basis to value property companies. Adjustments may need to be made to financial numbers and questions will be raised as to the reliability of such adjustments; and 3. Tax treatment we understand that the tax authorities will continue to compute tax using the previous accounting treatment where profit is recognized progressively. This will give rise to a property developer preparing a second set of accounts to compute tax, thereby incurring additional costs.

the IFRIC Committee felt that the property developers in Malaysia have continuously transferred the risks and rewards of the

Status of implementation
Given the significant impact to the property industry, MASB has approached the International Financial Reporting Interpretations Committee (IFRIC Committee) to discuss this IFRIC. In November 2011, the IFRIC Committee reviewed the implications of IFRIC 15 in Malaysia. The silver lining from this review is that our property developers may be able to recognise profit on a progressive basis. This is because the IFRIC Committee felt that the property developers in Malaysia have continuously transferred the risks and rewards of the properties ownership to their customers while the developments are in progress.

properties ownership to their customers while the developments are in progress.

In the same month, IASB issued exposure draft for IAS 18 Revenue for public comment which brings in a new recognition concept on revenue that may replace IFRIC 15. IASB planned to finalise this new IAS 18 by the second half of 2012. In view of the these proposed changes to IAS 18 and IFRIC 15 and the significant implications to the property industry, it is not surprising that MASB had decided on a one year transition period to implement IFRIC 15.

This article is written by James Chan Audit Partner

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